Chapter 3

Chapter 3
Cost Behaviour: Analysis and Use
Discussion Case 3-1
The relevant range in this example is 1,000 admissions to 2,000

admissions.
Management could use this information to predict costs in the follow way:
 If the number of patient admissions is expected to exceed 2,000
per month on a regular basis then an additional staff member
would need to be hired. If that individual is paid the same as the
existing staff members, this would result in fixed costs increasing
by $4,750 per month. The actual amount would depend on factors
such as the experience or education of the new staff member.
 If the number of patient admissions is expected to fall below
1,000 on a regular basis, then one staff member would need to be
let go. This would have the effect of reducing costs by $4,750.
 Note that there is no information provided to suggest that the $3
per admission variable costs would change if admissions exceed
2,000 or fall below 1,000 per month. This suggests that if only 900
patients were admitted per month on a regular basis, the variable
cost per admission would still be $3, or $2,700 in total per month.
© McGraw Hill Ltd. 2021. All rights reserved.

Solutions Manual, Chapter 3 1
Solutions to Questions
3-1 Examples of variable costs in a restaurant plans with a base amount of data plus overage
include food and beverages, some types of charges.
labour (e.g., employees paid an hourly wage),
cleaning supplies such as dishwasher soap, and 3-8
a portion of utility costs.
a. Committed d. Discretionary
3-2 b. Committed e. Committed
a. Unit fixed costs decrease as volume c. Discretionary f. Discretionary
increases.
b. Unit variable costs remain constant as 3-9 Knowing the relevant range will help
volume increases. managers more accurately predict fixed costs
c. Total fixed costs remain constant as volume when activity levels are expected to fall above or
increases. below that range. For example, if the activity
d. Total variable costs increase as volume level is expected to exceed the maximum
increases. amount in the relevant range for an extended
period, fixed costs will likely increase. This is
3-3 The activity base is what causes a because more of the resources represented by
variable cost to be incurred. The activity base the fixed cost (e.g., plant capacity) will be
would likely either be sales dollars or unit sales needed to meet demand. The opposite is true if
achieved by the salesperson. It would depend activity levels are expected to fall below the
on whether the commission is bases on minimum amount in the relevant range. As such,
revenues or unit sales. understanding the relevant range is very
important when estimating fixed costs.
3-4 A non-linear variable cost is one where
the cost per unit amount increases or decreases 3-10 One advantage is that it likely doesn’t
at some point as the activity level changes. take much time to use since managers are
Acquiring materials at a lower cost per unit until employing their knowledge to estimate cost
the amount purchased exceeds a pre-defined behavior. As such, it is likely a low-cost
threshold is an example of a non-linear variable approach. A disadvantage is that it may not be
cost. accurate if the manager’s knowledge is limited
or if something related to how the costs being
3-5 A true variable cost change in direct estimated are incurred has changed and the
proportion to the activity level. Conversely, a manager is unaware of this.
step-variable cost only changes in response to
fairly wide changes in the activity level. 3-11 The purpose of preparing a scattergraph
Maintenance staff expenses at a hospital or is to allow managers to evaluate whether or not
cleaning staff expenses at a hotel would be the relationship between two variables
examples of step-variable expenses. (independent and dependent) is linear.
3-6 A non-linear variable cost is one where 3-12 It is problematic because the high and
the per unit amount changes as volume low levels of activity employed by the high-low
increases or decreases. An example is direct method may not be representative of normal
materials where the per unit purchase price activity levels. As such, the cost function may be
decreases as a higher volume of materials is inaccurate. The scattergraph should visually
purchased. show this potential problem.
3-7 A mixed cost has both variable and fixed 3-13 The formula for a mixed cost is Y = a +
elements. Examples include some types of bX. In cost analysis, the “a” term represents the
wages such as sales employees paid a fixed fixed cost, and the “b” term represents the
wage plus commissions, utilities, and internet variable cost per unit of activity.

2 Managerial Accounting, 12th Canadian Edition
3-14 The gross margin is the difference
between sales and the cost of goods sold (CGS)
where CGS includes both variable and fixed
manufacturing costs. The contribution margin is
the difference between sales and total variable
costs including manufacturing and non-
manufacturing costs (see Exhibit 3-11).

