COST TERMS, CONCEPTS, AND BEHAVIOR

COST – is commonly defined as a measurement, in monetary terms, of the amount of

resources used for some purpose. When notified by a long term that defines the purpose, it
becomes operational, e.g., selling cost, acquisition cost, variable cost, etc.

- A cost is a resource sacrificed or foregone to achieve a specific objective.

COST OBJECT – is often a product or department for which costs are accumulated or
measured. For example, a product is the cost object for direct materials, direct labor, and
manufacturing overhead. The factory maintenance department is a cost object for the cost
of the maintenance employees and the maintenance supplies.

COST POOL – is a grouping of individual costs, typically by department or service center.

Cost allocations are then made from a cost pool. For example, the cost of the maintenance
department is accumulated in a cost pool and then allocated to those departments using its
services.

Cost pools are commonly used for the allocation of production overhead to units of
production, as required by several accounting frameworks. They are also used in activity-
based costing to allocate costs to activities, e.g., overhead account.

COST DRIVER – is the unit of an activity that causes the change in activity's cost. Cost
driver is any factor which causes a change in the cost of an activity.

ACTIVITY – refers to any event, action, transaction or work sequence that incurs costs
when producing a product or providing a service.

CLASSIFICATIONS OF COST
1. Assignment of Cost, to Cost object (Traceability)
Direct Cost- easily and conveniently traced to a cost object
Indirect Cost - cannot be easily and conveniently traced
2. Accounting for costs in manufacturing companies
Manufacturing Costs – Direct Materials, Direct Labor and Manufacturing
Overhead
Non-manufacturing Costs - Selling and Administrative Cost
3. Preparations of Financial Statements
Product Cost (Inventoriable)
Period Cost (Expensed)
4. Predicting of Cost behavior in response to changes in activity
Variable Cost
Fixed Cost
Mixed Cost
In Total Per Unit
Variable Varies Fixed
 Cost
Fixed Cost Fixed Varies
Mixed Cost Mixed Mixed

5. Making Decisions
Differential Cost (Alternatives)
Sunk Cost (should be ignored)
Opportunity Cost (forgone benefit)

COST CONCEPTS AND BEHAVIOR

COST BEHAVIOR CHARACTERISTICS

Compare and contrast the following types of costs: (1) variable and step-variable and (2)
fixed and step-fixed.

(1) A variable cost changes in direct proportion to a change in an activity level or cost
driver, with a typical example being direct material. A step-variable cost is nearly
variable, but it increases in small steps rather than continuously (e.g., additional direct
labor).

(2) A fixed cost remains unchanged as the activity level varies (e.g., rent). In contrast, a
step-fixed cost remains fixed over a sizable range of activity, but jumps to a different
amount for activities outside that range (e.g., the salaries of new employees who are
needed because of volume changes).

THE RELEVANT RANGE

The relevant range is the range of activity within which management expects a company to
operate. This can be based on past experience and/or sales projections.

This concept is important because management need not concern itself with extremely
high or low levels of activity that are unlikely to occur. Also, observed cost relationships
are typically valid within the relevant range and can therefore be used for purposes of
estimation at other levels within that range.

COMMITTED COSTS AND DISCRETIONARY COSTS

A committed cost is a fixed amount that stems from an organization's ownership or use of
facilities, and its basic organizational structure. Property taxes, rent, and salaries of top
management are examples of committed costs.
A discretionary cost, also a fixed amount, occurs as a result of a management decision to
spend a particular amount of money for some purpose. Examples are advertising, training,
promotion, and contributions to charitable organizations.

The distinction between committed and discretionary costs is that committed costs can be
changed only by major decisions with long-term implications. Discretionary costs can be
changed in the short run and, thus, are cost-cutting targets should an organization
encounter financial difficulties.

METHODS OF SPLITTING MIXED COSTS

1. High-Low Points Method – In this method, the fixed and variable elements of the
mixed costs are computed from two data points (periods) – the high and low periods as
to activity level or cost driver.

2. Statistical Scatter-graph Method – Various costs (the dependent variable) are plotted
on a vertical line (y-axis) and measurement figures (cost drivers or activity levels) are
plotted on a horizontal line (x-axis). A straight line is drawn through the points and,
using this line, the rate of variability and the fixed cost are computed.

