MAS-01 Cost Behavior Analysis

MAS-01: COST BEHAVIOR ANALYSIS
Cost – the monetary amount of the resources given up or sacrificed to attain some objective such as
acquiring goods and services. When notified by a term that defines the purpose, cost becomes
operational (e.g. acquisition cost; production cost; cost of goods sold).
COST BEHAVIOR
Cost behavior is the relationship between cost and activity – as to how costs react to changes in an
activity like production. As production increases, some costs remain the same (i.e., fixed) while some
costs increase or decrease (i.e., variable). Consider the following (assuming activity is based on
production):
COSTS TOTAL AMOUNT PER UNIT AMOUNT
1. Fixed Constant Decreases as production increases (i.e.,

inverse relationship)
2. Variable Increases as production increases (i.e., Constant

direct relationship)
3. Mixed Increases less proportionately (vs. total Decreases less proportionately (vs. unit
variable cost) as production increases fixed costs) as production increases
Y = a + Bx
Where:
Y – the total costs (dependent variable)
a – the total fixed costs (vertical/y-axis intercept)
b – the variable cost per unit (slope of the line)
X – the activity or cost driver (independent variable)
bX – the total variable costs
COST BEHAVIOR ASSUMPTIONS AND LIMITATIONS

Relevant Range Assumption
Relevant range refers to the range of activity within which the cost behavior patterns are valid. Any level
of activity outside this range may show a different cost behavior pattern.
Time Assumption
The cost behavior patterns identified are true only over a specified period of time. Beyond this, the cost
may show a different cost behavior pattern.
Linearity Assumption
The cost is assumed to manifest a linear relationship over a relevant range despite its tendency to show
otherwise over the long run.
COST ESTIMATION: SEGREGATING VARIABLE AND FIXED COSTS

1. High-Low Points Method
The fixed and variable portions of the mixed costs are computed from two sampled data points – the
highest and lowest points based on activity or cost driver.
Variable cost per unit (b) = Change in Costs (YH – TL)

Change in Activity (XH – XL)
2. Scattergraph (Scatter Diagram) Method

All observed costs at different activity levels are plotted on a graph. Based on sound judgment, a
regression line is then fitted to the plotted points to represent the line function.
3. Least – Squares Regression Method

Least-squares method is a statistical technique that investigates the association between dependent and
independent variables. This method determines the line of best fit for a set of observations by minimizing
the sum of the squared deviations between cost line and the data points.
● If there is only one dependent variable, the analysis is known as SIMPLE REGRESSION.
● If the analysis involves multiple independent variables, it is known as MULTIPLE REGRESSION.
4. Other Cost Estimation Methods

● Industrial Engineering Method – based on the relationship between inputs and outputs in physical
forms; engineering estimates indicate what and how much costs should be.
● Account Analysis Method – each account is classified as either fixed or variable based on
experience and judgment of accounting and other qualified personnel in the organization.
● Conference Method – costs are classified based on opinions from various company departments
such as purchasing, process engineering, manufacturing, employee relations and so on.
CORRELATION ANALYSIS
Correlation Analysis is used to measure the strength of linear relationship between two or more variables.
The correlation between two variables can be seen by drawing a scatter diagram:
● If the points seem to form a straight line, there is a high relation.
● If the points form a random pattern, there is a low correlation or no correlation at all.
Coefficient of Correlation (r) measures the relative strength of linear relationship between two (2)
variables. Its value ranges from -1.0 +1.0:
“r” Linear Relationship Scatter Diagram
-1.0 Inverse Downward Sloping Line
0 None No Apparent Pattern (Random Points)
+1.0 Direct Upward Sloping Line
Coefficient of Determination (r2) is the proportion of the total variation in Y that is accounted for by the
regression equation regardless of whether the relationship between X and Y is direct or inverse. It is a
measure of the “goodness of fit” in the regression. The higher the r 2, the more confidence one can have in
the estimated cost formula.
EXERCISES: COST BEHAVIOR ANALYSIS
1. Variable Costs vs. Fixed Costs

Adriel Company manufactures and sells a single product. A partially completed schedule of the
company’s total and per unit costs over a relevant range of 600 to 100 units produced each year is given
below:
Units Produced
(I) 60 (II) 80 (III) 100
TOTAL COSTS:
(A) Variable Costs 120 160 200
(B) Fixed Costs 600 600 600
(C) Total Costs 720 760 800

