No. 125 Brgy.

San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

MS06-02: COST CONCEPTS AND CLASSIFICATION

DEFINITION OF COST, COST DRIVER, COST POOL, AND COST OBJECT

Cost pertains to a resource “given up” or “to be given up” to attain a specific objective. Usually, costs are
driven by various activities within an organization (cost driver).
Cost Driver pertains to an activity measure that directly has a cause and effect relationship with a certain
cost. (e.g. direct labor hours for the manufacturing overhead of a labor- intensive organization). Cost pool
pertains to a collection of costs (e.g. direct material cost pool). Cost object pertains to anything that
accumulates cost or the final recipient of costs (e.g. various departments and/or products).

CLASSIFICATION OF COSTS

1. As to nature of cost/expense
a. Manufacturing cost
b. Commercial expenses

2. As to financial statement presentation

a. Inventoriable cost
b. Period costs

3. As to controllability
a. Controllable cost
b. Non-controllable cost

4. As to behavior (general classification)

a. Variable cost
b. Fixed cost
c. Mixed cost

5. As to association with responsibility centers/cost objects

a. Direct cost
b. Indirect cost
c. Common cost
d. Joint cost

6. As to management discretion
a. Committed cost
b. Discretionary cost

7. As to importance in decision making process

a. Relevant cost
b. Irrelevant cost
c. Differential cost
d. Sunk cost
e. Avoidable cost
f. Unavoidable cost
g. Marginal cost
h. Out-of-pocket cost
i. Opportunity cost

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 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

DEFINITION OF COST BEHAVIOR AND ITS RELATED ASSUMPTIONS

Cost behavior pertains to the association between cost and its related driver (activity).
It pertains to how cost is expected to change as its related cost driver changes. However, it must be noted
that cost behavior works on the following assumptions:

a. Relevant range assumption – relevant range is the level of activity where cost relationships are
considered valid. It is also the level of activity where cost relationships exhibit linear relationship.
b. Time period assumption- cost behavior is only considered valid for a certain period of time. It
must be noted that over the long run, behavior of certain costs might change.

CLASSIFICATION OF COSTS AS TO BEHAVIOR

In management accounting, the following cost classifications as to behavior are being used:
a. Variable cost – costs that has direct relationship with its cost driver on a per total basis.
b. Fixed Cost – costs that remain constant in total regardless of changes in activity.
c. Step-Variable Cost – costs that are closely classified as variable; characterized by small
increments
d. Step-Fixed Cost – costs that remain constant for a period but is subsequently affected by the
level of activity; characterized by prolonged constant level of cost
e. Semi-variable (mixed) cost – hybrid (i.e. combination of fixed and variable) cost
f. Curvilinear cost – cost depicted by a curved graph (incorporating concepts of marginal cost)

COST ESTIMATION: SEGREGATING MIXED COST

Cost estimation is the process of determining cost behavior. Specifically, it pertains to the process of
separating the fixed and variable component of a mixed cost. In cost estimation, always be guided of the
general cost formula expressed as follows:

𝑌 = 𝑎 + 𝑏𝑥

where:
Y = total cost at the specific level of activity
a = total fixed cost component
b = is the variable cost per cost driver
x = measure of the cost driver

Account Classification Method (Account Analysis) – account classification method/

account analysis pertains to the classification of cost whether it’s fixed, variable, or semi-variable based on
the judgment of the accountant. Note that the judgment is normally based on historical activity, company
policies and etc.

Scatter Graph Method – The scatter graph method involves the use of a visual fit line. It involves estimation
of the fixed and variable cost component by plotting the set of historical cost and activity data in a graph
and visually fitting a line that can denote the cost function for the given set of data. Note that the line should
at least (1) be able to cut the graph where points above and below the line are not significantly different,
and (2) be close/near to most of the points plotted in the graph.

High – Low Method – the high-low method of segregating mixed cost makes use of two points within a
data set to determine the fixed and variable component of the mixed cost. Variable cost per unit (b) is
computed by using the highest and lowest point (based on activity level) in the given set of data. The
formula is expressed as follows:

𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡 (𝐻𝑖𝑔ℎ𝑒𝑠𝑡) − 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡 (𝐿𝑜𝑤𝑒𝑠𝑡)

𝑏=
𝑇𝑜𝑡𝑎𝑙 𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦 (𝐻𝑖𝑔ℎ𝑒𝑠𝑡) − 𝑇𝑜𝑡𝑎𝑙 𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦 (𝐿𝑜𝑤𝑒𝑠𝑡)

While total fixed cost component can be solved algebraically using either the highest or lowest point.