Foundational Exercises
1. Units Shipped Shipping Expense

High activity level............ 8 $3,600
Low activity level............. 2 1,500
2. Variable cost element:
3. Fixed cost element:

Shipping expense at the high activity level................... $3,600
Less variable cost element ($350 per unit × 8 units)..... 2,800
Total fixed cost.......................................................... $ 800
4. The cost formula is $800 per month plus $350 per unit shipped or
Y = $800 + $350X,
5. Total shipping expense = $800 + $350(7)

= $3,250
6. Fixed expense is $800.
7. Variable expense = $350(10)

= $3,500
8.
Price per unit $5,000

Less variable costs:
Variable manufacturing $2,500
Variable overhead 500
Variable selling & admin. 200
Variable shipping expense 350 3,550
Contribution margin per unit $1,450

Foundational Exercises (continued)
9. Total contribution margin = 7 x $1,450 per unit

= $10,150.
10. Operating income = Contribution margin – fixed costs

= $10,150 - $3,000 - $800 (shipping)
= $6,350
11. Contribution margin would decrease by:

$5,000 x 5% x 7 = $1,750
12. Operating income would decrease by the same $1,750 as per part 11.
13. Variable shipping expenses for 12 units:

($350 x 10) + [($350 x 90%) x 2]
$3,500 + $630 = $4,130
14. Total shipping expenses for 12 units:

$4,130 (per part 13) + $800 = $4,930
15. Non-linear because variable shipping expenses per unit are decreasing
as the volume shipped increases.

Exercise 3-1 (15 minutes)
1. Smoothies Served
in a Week
2,100 2,800 3,500
Fixed cost................................ $2,500 $2,500 $2,500
Variable cost ($0.75 per cup)..... 1,575 2,100 2,625
Total cost................................. $4,075 $4,600 $5,125
Cost per smoothie served *....... $1.94 $1.64 $1.46
* Total cost ÷ smoothies served in a week
2. The average cost of a smoothie declines as the number of smoothies

served increases because the fixed cost is spread over more units.

1. The completed scattergraph is presented below:
$6,000
$5,000
$4,000
Shipping Expense
$3,000
$2,000
$1,000
$0
0 1 2 3 4 5 6 7 8 9
Units Shipped
2. It appears that shipping expenses are linearly related to the number of

units shipped. As the number of units shipped increases there is a very
linear increase in shipping expenses.
3. Based on a visual inspection of the scattergraph it seems that shipping

expenses are a mixed cost. This is because it appears that if a straight
line was drawn through the plotted points it would intersect the vertical
axis at a cost above $0 (likely less than $1,000). This indicates that
there must be some fixed shipping expenses along with some variable
expenses since the total shipping expenses increase as the number of
units shipped increases.

1. Units Shipping
Month Shipped Expenses
High activity level (June)...... 8 $5,400
Low activity level (August). . . 1 $1,200
Change............................... 7 $4,200
Variable cost = Change in cost ÷ Change in activity
= $4,200 ÷ 7 units shipped
= $600 per unit shipped
Total cost (June)....................................................... $5,400
Variable cost element
($600 per unit shipped × 8 units)............................. 4,800
Fixed cost element.................................................... $600
2. The cost formula is Y = $600 + $600X

Where Y = total shipping expenses and X = the number of units
shipped.
3. I would not feel comfortable estimating shipping costs using the cost
formula from part 2 because it appears that 20 units would likely be
outside the relevant range for expenses. That is, 20 units is 150% more
than the highest level of activity used to estimate the cost formula.

Crazy Canucks
Income Statement—Ski Department
For the Month Ended January 31
Sales................................................................ $300,000
Variable expenses:
Cost of goods sold ($900 per pair of skis $180,000
× 200 pairs*)..............................................
Selling expenses ($150 per pair × 200 30,000
pairs)..........................................................
Administrative expenses (20% × 4,000 214,000
$20,000).....................................................
Contribution margin.......................................... 86,000
Fixed expenses:
Selling expenses (60,000-30,000).................... 30,000
Administrative expenses(80% x 20,000)........... 16,000 46,000
Operating income.............................................. $ 40,000
*$300,000 sales ÷ $1,500 per pair of skis = 200 pairs.
2. Since 200 pairs of skis were sold and the contribution margin totaled
$86,000 for the month, the contribution of each pair of skis toward fixed
expenses and profits was $430 ($86,000 ÷ 200 pairs). Another way to
compute the $430 is:
Selling price per pair of skis................ $1,500
Less variable expenses:
Cost per pair of skis......................... $900
Selling expenses.............................. 150
Administrative expenses
($4,000 ÷ 200 pairs)..................... 20 1,070
Contribution margin per pair............... $430
3. If 150 pairs of skis were sold in a month then the total contribution mar-
gin would be:
150 x $430 = $64,500.

