MAS_1.2.

1 INTEGRATED REVIEW & REFRESHER COURSE

R.D.BALOCATING
UNIVERSITY OF LUZON
COLLEGE OF ACCOUNTANCY

MANAGEMENT ADVISORY SERVICES

COST TERMS, CONCEPTS & BEHAVIOR

Basic Cost Terms and Concepts

A. What is a cost?
1. A cost is a sacrifice of resources.
2. An elusive term; to have meaningful and specific use for management, must be classified and described
B. Cost object
1. Anything for which management wants to collect or accumulate costs.
C. Cost v.s. Expense and Loss
1. Expense is an expired cost that has given a benefit.
2. Loss is cost that expires without producing any revenue or benefit
D. Classification of costs
1. Elements of manufacturing cost
a. Direct materials b. Direct labor c. Factory overhead
2. Relationship to production
a. Prime costs = direct materials plus direct labor
b. Conversion cost = direct labor plus factory overhead
3. Relationship to volume (behavior)
a. Variable costs b. Fixed costs c. Mixed costs
4. Ability to trace (relation to cost object)
a. Direct costs b. Indirect costs
5. Department where incurred
a. Production department costs b. Service or support department costs
6. Functional classification
a. Manufacturing costs c. Administration costs
b. Marketing costs d. Financing costs
7. Period charged to income
a. Product costs b. Period costs
8. Relationship to planning, controlling and decision-making
a. Standard and budgeted costs g. Differential costs
b. Controllable and noncontrollable costs h. Opportunity costs and out-of-pocket costs
c. Committed and discretionary fixed costs i. Incremental and marginal costs
d. Relevant and irrelevant costs j. Valued-adding and nonvalue-adding costs
e. Avoidable and unavoidable costs k. Prevention costs, appraisal costs, failure
f. Historical and sunk costs (internal and external) costs
E. Methods of cost assignment to cost object
1. Direct tracing 2. Driver tracing 3. Allocation

COST BEHAVIOR AND ANALYSIS OF MIXED COST

COST BEHAVIOR – the functional relationship between changes in activity and changes in cost.
RELEVANT RANGE – the range of activity within which assumptions relative to variable and fixed cost behavior are valid.
COST FORMULA OR COST FUNCTION – a formula relating cost to activity. This can be expressed in a linear equation y =
a + bx.
COST STRUCTURE – the relative proportion of fixed, variable, and mixed costs found within an organization.
CLASSIFICATION OF COST ACCORDING TO BEHAVIOR:
1. Variable cost – cost that changes in total in direct proportion to changes in activity level throughout the relevant range.
Variable cost is constant per unit.
2. Fixed cost – constant in total amount regardless of the change in activity level throughout the relevant range. This
cost vary indirectly with changes in activity on a per unit basis.
3. Semivariable costs or mixed costs – costs that have both variable and fixed components
4. Step cost is a type of cost that shifts upward or downward when activity changes by a certain interval or “step”. Step
variable costs have small steps; while step fixed costs have large steps.
TYPES OF FIXED COST:
1. Committed fixed costs – those cost that are difficult to adjust and that relate to investment in facilities, equipment,
and the basic organization structure of the firm. These cost cannot be reduced within a short period of time.
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R.D.BALOCATING
2. Discretionary fixed cost – also programmed or managed fixed costs, are cost that managers can elect to spend or
not to spend. Examples are advertising, research, and management development programs.
SPLITTING SEMIVARIABLE OR MIXED COSTS:
1. Least squares regression method – a method of cost estimation based on statistical techniques for fitting line to an
observed series of data points, usually by minimizing the sum of squared deviations of the observed data from the
fitted line. This method makes use of two least squares equation.
Equation 1: y = na + bx
Equation 2: xy = ax + bx2
These equations are derived from the cost formula y = a + bx.
y = the total cost or mixed cost; the dependent variable
a = fixed cost, the y-intercept
b = rate of variability; the slope of regression line
x = cost driver; the independent variable
n = number of activities observed
To find the values of a and b in the least squares formula, the elimination procedure may be used.
To find the values of a and b using the direct substitution formula, the formulae are:
n (xy) - (x) (y)
b=
n (x2 ) - (x) (x)
a = (y/n) – b(x/n)
2. Scatter diagram/scatter graph/visual fit—rough guide for cost estimation which plot the cost against the past activity
levels. By visual inspection, the regression line is drawn on the graph so that the distances of the observations above
the line are equal to the distances of observations below the line.
3. High-Low point method—a method of cost segregation using only two points, the highest and the lowest activity level.
This is the least accurate method of analyzing semi-variable costs.
Highest cost – lowest cost
Variable rate =
Highest activity – lowest activity
Fixed cost = Total cost – variable cost
COEFFICIENT OF DETERMINATION ( r2 ) - measures the degree of correlation; measures how well the regression line
accounts for the changes in the dependent variable.
(estimated conditional standard deviation from line of regression)2
r = 1-
2

(standard deviation from the average of all data)2

COEFFICIENT OF CORRELATION ( r ) – a measure of relative relationship between two variables.

r= r2

SIMPLE REGRESSION – makes use of two variables, one dependent and one independent. The formula y = a + bx is a
simple regression formula.
MULTIPLE REGRESSION – makes use of more than two variables, one dependent and two or more independent variables.

