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Chapter 5
Cost Behavior: Analysis and Use
Variable CostsVariable Costs
Total Variable Cost GraphTotal Variable Cost GraphT
otal
Cos
ts
$300,000$250,000$200,000$150,000$100,000 $50,000
10 20 300
Unit Variable Cost GraphUnit Variable Cost Graph
$20$15$10$5
0Cos
t pe
r U
nit
10 20 30
5,000 $ 50,000 $10 10,000 100,000 10 15,000 150,000 10 20,000 200,000 10 25,000 250,000 10 30,000 300,000 10
Units Total CostProduced Cost per Unit
Units Produced (000)
Units Produced (000)
The Activity Base/Cost driver
A measure of what causes the
incurrence of a variable cost
A measure of what causes the
incurrence of a variable cost
UnitsUnitsproducedproduced
UnitsUnitsproducedproduced
Miles driven
Miles driven
Labor hours
Labor hours
Machine hours
Machine hours
True Variable vs. Step Variable
Step Variable Costs - A cost that is obtainable only in chunks – changes abruptly at intervals of activity.
Cos
t
Volume
Cos
t
Volume
True variable cost Step variable cost
Step-Variable Costs
Activity
Cos
t
Total cost remainsconstant within anarrow range of
activity
Total cost increases to a new higher cost for the next
higher range of activity
RelevantRange
A straight line closely
approximates a curvilinear
variable cost line within the
relevant range.
A straight line closely
approximates a curvilinear
variable cost line within the
relevant range.
Activity
To
tal
Co
st
Economist’sCurvilinear Cost
Function
The Linearity Assumption and the Relevant Range
Accountant’s Straight-Line Approximation (constant
unit variable cost)
Fixed CostsFixed Costs
Total Fixed Cost GraphTotal Fixed Cost GraphT
otal
Cos
ts
0
Unit Fixed Cost GraphUnit Fixed Cost Graph
Cos
t pe
r U
nit
50,000 $75,000 $1.500 100,000 75,000 .750 150,000 75,000 .500 200,000 75,000 .375 250,000 75,000 .300 300,000 75,000 .250
Units Total CostProduced Cost per Unit
$150,000$125,000$100,000$75,000$50,000
$25,000
100 200 300
$1.50$1.25$1.00$.75$.50
$.25
100 200 3000
Units Produced (000) Units Produced (000)
ExamplesAdvertising and Research and Development
ExamplesAdvertising and Research and Development
ExamplesDepreciation on Equipment and
Real Estate Taxes
ExamplesDepreciation on Equipment and
Real Estate Taxes
Types of Fixed Costs
DiscretionaryMay be altered in the short-term by current managerial decisions
DiscretionaryMay be altered in the short-term by current managerial decisions
CommittedLong-term, cannot be significantly reduced
in the short term.
CommittedLong-term, cannot be significantly reduced
in the short term.
Example: Office space is available at a rental rate of
$30,000 per year in increments of 1,000 square
feet. As the business grows more space is
rented, increasing the total cost.
Step-Fixed Costs
Ren
t C
ost
in T
hou
san
ds
of D
olla
rs
0 1,000 2,000 3,000 Rented Area (Square Feet)
0
30
60
Step-Fixed Costs and Relevant Range
90
Relevant
Range
Total cost doesn’t change for a wide
range of activity, and then jumps to a new higher cost for the
next higher range of activity.
Total cost doesn’t change for a wide
range of activity, and then jumps to a new higher cost for the
next higher range of activity.
How does this type of How does this type of fixed cost differ from fixed cost differ from a step-variable cost?a step-variable cost?
Step-variable costs can be adjusted more quickly
and . . .
The width of the activity steps is much wider for
the fixed cost.
Fixed Costs and Relevant Range
Quick Check
Which of the following statements about cost behavior are true?
1. Fixed costs per unit vary with the level of activity.
2. Variable costs per unit are constant within the relevant range.
3. Total fixed costs are constant within the relevant range.
4. Total variable costs are constant within the relevant range.
Which of the following statements about cost behavior are true?
1. Fixed costs per unit vary with the level of activity.
2. Variable costs per unit are constant within the relevant range.
3. Total fixed costs are constant within the relevant range.
4. Total variable costs are constant within the relevant range.
Cost Behavior Patterns Example
Bicycles by the Sea incurs variable costs of $52 for each of its bicycles.
Bicycles by the Sea also incurs $94,500 infixed costs per year
Total Costs and Unit Costs Example
What is the unit cost when Bicycles assembles 1,000 bicycles in a year?
