Accounting for Managers

Module 6: Cost Behavior Patterns

Costs
Product vs. Period Costs

Product Costs: any cost of acquiring or producing a product

Ex/: Direct materials, labor, overhead

Period Costs: Any costs not related to the manufacture or acquisition of the product.
Ex/: Sales commissions, administrative costs, advertising, rent of office space.
Manufacturing Costs

Manufacturing overhead: This is a catch-all category and it includes any costs of manufacturing
other than materials and labor. Incidental materials and labor, maintenance on machinery or
custoridal wages would be included here. Any expense incurred for the manufacture or
acquisition of the product a company makes or sells, that is NOT direct labor or direct
materials, will be put here, and then later allocated.
Fixed vs. Variable Costs

• Committed Fixed Cost vs.

Discretionary Fixed Costs
• Fixed costs happen regardless of the
manufacturing or sales level
• Variable costs will change depending on
how many products you buy or manufacture.
They all depend on how much product is being sold.
Relevant Range

The relevant range is the range of activity where the assumption that cost behavior is a straight
line (linear) is reasonably valid. Managerial accountants like to assume that the relationship
between a cost and an activity run in a straight line.
Mixed Costs Analysis
Mixed Costs

The equation for mixed costs looks like this:

Y= The total mixed costs
a= The total fixed costs
b= The variable cost
per unit of activity
X= The level of activity
The steeper the slope
on the variable line,
the higher the
variable cost per unit.
Independent vs. Dependent Variable

Y= total maintenance cost and will be plotted on the vertical axis of our graph. This cost is the
dependent variable since the amount depends on the activity for the period.
X= the activity or number of dogs groomed. This will be plotted on the horizontal axis and is
the independent variable, because it is the factor that causes the variation in the cost.
High-Low Method

• With this method we first look for the period with the lowest level of activity and the highest
level.

• Variable cost = Cost at the high activity level-cost at the low level of activity, High activity
level − Low activity level, Variable cost = Change in cost
• NOTE*: This method can ONLY be used if there is a linear correlation between the costs
and quantity!
Least Squares Regression Method

This method uses all of the data available to separate the fixed and variable portions of a mixed
cost. A regression line is fitted into the data using the following formula:
Y= a + bX
Y= maintenance costs
X= Number of dogs groomed
a= the total fixed cost
b= the variable cost per unit of activity
Quick Review

• It’s important to understand the differences between the variety of costs you’ll be faced with:
• Product vs. period costs
• Manufacturing costs
• Fixed vs. variable costs
• Mixed costs
• Knowing how to utilize both the high-low method and the least squares regression method
will assist you in accurately determining your costs.