1. The company’s variable cost per hour would be:
Taking into account the difference in behaviour between variable and

fixed costs, the completed schedule would be:
Operating Hours
12,000 14,000 16,000 18,000
Total costs:
Variable costs........................ $54,000 * $63,000 $72,000 $81,000
Fixed costs........................... 504,000 * 504,000 504,000 504,000
Total costs...............................$558,000 * $567,000 $576,000 $585,000
Cost per hour:
Variable cost......................... $4.50 $4.50 $4.50 $4.50
Fixed cost............................. 42.00 36.00 31.50 28.00
Total cost per unit.................... $46.50 $40.50 $36.00 $32.50
*Given.
Sales (15,000 hours × $40 per hour)............................ $600,000

Variable expenses (15,000 hours × $4.50 per hour)....... 67,500
Contribution margin..................................................... 532,500
Fixed expenses............................................................ 504,000
Operating income........................................................ $ 28,500

Vari-
Fixed able Total
1.Account Cost Cost
Production supervision1 $120,000 $42,000 $162,000
Utilities2 $ 12,000 $67,200$ 79,200
Sales staff wages3 $140,000 $84,000 $224,000
Quality control inspections4 $ 36,000 $ 5,600$ 41,600
1
Fixed: $150,000 x .8; Variable ($150,000 x .2)/500 x 700
2
Fixed: $60,000 x .2; Variable ($60,000 x .8)/500 x 700
3
Fixed: $200,000 x .7; Variable ($200,000 x .3)/(500 x $2,000) x (700 x
$2,000)
4
Fixed: $40,000 x .9; Variable ($40,000 x .1)/(500 x .5) x (700 x .5)
2. Contribution margin:
Sales (700 x $2,000) $1,400,000
Variable Costs:
Direct materials (700 x $500) $350,000
Direct labour (700 x $250) 175,000
Production supervision 42,000
Utilities 67,200
Sales staff wages 84,000
Quality control inspections 5,600 723,800
Contribution margin $676,200

1. Kilometers Total Annual

Driven Cost*
High level of activity......................... 105,000 $11,970
Low level of activity.......................... 70,000 9,380
Change........................................... 35,000 $ 2,590
* 105,000 kilometers × $0.114 per kilometer = $11,970
70,000 kilometers × $0.134 per kilometer = $9,380
Variable cost per kilometer:
Fixed cost per year:

Total cost at 105,000 kilometers..................... $11,970
Less variable portion:
105,000 kilometers × $0.074 per kilometer. . 7,770
Fixed cost per year........................................ $ 4,200
2. Y = $4,200 + $0.074X
3. Fixed cost......................................................... $ 4,200

Variable cost:
80,000 kilometers × $0.074 per kilometer........ 5,920
Total annual cost............................................... $10,120

1. Blood Tests Costs

High activity level (February)........ 3,500 $14,500
Low activity level (June)............... 1,500 8,500
Change....................................... 2,000 $ 6,000
Variable cost per blood test:

Change in cost = $6,000 = $3 per blood test
Change in activity 2,000 blood tests
Fixed cost per month:

Blood test cost at the high activity level................. $14,500
Less variable cost element:
3,500 blood tests × $3.00 per test..................... 10,500
Total fixed cost.................................................... $ 4,000
The cost formula is $4,000 per month plus $3.00 per blood test
performed or, in terms of the equation for a straight line:
Y = $4,000 + $3.00X
where X is the number of blood tests performed.
2. Expected blood test costs when 2,300 tests are performed:

Variable cost: 2,300 blood tests × $3.00 per test....... $6,900
Fixed cost............................................................... 4,000
Total cost................................................................ $10,900

1. The scattergraph appears below.
16,000
Chart Title
14,000
12,000
10,000
8,000
Cost of Blood tests
6,000
4,000
2,000
0
1,000 2,000 3,000 4,000
Number of Blood Tests Performed
2. The high-low method would not provide an accurate cost formula in this
situation, since a line drawn through the high and low points would have
a slope that is too flat. Consequently, the high-low method would
overestimate the fixed cost and underestimate the variable cost per unit.
Note the Y axis intercept in the chart, representing fixed costs, is
approximately $3,000, whereas the high-low method estimated fixed
costs of $4,000.