Engineering Method – This method of cost estimation utilizes time and motion studies to determine the
fixed and variable component of costs.

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 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

Least Squares Regression Method – This method of cost estimation takes into consideration all the points
in a given data set. Note that the objective of the method is to minimize the sum of the squared deviations
in order to arrive at a cost function that represents the data set. Note that the line representing the cost
function generated through this method is called the least-squares regression line. In computing for the
least square regression, the two formulas must be utilized:

∑ 𝑌 = 𝑁𝑎 + 𝑏 ∑ 𝑋

∑ 𝑋𝑌 = 𝑎 ∑ 𝑋 + 𝑏 ∑ 𝑋 2

where N is the number of observations

IMPORTANCE OF COST BEHAVIOR

Cost behavior helps management in planning as they can be able to make more realistic budgets (i.e. in
relation to its association with a specific activity. Cost behavior also helps in control through the help of
variance analysis (that is comparison of actual cost vs. budgeted cost). In using cost behavior in planning
and control, management should consider the concept of relevant range. Relevant Range is the level of
activity the entity is expected to operate. Relevant range also pertains to the level of activity where cost
behavior is considered valid.

COMMON PITFALLS IN COST ESTIMATION

 Use of incomplete and inaccurate information
 Failure to isolate outliers in the analysis
 Lack of consideration in qualitative considerations

EXERCISE NO. 1: GRAPHING COST BEHAVIOR

Identify the cost behavior(s) depicted by the graphs below:

EXERCISE NO.2: COST CLASSIFICATION AS TO BEHAVIOR

The management of Dawn Winery has gathered the following information for the past four months of its
operations.

Units 100 120 140 160

Cost A P40,000 P48,000 P56,000 P64,000

Cost B 80,000 80,000 80,000 80,000
Cost C 10,000 10,400 10,800 11,200

Cost D 10,000 12,000 14,000 16,000

Required: Determine the cost behavior of these costs.

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 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

EXERCISE NO. 3: HIGH LOW METHOD OF COST ESTIMATION

Wagner Smithy gathered the following information on maintenance cost and the respective work orders for
the year 2020:

Month Maintenance Costs Work Orders

January 12,000 7
February 10,500 6
March 3,500 1
April 2,000 1
May 8,100 5
June 8,400 7
July 8,900 8
August 10,000 9
September 10,700 10
October 13,500 10
November 12,300 12
December 11,250 11

Relevant events during 2020 follows:

 Due to the outbreak of COVID19, the Philippine Government had implemented the Enhanced
Community Quarantine starting on March 2020 and ceased at the start of May 2020. Business
operations during this period were prohibited.

 Maintenance conducted during the quarantine period were only made to the housing units used by the
company staff.

 Due to labor considerations, work orders are limited up to 4 times on a regular work week.

REQUIRED: Determine the following requirements:

1. What are the highest point and the lowest points?
2. How much is the estimated variable costs per work order?
3. How much is the estimated fixed maintenance cost each month?
4. What is the annual maintenance cost formula that Wagner may use in its projections?
5. If it is estimated that 15 work orders will be will be received in January 2021, what is the expected total
maintenance costs?
6. If it is estimated that 20 work orders will be will be received in February 2021, what is the expected total
maintenance costs?

EXERCISE NO. 4: LEAST-SQUARE METHOD OF COST ESTIMATION

REQUIRED: Using the same information in Exercise 3, determine the following using least-square
method:
1. How much is the estimated variable costs per work order?
2. How much is the estimated fixed maintenance cost each month?
3. What is the annual maintenance cost formula that Wagner may use in its projections?
4. If it is estimated that 14 work orders will be will be received in January 2021, what is the expected total
maintenance costs?
5. If it is estimated that 18 work orders will be will be received in February 2021, what is the expected total
maintenance costs

4|P a g e JBUGATAN/JSARIPADA
 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

MULTIPLE CHOICE: Select the best answer from the choices provided. Source: AICPA/RPCPA/Various
test banks.