3. Method of Least Squares (Regression Analysis) – This method mathematically

determines a line of best fit or a linear regression line through a set of plotted points so
that the sum of the squared deviations of each actual plotted point from the point
directly above or below it on the regression line is at minimum.

This method uses the following equations in computing for the values of unit variable
cost and fixed cost: Equation 1: ∑Y=na+b∑x
Equation 2: ∑xy=a∑x+b∑x^2

Deficiencies of the Visual-Fit and High-Low Methods

The visual-fit method suffers from a lack of objectivity. Given that the cost line is created by
visual approximation or "eyeballing," different cost analysts will likely produce different
lines. The high-low method, on the other hand, is objective. However, it uses only two data
points and ignores the rest, thus, generalizing about cost behavior by relying on only a very
small percentage of possible data observations.

Least-Squares Regression and Multiple Regression

In the least-squares regression (LSR) method, the cost line is positioned to minimize the
sum of the squared deviations between the cost line and the data points. The cost line fit to
the data using LSR is called a regression line. The statistical equation for this line is
represented by the formula: Y = a + bX, with X denoting activity level (independent
variable) and Y denoting the total cost (dependent variable).
The multiple-regression line has all the same properties of the simple LSR line, but more
than one independent variable is taken into consideration. The use of more independent
variables can better explain accompanying changes in cost.

Problem Solving

Problem 1. High Low Method (HLM)

The following information is available about factory supplies cost for the first 6 months:

Month Production (Units) (x) Supplies Cost (y)

January 14,000 ₱ 104,430
February 11,400 88,718
March 10,400 81,098
April 8,800 68,906
May 9,400 73,478
June 5,400 41,478

1. What is the variable cost per unit? ___________________

2. Total fixed cost? ___________________
3. Determine total cost if the company produced 6,500 units. ___________________

VC per unit = Highest Cost – Lowest Cost divided by Highest

Activity – Lowest Activity

VC per unit = P104,430-P41,478 / 14,000-5,400

VC per unit = P62,952 / 8,600
VC per unit = P7.32

Total Cost = Fixed Cost + 7.32 (activity)

P104,430 = FC + 7.32(14,000)
P104,430 = FC + P102,480
FC = 104,430-102,480
FC= P1,950

Cost Equation: y = 7.32x + P1,950; where x is the number

of units
Y = 7.32 (6,500) + 1,950
Y = 47,580 + 1,950
Y = P49,530

If relevant range is from 6,000 units to 13,000 units,

4. What is the total fixed cost? ___________________

 5. Determine total cost if the company produced 12,000 ___________________
units.

VC per unit = 19,812/2,600

VC per unit = P7.62

P88,718 = P7.62 (11,400) + FC

P88,718 = P86,868 + FC
FC = P1,850

Cost Equation: y= 7.62x + 1,850; where x is the number of units

Y = 7.62(12,000) + 1,850
Y = 91,440 + 1,850
Y = P93,290

Problem 2. High Low Method (HLM)

An organization has the following total costs at two activity levels

P150,000 @ 20,000 units; P200,000 @ 36,000 units

Variable costs per unit is constant in this range of activity and there is an increase of
P30,000 in the total fixed costs when activity exceeds 30,000 units.

What is the total cost at an activity level of 25,000 units? ___________________

What is the total cost at an activity level of 34,000 units? ___________________

Problem 3. High Low Method (HLM)

Prado Company has been reviewing its total cost over the last few weeks and has
established the following:

Week Units Cos

produced t
1 220 ₱ 3,4
50
2 120 2,1
60
 3 350 4,4
25
4 400 4,8
00
5 480 5,4
00
6 380 5,7
00

Given the details above, assume now that the company is aware that fixed costs increase by
₱600 when production exceeds 200 units.

