COSTS AND COST CONCEPTS

Cost — a measurement, in monetary terms, of the amount of resources used for some purpose
When notified by a term that defines the purpose, cost becomes operational, e.g., ‘selling cost,
acquisition cost, variable cost, etc.

Cost Pool— an account in which 2 variety of similar costs are accumulated prior to allocation
to cost objects. It is a group of costs associated with an activity. Example: overhead account.

Cost object— the intermediate and final disposition of cost pools.

Example: product; job, process

Cost driver — a factor that causes a change in the cost pool for a particular activity. It is used
as a pcs, yet basis for cost allocation; any factor or activity that has a direct cause-effect
relationship.

Activity — any event, action, transaction, or work sequence that incurs costs when producing
a product or providing a service.

COST BEHAVIOR

COST BEHAVIOR — describes how a cost behaves or changes as the amount of cost driver
changes.

TYPES OF COSTS AS TO BEHAVIOR:

1. FIXED COST -— in total: constant within the relevant range as activity output changes; per
unit:
changes as activity level changes
2. VARIABLE COST — in total: varies in direct proportion to changes in activity output; per
unit:
remains constant
3. MIXED COST — has both fixed and variable components.

COST BEHAVIOR ASSUMPTIONS:

1. Relevant Range Assumption
Relevant range refers to the band of activity within which the identified cost behavior patterns
are valid. Any level of activity outside “this range may have a different cost behavior pattern.
2. Time Period Assumption
The cost behavior patterns identified are true only over a specified period of time.
Beyond this, the cost may show a different behavior.
SEGREGATION OF FIXED AND VARIABLE ELEMENTS OF MIXED COSTS:
1. High-Low Points 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 Scattergraph 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) — 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∑x2

COST FORMULA: y = a+ bx

Where: “y” denotes total cost. It is called the dependent variable because it is dependent on
the value of another variable, the activity level x
“a” is an estimate of the fixed cost
“b” is an estimate of the variable cost per unit of activity.
EXERCISES:
1. Consider the following costs that were incurred during the current year.

a. Advertising costs of Jobilee.

b. Straight-line depreciation on factory machinery of Samsang
c. Wages of assembly-line personnel of Toyotha.
d. Delivery costs on customer shipments of Huawey.
e. Newsprint consumed in printing the Manila Star.
f. Plant insurance costs of Bhench Gharments.
g. Glass costs incurred in light-bulb manufacturing of Omnay.
h. Tire costs incurred by Yunday.
i. Sales commissions paid to the sales force of Myfone.
j. Wood Glue consumed in the manufacture Libiran furniture.
k. Hourly wages of refinery security guards employed by Muscovado Corporation.
l. The salary of a financial vice president of Alexis Corporation.

REQUIRED; Evaluate each of the preceding and determine whether the cost is (a) a product
cost or a period cost, (b) variable or fixed in terms of behavior, and (c) for the product costs
only, whether the cost is properly classified as direct material, direct labor, or
manufacturing overhead. Item h is done as an example:

h. Tire costs: Product cost, variable, direct material

2. Athena Toy Company incurred the following costs during 2021. The company sold all of
its products manufactured during the year.

Direct Material P4,500,000

Direct Labor 3,300,000
Manufacturing overhead
Utilities (primarily electricity) 210,000
Depreciation of PPE 345,000
Insurance 240,000
Supervisory salaries 450,000
Property taxes 315,000
Selling costs:
Advertising 292,500
Sales commissions 135,000
Administrative costs
Salaries of top management & staff 558,000
Office supplies 60,000
Depreciation on building & equipment 120,000
During 2021, the company operated at about half of its capacity, due to a slowdown in the
economy. Prospects for 2022 are slightly better. Jared Lowes, the marketing manager,
forecasts 30 percent growth in sales over the 2021 levels.
REQUIRED: Categorize each of the costs listed above as to whether it is most likely variable
or fixed. Forecast the 2022 cost amount for each of the cost items listed above.

3. A Company, doing business in the city of Makati, reports the following total costs at two
levels of production:

Cost Item 2,000 units 5,000 units

Depreciation P5,000 P5,000
Materials 10,000 25,000
Labor 4,000 10,000
Factory Supplies 8,000 10,000
Factory suupervisors’ salaries 10,000 10,000
Insurance 3,000 3,000
Maintenance 5,000 19,000
Rent 20,000 20,000
Electricity 5,500 16,250

REQUIRED: Classify each cost as variable, fixed, or mixed.

4. Pampanga Meat Company produces one of the best meat products in Pampanga.
The company’s controller used the account-classification method to compile the following
information.

a. Depreciation schedules revealed that monthly depreciation on buildings and

equipment is P21,000.
b. Inspection of several invoices from meat-packers indicated that meat costs the
company P1.20 per kilo of meat produced.
c. Wage records showed that competition for production employees costs P0.85 per
kilo of meat. produced.
d. Payroll records showed that supervisory salaries total P11,000 per month.
e. Utility bills revealed that the company incurs, utility costs of P5,000 Per month plus
P0.25 per kilo of meat produced

REQUIRED:
1. Classify each cost item as variable, fixed, or semi- -variable.
2. Write a cost formula to express the cost behavior of the firm’s production costs, (Use the
form Y= a + bX where Y denotes production cost and X denotes quantity of meat produced