PER UNIT COSTS:
(D) Variable Costs 2 2 2
(E) Fixed Costs 10 7.5 6
Required:
1. Determine the correct amounts of those with (?) mark?
2. Which two (2) specific costs remain relevant over the relevant range? Total Fixed Cost & Variable
Cost per Unit
3. Which two (2) specific costs are directly related with production? Total Variable Cost & Fixed Cost
per Unit
4. Which specific costs are inversely related to production? Fixed Cost per Unit
5. Express the cost formula based on the line equation form Y=a+Bx y=600+2x
6. If the company produces 90 units, then how much is the expected total costs?
2. High-Low Method
The controller of Suredead Hospital would like to come up with a cost formula that links Admitting
Department cost to the number of patients admitted during a month. The Admitting Department’s costs
and the number of patients admitted during the past nine months follow:
Month Number of Patients Admitting Department’s Cost
April 18 P15,600
May 19 P15,200
June 17 P13,700
July 15 P14,600
August 15 P14,300
September 11 P13,200
October 11 P12,800
November* 48 P72,500 (OUTLIER)
December 16 P14,000
Required: Using the high-low method, determine:

1. Variable cost per unit = P300
2. Annual fixed costs = 15,200-19(300) =9,500*12=114,000
3. Monthly cost function = y=9,500+300x
4. Department’s estimated cost assuming 14 patients will be admitted next month
= 13,700
3. Least-Squares Regression Method

Sydney Company’s total overhead costs at various levels of activity are presented below:
Month Machine Hours Total Overhead Costs
March 500 P970
April 400 P851
May 600 P1,089

June 700 P1,208
The breakdown of the overhead costs in April at 400 machine-hour level activity is as follows:
Supplies (Variable) P260
Salaries (Fixed) 300
Utilities (Mixed) 291
Total 851
Variable cost per unit = 260/400=0.65
Required:
1. How much of June’s overhead cost of P1,208 consisted of utilities cost?
1,208-300-0.65(700)=453
2. Using a high-low method, determine the cost function for utilities cost.
453-291
700-400
Variable cost per unit = 0.54
Total Fixed Cost = 453-.54(700) = 75
y=75+.54x
3. Using a high-low method, determine the cost function for total overhead cost.
1,208-851
700-400
Variable cost per unit = 1.19
Total Fixed Cost = 1,208-1.19(700) = 375
y=375+1.19x
4. Using least-squares method, determine the cost function for total overhead costs.
y=a+bx
Σy = na + Σxb
Σxy = Σxa + Σx2b
(4,118 = 4a + 2,200b)*550
2,324,400 = 2,200a + 1,260,000b
2,264,900 = 2,200a + 1,210,000b
59,500 = 50,000b
b = 1.19
4,118 = 4a + 2,200b
4,118 = 4a + 2,200(1.19)
4a = 4,118 - 2,618
a = 375
y=375+1.19x
5. What would be the total overhead costs if operating level is at 200 machine hours?
y=375+1.19(200)
y=613
Solution Guide (requirement 1)

April (400 hrs) June (700 hrs)
Supplies (Variable) P260 ?
Salaries (Fixed) 300 ?
Utilities (Mixed) 291 ?
Total Overhead Costs P851 P1,208
Solution Guide (requirement 4 – Least Squares Method)

Month Hours (X) Total Costs (Y) X*Y X2
Mar 500 970 485,000 250,000
Apr 400 851 340,400 160,000
May 600 1,089 653,400 360,000
Jun 700 1,208 845,600 490,000
SUM 2,200 4,118 2,324,400 1,260,000

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MAS-01: COST BEHAVIOR ANALYSIS

1. Fixed Constant Decreases as production increases (i.e.,

2. Variable Increases as production increases (i.e., Constant

COST BEHAVIOR ASSUMPTIONS AND LIMITATIONS

COST ESTIMATION: SEGREGATING VARIABLE AND FIXED COSTS

Variable cost per unit (b) = Change in Costs (YH – TL)

2. Scattergraph (Scatter Diagram) Method

3. Least – Squares Regression Method

4. Other Cost Estimation Methods

-1.0 Inverse Downward Sloping Line

0 None No Apparent Pattern (Random Points)

+1.0 Direct Upward Sloping Line

EXERCISES: COST BEHAVIOR ANALYSIS

1. Variable Costs vs. Fixed Costs

(I) 60 (II) 80 (III) 100

(A) Variable Costs 120 160 200

(B) Fixed Costs 600 600 600

(C) Total Costs 720 760 800

(D) Variable Costs 2 2 2

(E) Fixed Costs 10 7.5 6

November* 48 P72,500 (OUTLIER)

Required: Using the high-low method, determine:

3. Least-Squares Regression Method

Month Machine Hours Total Overhead Costs

March 500 P970

April 400 P851

May 600 P1,089

Variable cost per unit = 260/400=0.65

Solution Guide (requirement 1)

Supplies (Variable) P260 ?

Salaries (Fixed) 300 ?

Utilities (Mixed) 291 ?

Total Overhead Costs P851 P1,208

Solution Guide (requirement 4 – Least Squares Method)

Mar 500 970 485,000 250,000

Apr 400 851 340,400 160,000

May 600 1,089 653,400 360,000

Jun 700 1,208 845,600 490,000

SUM 2,200 4,118 2,324,400 1,260,000

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