Chapter 3

Introduction to Management Accounting
FIFTEENTH EDITION
Charles T. Horngren, Stanford University

Gary L. Sundem, University of Washington – Seattle
William O. Stratton, Dixie State College of Utah
David Burgstahler, University of Washington – Seattle
Jeff Schatzberg, University of Arizona
Copyright ©Introduction
©2005 Prentice Hall Business Publishing, 2011 PearsontoEducation,
ManagementInc. publishing
Accountingas Prentice Hall
13/e, Horngren/Sundem/Stratton 33 - 1
Introduction to Management Accounting
Chapter 3
Measurement of Cost Behavior
Chapter 3 Learning Objectives
When you have finished studying this chapter, you should be able
to:
1. Explain step- and mixed-cost behavior.
2. Explain management influences on cost behavior.
3. Measure and mathematically express cost functions and use

them to predict costs.
4. Describe the importance of activity analysis for measuring

cost functions.
5. Measure cost behavior using the engineering analysis, account

analysis, high-low, visual-fit, and least-squares regression
methods.
Linear-Cost Behavior
Costs are assumed to be fixed or variable

within the relevant range of activity
Learning
Objective 1 Step-Cost Behavior Patterns
Step costs change abruptly at intervals

of activity because the resources and
their costs come in indivisible chunks.
Step-Cost Behavior Patterns
Mixed-Cost Behavior Patterns
Mixed costs contain elements of both

fixed- and variable-cost behavior.
The fixed-cost element is unchanged

over a range of cost-driver activity.
The variable-cost element varies

proportionately with cost-driver activity.
Mixed-Cost Behavior Patterns
Mixed costs contain elements of both fixed and variable costs.

The fixed-cost element is unchanged over a range of cost-driver
activity levels.
The variable-cost element of the mixed cost varies proportionately
with cost-driver activity within the relevant range.
Learning
Objective 2 Management’s Influence on Cost Behavior
Product or service attributes
Capacity
Technology
Policies to create incentives to control costs
Capacity Decisions
They are the fixed costs of being able

to achieve a desired level of production or
to provide a desired level of service while
maintaining product or service attributes.
13/e, Horngren/Sundem/Stratton 33 -- 10
Committed Fixed Costs
Committed fixed costs arise

from the possession of facilities,
equipment, and a basic organization.
Lease payments
Property taxes
Salaries of key personnel
Discretionary Fixed Costs
Discretionary fixed costs are costs fixed at certain levels

only because management decided that these levels of cost
should be incurred to meet the organization’s goals.
These discretionary fixed costs have no obvious

relationship to levels of output activity but
are determined as part of the periodic planning process.
Each planning period, management will determine

how much to spend on discretionary items. These costs
then become fixed until the next planning period.
Examples of Discretionary
Fixed Costs
Research and
development
Advertising
and promotion
Management
salaries
Technology Decisions
Choice of technology (e-commerce versus

in-store or mail-order sales) positions the
organization to meet its current goals and
to respond to changes in the environment.
Cost-Control Incentives
Managers use their Employees may

knowledge of cost receive rewards that
behavior to set are tied to meeting
cost expectations. these expectations.
Learning
Objective 3
Cost Functions
Planning and controlling the activities

of an organization require accurate
and useful estimates of future
fixed and variable costs.
Cost Functions
Understanding relationships between costs

and their cost drivers allows managers to...
Make better operating, marketing,

and production decisions
Plan and evaluate actions
Determine appropriate costs for

short-run and long-run decisions.
Cost Functions
The first step in estimating or predicting

costs is measuring cost behavior as a
function of appropriate cost drivers.
The second step is to use these cost

measures to estimate future costs at
expected levels of cost-driver activity.
Cost Function Equation
Let:
Y = Total cost
F = Fixed cost
V = Variable cost per unit
X = Cost-driver activity in number of units
The mixed-cost function is called a linear-cost function.
Mixed-cost function:
Y = F + VX
Y = $10,000 + $5.00X
Developing Cost Functions
The cost function must be believable.
A cost function’s estimates of costs

at actual levels of activity must reliably
conform with actually observed costs.
Learning
Objective 4 Choice of Cost Drivers: Activity Analysis
Choosing a cost function starts

with choosing cost drivers.
Managers use activity analysis to

identify appropriate cost drivers.
Activity analysis directs management

accountants to the appropriate
cost drivers for each cost.
Choice of Cost Drivers: Activity Analysis
Northwestern Computers makes two

products: Mozart-Plus and Powerdrive
In the past, most of the support costs

were twice as much as labor costs.
Northwest has upgraded the production

function, which has increased support
costs and reduced labor cost.
Using the old cost driver, labor cost, the

prediction of support costs would be:
Mozart-Plus Powerdrive
Labor cost $ 8.50 $130.00
Support cost:
2 × Direct labor
cost $17.00 $260.00
Using the more appropriate cost driver,

the number of components added to products,
companies can predict support costs more accurately.
Mozart-Plus Powerdrive
Support cost at $20
per component
$20 × 5 components $100.00
$20 × 9 components $180.00
Difference in predicted
support cost $ 83.00 $ 80.00
higher lower
Managers will make better decisions with this more

accurate information.
Learning
Objective 5
Methods of Measuring Cost Functions
1. Engineering analysis
2. Account analysis
3. High-low analysis
4. Visual-fit analysis
5. Least-squares regression analysis
Engineering Analysis
Engineering analysis measures cost behavior

according to what costs should be,
not by what costs have been.
Engineering analysis entails a systematic

review of materials, supplies, labor,
support services, and facilities
needed for products and services.
Account Analysis
The simplest method of account analysis selects a plausible

cost driver and classifies each account as a variable or fixed cost.
Parkview Medical Center