1. Monthly operating costs at 80% occupancy:
4,000 rooms × 80% = 3,200 rooms;
3,200 rooms × $84 per room per day × 30 days... $8,064,000
Monthly operating costs at 40% occupancy (given).. 6,000,000
Change in cost...................................................... $2,064,000
Difference in rooms occupied:

80% occupancy (4,000 rooms × 80%)................. 3,200
40% occupancy (4,000 rooms × 40%)................. 1,600
Difference in rooms (change in activity).................. 1,600
Change in cost = $2,064,000 = $1,290 per room

Change in activity 1,600 rooms
$1,290 per room ÷ 30 days = $43 per room per day.
2. Monthly operating costs at 80% occupancy (above)... $8,064,000

Less variable costs:
3,200 rooms × $43 per room per day × 30 days..... 4,128,000
Fixed operating costs per month............................... $3,936,000
3. 4,000 rooms × 60% = 2,400 rooms occupied.

Fixed costs.............................................................. $3,936,000
Variable costs:
2,400 rooms × $43 per room per day × 30 days..... 3,096,000
Total expected costs................................................ $7,032,000

Problem 3-11 (45 minutes)
1. To determine the manufacturing costs incurred in March and June
recall from Chapter 2 that:
Cost of goods manufactured = Direct materials + direct labour +
manufacturing overhead + beginning work in process inventory –
ending work in process inventory
For March manufacturing overhead cost is:

$168,000 = $36,000 (6,000 x $6) + $60,000 (6,000 x $10) + X +
$9,000 - $15,000
X = $78,000
For June manufacturing overhead cost is:

$257,000 = $54,000 (9,000 x $6) + $90,000 (9,000 x $10) + X +
$32,000 - $21,000
X = $102,000
Overhead
2. Units Costs
High activity level (June).............. 9,000 $102,000
Low activity level (March)............. 6,000 78,000
Change....................................... 3,000 $ 24,000
Variable cost per unit:

Change in cost = $24,000 = $8 per unit
Change in activity 3,000 units
Fixed cost per month:

Total overhead cost at the high activity level.......... $102,000
9,000 units × $8.00 per unit.............................. 72,000
Total fixed cost.................................................... $ 30,000
The cost formula is Y = $30,000 + $8.00X
where X is the number of units produced.

Problem 3-11 (continued)
3. Cost of goods manufactured if 7,000 units are produced:
Direct materials:7,000 x $6…………………… $42,000

Direct labour: 7,000 x $10......................... 70,000
Manufacturing overhead............................
Variable: 7,000 x $8............................ 56,000
Fixed................................................. 30,000
Cost of goods manufactured*................... $198,000
*Work in process is ignored because the requirements indicated that it did

not change in the month.

1. Traditional income statement
Winter Leisure
Traditional Income Statement
Quarter ended December 31
Sales................................................................ $1,600,000
Cost of goods sold
($60,000 + $640,000 – $90,000)..................... 610,000
Gross margin.................................................... 990,000
Selling and administrative expenses:
Selling expenses (($100 per unit × 2,000 snow-
boards*) + $300,000).................................. 500,000
Administrative expenses (($40 per unit × 2,000
snowboards) + $240,000)............................ 320,000 820,000
*$1,600,000 sales ÷ $800 per snowboard = 2,000 snowboards.
2. Contribution format income statement

Winter Leisure
Contribution Format Income Statement
Quarter ended December 31
Sales................................................................ $1,600,000
Variable expenses:
Cost of goods sold
($60,000 + $640,000 – $90,000).................. $610,000
Selling expenses
($100 per unit × 2,000 snowboards)............. 200,000
Administrative expenses
($40 per unit × 2,000 snowboards)............... 80,000 890,000
Contribution margin.......................................... 710,000
Fixed expenses:
Selling expenses............................................. 300,000
Administrative expenses.................................. 240,000 540,000

3. Since 2,000 snowboards were sold and the contribution margin totaled
$710,000 for the quarter, the contribution of each snowboard toward
fixed expenses and profits was $355 ($710,000 ÷ 2,000 snowboards).
Alternate calculation:
Selling price $800 – $445 variable costs (cost of goods sold $305* +
Selling $100 + admin $40) = $355
*($610,000 ÷ 2,000)
4. If only 1,500 snowboards were sold then operating income would

decline from the $170,000 determined in part 1 by:
500 (2,000 – 1,500) x $355 per unit contribution margin (from part 3)
= $177,500.
Therefore, operating income (loss) would be:

$170,000 - $177,500 = $(7,500)

1. a. 5
b. 1
c. 4
d. 2
e. 9
f. 3
g. 6
h. 8
i. 7
2. Knowledge of the underlying cost behaviour patterns will allow a

manager to properly analyze the firm’s cost structure. The reason is that
all costs don’t behave in the same way. One cost might move in one
direction as a result of a particular action, and another cost might move
in an opposite direction. If the behaviour pattern of each cost is clearly
understood, the impact of a firm’s activities on its costs can be
estimated before the activity has occurred.