1. What would be the total cost at a production level of 420 units? ___________________
2. What would be the total cost at a production level of 170 units? ___________________

Problem 4. High Low Method (HLM)

The following information summarized total production costs and number of units of
product produced by Balolong Company over the last 6 months:

Month Units Produced Total Cost

1 3,000 ₱12,000
2 4,200 15,000
3 4,000 16,000
4 3,400 13,500
5 3,200 11,500
6 3,100 11,500
Using high-low method:
Determine the cost formula. _______________________
What would be the total cost if the company plans to produce 3,500 units? _______________________

Problem 5

During the month of June, direct labor cost totaled P13,000 and direct labor cost was 20%
of prime cost.
During June the total manufacturing costs were P88,000.
1. Calculate the total prime cost. P65,000
2. The manufacturing overhead was? P23,000

DM + DL + MOH = TMC
DM + 13,000 + MOH = TMC
52,000+13,000 + MOH = 88,000
MOH = P23,000
DM + DL = PRIME COST
DM + 13,000 = PRIME COST
Let x be the prime cost; 0.8x is the DM
X= 13,000 + 0.8X
X-0.8X = 13,000
0.2X=13,000
X = 65,000

Problem 6
The accounting records of RFIVE Company (Kila Ma’am Rose Ann) revealed the following
costs:

Direct material used P50,000 DM

Factory utilities 35,000 MOH
Wages of assembly-line personnel 170,000 DL
Customer entertainment 45,000
Indirect materials used 19,000 MOH
Depreciation on salespersons' cars 51,000
Production equipment rental costs 110,000 MOH

1. Calculate the total direct costs? P220,000

2. Calculate the total manufacturing overhead costs? P164,000
3. What is the total conversion costs? P334,000

Problem 7

The management of RCP Corporation has asked your help as an intern in preparing some
key reports for September. The beginning balance in the raw materials inventory account
was P40,000. During the month, the company made raw materials purchases amounting to
P89,000 and used P77,000 out of the total materials available to use in production. At the
end of the month, the balance in the raw materials inventory account was P52,000. Direct
labor cost was P44,000 and manufacturing overhead was P91,000.

The beginning balance in the work in process account was P44,000 and the ending
balance was P39,000. The beginning balance in the finished goods account was P73,000
and the ending balance was P78,000. Selling expense was P40,000 and administrative
expense was P55,000.

1. Calculate the total prime cost for September.

2. The conversion cost for September was?
 3. How much is the total cost of inventory to be presented in the financial position of
the Company?

Problem 8

Some selected sales and cost data for RCP Company are given below:

Direct materials used (variable cost) P200,000

Indirect materials used (variable cost) 70,000
Direct labor cost incurred (variable cost) 300,000
Indirect labor cost incurred (80% fixed) 80,000
Other factory overhead cost (40% variable) 150,000
Selling and administrative expenses (60% variable) 240,000

1. Total variable cost.

2. Total fixed cost

Problem 10

Below are the amounts gathered in order to calculate the total product cost incurred by
Marcial Company:

Materials used (including P70,000 of indirect P780,000

materials)
Labor cost (including P80,000 maintenance 720,000
salaries)
Supervisor salaries - plant 510,000
Heat, light and power - plant 135,000
Sales salaries 327,000
Advertising expenses 304,000
Insurance and property taxes - plant 143,000
Insurance and property taxes - corporate offices 208,000
Equipment depreciation – plant 119,000
Equipment depreciation - corporate offices 92,000

1. Total manufacturing overhead cost.

2. Selling expenses.
3. Administrative expenses.

Problem 11
Identification of Variable, Fixed, and Semi-variable Costs. Place a check mark in the
appropriate column to indicate whether the following costs are variable, fixed, or semi-
variable.
 Item Variable Fixed Semi-variable
1 Small tools /
2 Patent amortization /
3 Health and accident insurance /
4 Heat, light, and power /
5 Straight-line depreciation /
6 Maintenance of buildings and grounds /
7 Royalties /
8 Materials handling /
9 Property and liability insurance /
10 Maintenance of factory equipment /

Problem 12
Classification of Costs. Place a check mark in the appropriate column to indicate the proper
classification of each of the following costs.

Other
Administra
Indirect Indirect Indirect Marketing
Item tive
Materials Labor Factory Expenses
Expenses
Costs

1 Factory heat, light, and power /

2 Advertising /
3 Wages of stockroom clerk /
4 Freight out /
5 Oil for machines /
Salary of vice president of
6
human relations /
7 Legal expenses /
8 Salary of the factory manager /
Employer payroll taxes on
9
controller's salary /
Idle time due to assembly line
10
breakdown /