Use Unit Costs Cautiously
Assume that Bicycles management uses aunit cost of $146.50
Management is budgeting costs fordifferent levels of production.
What is their budgeted cost for anestimated production of 600 bicycles?
600 × $146.50 = $87,900?
Use Unit Costs Cautiously
What is their budgeted cost for an estimatedproduction of 3,500 bicycles?
3,500 × $146.50 = $512,750?
Pop Quiz Which of the following costs would be variable with
respect to the number of cones sold at a Baskins & Robbins shop? (There may be more than one correct answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.
Pop Quiz Which of the following costs would be variable with
respect to the number of people who buy a ticket for a show at a movie theater? (There may be more than one correct answer.)
A. The cost of renting the film.
B. Royalties on ticket sales.
C. Wage and salary costs of theater employees.
D. The cost of cleaning up after the show.
Fixed Monthly
Utility Charge
Variable
Cost per KW
Activity (Kilowatt Hours)
Tot
al U
tili
ty C
ost
X
Y
A mixed cost has both fixed and variablecomponents. Consider the example of utility cost.
A mixed cost has both fixed and variablecomponents. Consider the example of utility cost.
Mixed Costs
Total mixed cost
Fixed Monthly
Utility Charge
Variable
Cost per KW
Activity (Kilowatt Hours)
Tot
al U
tili
ty C
ost
X
Y
Mixed Costs
Total mixed cost
Mixed Costs Example
If your fixed monthly utility charge is $40, your variable cost is $0.03 per kilowatt hour, and your monthly activity level is 2,000
kilowatt hours, what is the amount of your utility bill?
If your fixed monthly utility charge is $40, your variable cost is $0.03 per kilowatt hour, and your monthly activity level is 2,000
kilowatt hours, what is the amount of your utility bill?
Y = a + bX
Y = $40 + ($0.03 × 2,000)
Y = $100$100
Practice…Hospital Costs
Variable, step, mixed, discretionary or committed fixed?
• Training costs of an administrative employee
• Straight line depreciation
• Cost of services of L&J Consulting
• Nursing supervisor salaries – supervisor needed for each 45 nursing personnel
Practice…Hospital Costs
Variable, step, mixed, discretionary or committed fixed?
• Operating costs of x-ray equipment ($95,000 per year plus $3 per film)
• Insurance for all full time employees
• Costs incurred by Dr. Rath in cancer research
Account-Classification Method
Engineering Method
Scattergraph Method
High-Low Method
The Analysis of Mixed Costs
Least-Squares Regression Method
Analysis of Mixed Costs
Each account is classified as eithervariable or fixed based on the analyst’s
knowledge of how the account behaves.
Each account is classified as eithervariable or fixed based on the analyst’s
knowledge of how the account behaves.
Cost estimates are based on an evaluation of production methods, and material, labor and
overhead requirements.
Cost estimates are based on an evaluation of production methods, and material, labor and
overhead requirements.
Account Analysis and the Engineering ApproachAccount Analysis and the Engineering Approach
Overhead Costs for 1,000 UnitsTotal Variable Fixed
Account Cost Cost CostIndirect Labor 450$ 450$ Indirect Material 700 700 Depreciation 1,000 1,000 Property Taxes 200 200 Insurance 300 300 Utilities 400 350 50 Maintenance 600 500 100 Totals 3,650$ 2,000$ 1,650$
Account Classification MethodExample
Plot the data points on a graph (total cost vs. activity).
Plot the data points on a graph (total cost vs. activity).
0 1 2 3 4
*
Mai
nten
ance
Cos
t1,
000’
s of
Dol
lars
10
20
0
***
**
**
*
*
Patient-days in 1,000’s
X
Y
The Scattergraph Method
High-Low Method - Cost and Activity DataAssume the following hours of maintenance work and the total maintenance costs for six months.
The Contribution Format
Used primarily forUsed primarily forexternal reporting.external reporting.
Used primarily byUsed primarily bymanagement.management.
Uses of the Contribution Format
The contribution income statement format is used as an internal planning and decision making tool. We will
use this approach for:
1. Cost-volume-profit analysis (Chapter 6).
2. Budgeting (Chapter 9).
3. Segmented reporting of profit data (Chapter 12).
4. Special decisions such as pricing and make-or-buy analysis (Chapter 13).
The contribution income statement format is used as an internal planning and decision making tool. We will
use this approach for:
1. Cost-volume-profit analysis (Chapter 6).
2. Budgeting (Chapter 9).
3. Segmented reporting of profit data (Chapter 12).
4. Special decisions such as pricing and make-or-buy analysis (Chapter 13).