Monthly cost Amount Fixed Variable
Supervisor’s salary and benefits $ 3,800 $3,800

Hourly workers’ wages and benefits 14,674 $14,674
Equipment depreciation and rentals 5,873 5,873
Equipment repairs 5,604 5,604
Cleaning supplies 7,472 7,472
Total maintenance costs $37,423 $9,673 $27,750
Account Analysis Example
3,700 patient-days
Fixed cost per month = $9,673
Variable cost per patient-day

= $27,750 ÷ 3,700
= $7.50 per patient-day
Y = $9,673 + ($7.50 × patient-days)
High-Low Method
Plot historical data points on a graph.
Focus on the highest- and lowest-activity points.
High month: April

Maintenance cost: $47,000
Number of patient-days: 4,900
Low month: September

Maintenance cost: $17,000
Number of patient-days: 1,200
High-Low Method Example
The point at which the line intersects the Y axis is

the intercept, F, or estimate of Fixed Costs, and the
slope of the line measures the variable cost.
What is the variable cost (V)?

Using algebra to solve for variable and fixed costs.
Variable costs = Change in costs

change in activity
V = ($47,000 – $17,000) ÷ (4,900 – 1,200)

= $30,000 ÷ 3,700 = $8.1081
What is the fixed cost (F)?
F = Total mixed cost – total variable cost

At X (high): F = $47,000 - ($8.1081× 4,900 patient-days)
= $47,000 – $39,730
= $7,270 a month
At X (low): F = $17,000 = ($8.1081× 1,200 patient-days)

= $17,000 – $9,730
= $7,270 a month
Cost function measured by high-low method:

Y = $7,270 per month + ($8.1081 × patient-days)
Visual-Fit Method
In the visual-fit method, the cost analyst

visually fits a straight line through a plot
of all of the available data, not just
between the high point and the
low point, making it more reliable
than the high-low method.
Least-Squares Regression Method
Regression analysis measures

a cost function more objectively
by using statistics to fit a cost
function to all the data.
Regression analysis measures

cost behavior more reliably than
other cost measurement methods.
Coefficient of Determination
One measure of reliability,

or goodness of fit, is the
coefficient of determination,
R² (or R-squared).
The coefficient of determination

measures how much of the
fluctuation of a cost is explained
by changes in the cost driver.
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publishing as Prentice Hall

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Introduction to Management Accounting

Charles T. Horngren, Stanford University

Measurement of Cost Behavior

2. Explain management influences on cost behavior.

3. Measure and mathematically express cost functions and use

4. Describe the importance of activity analysis for measuring

5. Measure cost behavior using the engineering analysis, account

Costs are assumed to be fixed or variable

Step costs change abruptly at intervals

Mixed costs contain elements of both

The fixed-cost element is unchanged

The variable-cost element varies

Mixed costs contain elements of both fixed and variable costs.

Product or service attributes

Policies to create incentives to control costs

They are the fixed costs of being able

Committed fixed costs arise

Salaries of key personnel

Discretionary fixed costs are costs fixed at certain levels

These discretionary fixed costs have no obvious

Each planning period, management will determine

Choice of technology (e-commerce versus

Managers use their Employees may

Planning and controlling the activities

Understanding relationships between costs

Make better operating, marketing,

Plan and evaluate actions

Determine appropriate costs for

The first step in estimating or predicting

The second step is to use these cost

The mixed-cost function is called a linear-cost function.

The cost function must be believable.

A cost function’s estimates of costs

Choosing a cost function starts

Managers use activity analysis to

Activity analysis directs management

Northwestern Computers makes two

In the past, most of the support costs

Northwest has upgraded the production

Using the old cost driver, labor cost, the

Using the more appropriate cost driver,

Managers will make better decisions with this more

Engineering analysis measures cost behavior

Engineering analysis entails a systematic

The simplest method of account analysis selects a plausible

Parkview Medical Center

Supervisor’s salary and benefits $ 3,800 $3,800

Fixed cost per month = $9,673

Variable cost per patient-day

Y = $9,673 + ($7.50 × patient-days)

Plot historical data points on a graph.

Focus on the highest- and lowest-activity points.

High month: April

Low month: September

The point at which the line intersects the Y axis is

What is the variable cost (V)?

Variable costs = Change in costs

V = ($47,000 – $17,000) ÷ (4,900 – 1,200)

What is the fixed cost (F)?

F = Total mixed cost – total variable cost

At X (low): F = $17,000 = ($8.1081× 1,200 patient-days)

Cost function measured by high-low method:

In the visual-fit method, the cost analyst

Regression analysis measures