1. In the cost analysis using the slope-intercept form of linear equation Y = a + bX, the variable cost per
cost driver (b) is regarded as the
a. Slope
b. Coefficient of independent variable
c. Independent variable
d. Both A and B

2. It is an observation that lies an abnormal distance from other values in a random sample from a
population depicted in a scatter diagram.
a. Standard deviation
b. Regression coefficient
c. Outlier
d. Margin of error

3. Which cost segregation approach provides the most mathematically accurate cost estimate?
a. Scatter diagram
b. High-low method
c. Arithmetic smoothing approach
d. Least-squares method

4. Which of the following represents an advantage of scatter diagram in cost segregation?

a. Includes variables outside the relevant range
b. Determining the highest and lowest points in the cost data
c. Considers more than two points
d. Provides a precise picture of the “goodness of fit” of the points in the line

5. Which of the following statements is most likely correct?

a. The higher level of activity within the relevant range, the higher variable cost per unit
b. The lower level of activity outside the relevant range, variable cost per unit remains constant
c. The lower level of production within the relevant range, the lower is the total fixed cost
d. The higher level of production outside the relevant range, the greater the total variable costs

6. Wangshu Inn is contemplating to analyze how its revenue coming from tourist visits is being affected by
the thunderstorm occurrences. With the help of Albedo, a genius mathematician, a coefficient of
correlation (r) is computed as - 0.92. What is the best explanation of this figure?
a. An increase in revenue from tourist visits causes an increase in thunderstorm occurrence
b. An decrease in revenue from tourist visits causes an increase in thunderstorm occurrence
c. An increase in thunderstorm occurrences causes an increase in revenue from tourist visits
d. An increase in thunderstorm occurrences causes an decrease in revenue from tourist visits

7. Wangsheng Funeral Parlor is contemplating to analyze how its revenue is being affected by the number
of festivals in Liyue. With the help of Zhongli, the experienced consultant, a coefficient of correlation (r)
is computed as - 0.43. What is the best explanation of this figure?
a. An increase in revenue of the funeral parlor causes an increase in festivals in Liyue
b. An decrease in revenue of the funeral parlor causes an increase in festivals in Liyue
c. An increase in festivals in Liyue causes an decrease in revenue of the funeral parlor
d. The number of festivals in Liyue may not have a significant relationship with how the revenue of the
funeral parlor behaves

8. In regression analysis, which of the following coefficient of correlation (r) represents the strongest
inverse relationship between variables?
a. 0.99
b. 0.25
c. - 1.02
d. - 0.85

9. How might a scatter diagram look like if the correlation coefficient (r) of the dependent and independent
variables is zero?
a. A regression line that slopes up to the right
b. A regression line that slopes down to the right
c. Sets of values will be plotted at random points
d. Scatter diagram is not possible under the circumstances

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 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

10. “Goodness of fit” in a regression analysis is described by

a. Coefficient of correlation
b. Significance function
c. Coefficient of determination
d. P - value

11. Liyue Pavilion is relocating its facilities. The company estimates that it will take four container vans to
move office contents. If the rental charge per van is P10,000 plus P25 per km, what is the expected
cost to move 500 km?
a. P22,500
b. P50,000
c. P90,000
d. P40,000

12. Wanmin Restaurant provides you with the following flexible overhead budget at three different capacity
levels:

Capacity Overhead
60% 49,000
70% 53,000
85% 59,000

What will be the estimated flexible overhead at 92% capacity?

a. P61,800
b. P67,000
c. P68,893
d. P63,859

13. At maximum capacity of 50,000 units, the total unit cost of a certain product amounted to P160. Details
are as follows:

Variable costs P100

Fixed costs 60
Unit costs P160

What is the total unit costs at 40,000 units?

a. 185
b. 200
c. 175
d. 140

14. The following are the condensed income statement of Mondstadt Corporation for the months of August
and September 2020:

August September
Sales P450,000 P600,000
Cost of Sales 180,000 225,000
Gross Margin 270,000 375,000
Selling and Administrative 120,000 150,000
Profit P150,000 P225,000

Mondstadt is planning to use the actual results sustained from the operation during the two-month period
for the planning of the succeeding months.