5. Bodywow Fitness, Inc. operates a chain of fitness centers in Metro Manila. The firm’s
controller is accumulating data to be used in preparing its annual profit plan for the coming
year. The cost behavior pattern of the firm’s equipment maintenance costs must be
determined. The accounting staff has suggested the use of an equation, in the form of Y = a
+ bx, for maintenance costs. Data regarding the Maintenance pus and costs for Last year
are as follows:

January 525 P4,710

February 505 4,310
March 310 2,990
April 495 4,200
May 315 3,000
June 485 4,215
July 315 2,950
August 405 3,680
September 475 4,100
October 345 3,250
November 350 3,260
December 50 400

REQUIRED:
1. Using the high-low method of cost estimation, estimate the behavior of the maintenance
costs incurred by Bodywow Fitness, Inc. Express the cost behavior pattern in equation form.
2. Compute the predicted maintenance cost at 600 hours of activity.

6. Konti’s Cakes is a small one-person company that provides elaborate and imaginative
wedding cakes to order for very large wedding receptions. The owner of the company would
like to understand the cost structure of the company and has compiled the following records
of activity and costs incurred. The owner believes that the number of weddings catered is the
best measure of activity.
Month Weddings Costs Incurred
January 3 P3,800
February 2 3,600
March 6 4,000
April 9 4,300
May 12 4,500
June 20 5,200
REQUIRED:
a. Using the high-low method, estimate the variable cost per wedding and the total fixed cost
per month. (Round off the variable cost per wedding to the nearest centavo and the total fixed
cost to the nearest peso.)
b. Using the least-squares regression method, estimate the variable cost per wedding and the
total fixed cost per month. (Round off the variable cost per wedding to the nearest centavo
and the total fixed cost to the nearest peso.)

7. The method of least squares was used to develop a cost equation to predict the cost of
maintenance. Monthly data for the past four years were used for the regression.

The following computer output was received:

Intercept P5,000
Slope 10
Coefficient of correlation 0.90

The driver used was “number of maintenance hours.”

REQUIRED:
1. What is the cost formula?
2. Using the cost formula, predict the cost e of maintenance if 650 maintenance hours are to
be worked next month.
3. What percentage of the variability in maintenance cost explained by number of
maintenance hours? Do you think the equation will predict well? Why or why not
4. Using the results from the regression equation, predict the cost of maintenance of next
year if 7,500 maintenance hours are predicted.

8. Jayson Company is making plans for the introduction of a new product, which has a target
selling price of P7 per unit. The following estimates of manufacturing costs have been
Derived for 6 million units, to be produced during the first year:

Direct material: P6,000,000

Direct labor: P2,100,000 (at P14 per hour)

Overhead costs have not yet been estimated, but monthly data on total production and
overhead for the past 12 months have been analyzed by using least-squares regression. The
major overhead cost driver is direct labor hours, with the following results:
 Computed values:
Fixed overhead cost: P3,200,000
Coefficient of independent variable: P2.25
REQUIRED:
a. Prepare the company's regression equation (Y = a + bx) to estimate overhead.
b. Calculate the predicted overhead cost at an activity level of 6,300,000 units.
c. What is North's dependent variable in this case?
d. How can the company evaluate the “quality” of its regression equation?

9. Charger Corporation has three costs: A, which is variable; B, which is fixed; and C, which
is semi-variable. The company uses the high-low method and extracted the following data
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; at
200,000 hours, the high point, Cost C's fixed portion amounted to P1.75 per hour.
• At 160,000 hours of activity, the sum of Costs A, B, and C amounted to
P8,162,000.

REQUIRED:
A. Compute the variable portion (total} of Cost C at 140,000 hours of activity.
B. Compute Cost C (total) at 160,000 hours of activity.
C. Compute Cost B (total) at 160,000 hours of activity.

10. Cleo Company wants to determine the factors that are associated with overhead. The
controller for Cleo constructed a multiple regression equation using the following independent
variables: direct labor hours, number of setups, and number of purchase orders. The analysis
was run using the past 50 months of data. From the printout, the following data were obtained:
Parameter Estimate
Intercept P20,000
Rates of variability:
Direct labor hours (H) P 10
Number of setups (S) P500
Number of purchase orders (P) P8
Number of observations (n) 50

REQUIRED:
1. Write out the cost formula for monthly overhead for Cleo Company.
2. If Cleo budgets the following for next month, what is the budgeted overhead cost?
• Direct labor hours 200
• Number of setups 30
• Number of purchase orders 150
3. Suppose that Cleo’s engineers expect the number of setups to decrease by 10 percent.
How much overhead cost would be saved for the following month?

11. The chief statistician of Valenzuela Company has developed the formula:

Y = P150,000+ 3L + 5M

Where: Y = total monthly manufacturing overhead cost

L = labor hours
M = machine hours

The measure of goodness of fit is good and no evidence of multicolinearity exists. The
company will use 15,000 labor hours and 4,000 machine hours next month.

REQUIRED:
1. Determine the total manufacturing overhead costs that Valenzuela should incur next
month.
2. Valenzuela makes a product that has P12.00 in materials costs. It requires two hours of
labor time and 30 minutes of machine’ time. Laborers earn P15 per hour:
What is the product’s per unit variable manufacturing cost?
3. Suppose that Valenzuela could reduce the labor time for the product described in
requirement 2 by 30 minutes, to 1.50 hours. Machine time will remain the same. By how much
would the per unit variable manufacturing cost fall?