MULTIPLE CHOICE
1. The simplifying assumption that cost estimation are based on include which of the following:
a. Cost behavior depends on one activity variable (except multiple regression)
b. Cost behavior patterns are not linear within the relevant range.
c. Costs are only fixed
d. All of the above

2. Coefficient of determination:
a. measures how well the line fits the data c. is the standard error of the coefficient
b. is a perfect fit when its value is 1.0 d. a and b

3. Multiple regression:
a. has one dependent variable c. has only one independent variable
b. has more than one independent variable d. a and b

4. Correlation is a term frequently used in conjunction with regression analysis and is measured by the value of correlation
coefficient, r. The best explanation of the value r is that it:
a. Interprets variances in terms of independent variable.
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b. Ranges in size from negative infinity to positive infinity.
c. Is a measure of the relative relationship between two variables.
d. Is positive only for downward-sloping regression lines.

5. If the coefficient of correlation between two variables is zero, how might a scatter diagram of those variables appear?
a. Random points
b. At least square line that slopes up to the right
c. At least square line that slopes down to the right
d. Under this condition, a scatter diagram could not be plotted

6. Simple regression analysis involves the use of:

Dependent Variables Independent Variables Dependent Variables Independent Variables
a. One None c. One Two
b. One One d. None Two

7. In determining cost behavior in business, the cost function is often expressed as y = a + bx. Which one of the following
cost estimation methods should not be used in estimating fixed and variable costs for the equation?
a. Graphic method c. High and Low point method
b. Simple regression d. Multiple regression

8. Regression analysis is superior to other cost behavior analysis techniques because it:
a. Examines only one variable c. Proves a cause and effect relationship
b. Produces measures of probable error d. It is not a sampling technique

9. The term relevant range as used in cost accounting means the range over which:
a. relevant costs are incurred c. total cost remain unchanged
b. cost relationships are valid d. production may vary

10. Cost drivers are:

a. activities that cause costs to increase as the activity increases
b. accounting techniques used to control costs
c. accounting measurements used to evaluate whether or not performance is proceeding according to plan
d. a mechanical basis, such as machine hours, computer time, size of equipment, or square footage of factory, used to
assign activities

THE NEXT FOUR QUESTIONS ARE BASED ON THE FOLLOWING:

As part of a cost study, the cost accountant of Rod Lagman, Inc. has recorded the cost of operations at seven different
levels of material usage. The information is shown as follows:
Kilos of Materials Cost of operations
100 P 1,000
75 600
25 400
150 1,500
175 1,600
50 600
125 1,300
Sum of the kilos 700
Sum of the costs 7,000
Sum of the kilos times costs 852,500
Sum of the kilos squared 87,500

Note: Round all answers to second decimal place.

11. Using the high-low point method, the variable cost of operation per kilo of materials used is:
a. P7.80 b. P8.00 c. P9.14 d. P16.70

12. Using the high-low point method, the fixed cost of operation is:
a. P200 b. P400 c. P1,200 d. P1,600

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13. Using the least-square method, the average rate of variability (b) per kilo of materials use is:
a. P5.16 b. P8.71 c. P10.84 d. P11.64

14. Using the least squares, the fixed portion of the cost is:
a. P109 b. P129 c. P200 d. P271

15. In regression analysis, which of the following correlation coefficients represents the strongest relationship between the
independent and dependent variables?
a. 1.03 b. -.02 c. -.89 d. .75

16. An auditor used regression analysis to evaluate the relationship between utility costs and machine hours. The following
information was developed using a computer software program:
Intercept 2,050 Regression coefficient .825
Correlation coefficient .800 Standard error estimate 200
No. of observations 36
What is the expected utility cost if the company’s 10 machines will be used for 2,400 hours next month?
a. P4,050 b. P4,030 c. P3,970 d. P3830

17. ABC Co. normally uses 40,000 direct labor hours for manufacturing 120,000 units of product. Three units are produced
in one hour, and the direct labor rate is P15 per hour. At normal capacity of 40,000 hours, the factory overhead is
estimated as follows:
Fixed overhead P100,000
Variable overhead 120,000
Total overhead 220,000
If 30,000 direct labors hours are used, total factory overhead costs would amount to:
a. P165,000 b. P190,000 c. P195,000 d. P220,000

18. Using regression analysis, Sky blue co. graphed the following relationship of its cheapest product line’s sales with its
customers’ income levels:

sales

Income level
If there is a strong statistical relationship between the sales and the customers’ income levels, which of the following
numbers best represents the correlation coefficient for this relationship?
a. -9.00 b. –0.93 c. +0. 93 d. +9.00

19. Lego co. uses regression analysis to develop a model for predicting overhead costs. Two different cost drivers (machine
hours and direct materials weight) are under consideration as the independent variable. Relevant data were run on a
computer program using one of the standard regression programs, with the following results:
Machine hours: Direct materials weight:
Y intercept = 2,500 Y intercept = 4,600
b = 5.0 b = 2.6
r2 = .70 r2 = .50
Which regression equation should be used?
a. Y = 2,500 + 5.0X c. Y = 4,600 + 2.6X
b. Y = 2,500 + 3.5X d. Y = 4,600 + 1.3X

20. The cost behavior method that may use time and motion studies to determine the activities and amounts for cost behavior
analysis is
a. account analysis method.
b. industrial engineering method.
c. regression analysis.
d. high-low method.