What is cost formula that Mondstadt may use in its profit planning?
a. Y – 75,000X = 0.50
b. Y = 0.50X – 75,000
c. Y = 75,000 + 0.50X
d. Cannot be determined

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 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

15. The statistician of Adeptus, Inc. performed a regression analysis using the observations from 2,400 to
6,000 labor hours in an attempt to create a labor cost formula for the Company. The result of the
analysis shows the following:
 Intercept = 32,312
 Slope = 117
 R-squared = 0.9203456
 Significance F = 0.0796544
 P-value = 0.04342214
 T-stat = 2.307991
 Standard error = 12,353
 Y = total labor costs

Compute for the estimated labor cost at 3,000 labor hours

a. P395,665
b. P383,312
c. P352,780
d. P365,133

16. Albeidou Bath Soap, budgets its total production costs at P110,000 for 150,000 units of output and
P137,500 for 200,000 units of output. Since additional facilities are needed to produce 200,000 units,
fixed costs are budgeted at 20% more than for 150,000 units. What is Albeidou's budgeted fixed cost
at 200,000 units?
a. P82,500
b. P49,500
c. P68,750
d. P59,400

(For numbers 17 – 20)

Xiao ling Restaurant has three costs: A, which is variable; B, which is fixed; and C, which is mixed. The
company, which uses the high-low method, extracted the following data from its accounting records:
 At 180,000 hours of activity, Cost A totaled P2,610,000.
 At 140,000 hours, the low point during the period, Cost C totaled P1,498,000; starting at 200,000
hours, the Cost C’s fixed portion is 2.10 per unit, which is budgeted at 20% more than for 140,000
hours.
 At 160,000 hours of activity, the sum of Costs A, B, and C amounted to P8,162,000.

17. What is the budgeted fixed costs for Cost C at 140,000 hours?
a. P4,132,000
b. P420,000
c. P350,000
d. Cannot be determined

18. What is Cost C’s total cost at 160,000 hours of activity?

a. P1,662,000
b. P1,712,000
c. P1,732,000
d. Cannot be determined

19. What is Cost C’s total cost at 200,000 hours of activity?

a. P2,060,000
b. P2,140,000
c. P2,410,000
d. Cannot be determined

20. What is Cost B’s total cost at 160,000 hours of activity?

a. P4,810,000
b. P4,180,000
c. P2,320,000
d. Cannot be determined

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 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

21. In describing the linear cost formula Y = a + bX, which of the following statements is correct?
a. “a” and “b” are valid for all levels of activity
b. “Y” is the independent variable
c. “a” is the variable rate
d. In the high-low method, “b” equals the change in cost (Y) divided by the change in activity (X)

22. Which of the following is NOT a method of splitting a semi-variable cost?

a. High and low point c. Scatter diagram
b. Least squares method d. Linear programming

23. Cheese Cake Company applies the high-low method of cost estimation to customer service data for
the last 4 months of 2021:

Month No. of Cost ( P )

Customer
September 1, 200 3, 120
October 1, 300 3, 185
November 1, 800 4, 320
December 1, 700 3, 895

What is the estimated variable cost component per order?

a. P2.00 c. P2.48
b. P2.42 d. P2.50

24. Macchiato, Inc. provides you with the following flexible budget of factory overhead at three different
capacity levels:

Capacity Factory Overhead

65% P100,000
70% 106,000
90% 120,000

What will be the flexible budget of factory overhead at 85% capacity?

a. P116,000 c. P130,769
b. P118,450 d. P120,645

25. Multiple regression analysis involves

a. One dependent variable and one independent variable
b. One dependent variable and many independent variables
c. Many dependent variables and one independent variable
d. Many dependent variables and many independent variables

26. Cost behavior analysis is a study of how a firm's costs

a. relate to competitors' costs.
b. relate to general price level changes.
c. respond to changes in activity levels within the company.
d. respond to changes in the gross national product.

27. Which of the following is (are) true statement(s) about cost behavior in incremental analysis?

Statement I: Fixed costs will not change between alternatives

Statement II: Fixed costs may change between alternatives
Statement III: Variable costs will always change between alternatives

a. Statement I
b. Statement III
c. Statement II
d. Statement II and III

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 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

28. Which of the following statements related to assumptions about estimating linear cost functions is
FALSE?
a. Variations in a single cost driver explain variations in total costs.
b. A cost object is anything for which a separate measurement of costs is desired.
c. A linear function approximates cost behavior within the relevant range of the cost driver.
d. A high correlation between two variables ensures that a cause-and-effect relationship exists.

29. The total production cost for 20,000 units was P21,000 and the total production cost for making
50,000 units was P34,000. Once production exceeds 25,000 units, additional fixed costs of P4,000
were incurred. The total production cost for making 30,000 units is:
a. P9,000
b. P28,000
c. P24,000
d. P31,900

30. Whenever a cost cannot be linked to the product directly, the criteria to be selected in identifying the
cost driver is
a. Benefits received
b. Causal relation
c. Cause and effect
d. Reasonableness

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