1. The completed scattergraph follows:
$7,000
$6,000
$5,000
Power Costs
$4,000
$3,000
$2,000
$1,000
$0
20 40 60 80 100 120 140
Ignots Processed
Power costs appear to be closely related to the number of ignots processed

each month. The data points all fall quite close to the trend line added to
the plot and suggest the relationship between power costs and ignots
processed is approximately linear.

2. High-low method:
Number of Power-
Ignots Costs
High activity level.............. 130 $6,000
Low activity level............... 40 2,400
Change............................. 90 $3,600
Variable cost per ignot:
Change in cost = $3,600 = $40 per ignot
Change in activity 90 ignots
Fixed cost: Total power cost at high activity level........ $6,000

Less variable element:
130 ignots × $40 per ignot.................... 5,200
Fixed cost element................................... $ 800
Therefore, the cost formula is: Y = $800 + $40X.
3. Using the cost formula determined in part 2, when the number of ignots
processed is 140, the prediction of total costs is:
$800 + ($40 x 140) = $6,400.

1. Maintenance cost at the 90,000 machine-hour level of activity can be
isolated as follows:
Level of Activity
60,000 MHs 90,000 MHs
Total factory overhead cost......... $174,000 $246,000
Deduct:
Utilities cost @ $0.80 per MH*. 48,000 72,000
Supervisory salaries................. 21,000 21,000
Maintenance cost....................... $105,000 $153,000
*$48,000 ÷ 60,000 MHs = $0.80 per MH
2. High-low analysis of maintenance cost:

Machine- Maintenance
Hours Cost
High activity level..................... 90,000 $153,000
Low activity level..................... 60,000 105,000
Change................................... 30,000 $ 48,000
Variable rate:
Total fixed cost:

Total maintenance cost at the high activity level... $153,000
Less variable cost element
(90,000 MHs × $1.60 per MH)......................... 144,000
Fixed cost element............................................ $ 9,000
Therefore, the cost formula for maintenance is $9,000 per month plus
$1.60 per machine-hour or
Y = $9,000 + $1.60X.

3. Variable Cost per

Machine-Hour Fixed Cost
Utilities cost.................... $0.80
Supervisory salaries cost.. $21,000
Maintenance cost............ 1.60 9,000
Total overhead cost......... $2.40 $30,000
Thus, the cost formula would be: Y = $30,000 + $2.40X.
4. Total overhead cost at an activity level of 75,000 machine-hours:

Fixed costs................................................. $ 30,000
Variable costs: 75,000 MHs × $2.40 per MH. 180,000
Total overhead costs................................... $210,000

1. Cost of goods sold................... Variable
Advertising expense................. Fixed
Shipping expense.................... Mixed
Salaries and commissions......... Mixed
Insurance expense................... Fixed
Depreciation expense............... Fixed
2. Analysis of the mixed expenses:

Salaries and
Shipping Commissions
Units Expense Expense
High level of activity...... 5,000 $38,000 $90,000
Low level of activity....... 4,000 34,000 78,000
Change......................... 1,000 $ 4,000 $12,000
Variable cost element:
Fixed cost element:

Salaries and
Shipping Commissions
Expense Expense
Cost at high level of activity.... $38,000 $90,000
5,000 units × $4 per unit..... 20,000
5,000 units × $12 per unit. . . 60,000
Fixed cost element................. $18,000 $30,000

The cost formulas are:
Shipping expense:
$18,000 per month plus $4 per unit
or
Y = $18,000 + $4X
Salaries and commissions expense:
$30,000 per month plus $12 per unit
or
Y = $30,000 + $12X
3.
Skate World
Income Statement
For the Month Ended September 30
Sales (5,000 units × $100 per unit)........... $500,000
Variable expenses:
Cost of goods sold
(5,000 units × $60 per unit)................ $300,000
Shipping expense
(5,000 units × $4 per unit)................... 20,000
Salaries and commissions expense
(5,000 units × $12 per unit)................. 60,000 380,000
Contribution margin.................................. 120,000
Fixed expenses:
Advertising expense............................... 21,000
Shipping expense................................... 18,000
Salaries and commissions expense.......... 30,000
Insurance expense................................. 6,000
Depreciation expense............................. 15,000 90,000
Operating income..................................... $ 30,000

1. Maintenance cost at the 75,000 machine-hour level of activity can be
isolated as follows:
Level of Activity
50,000 MHs 75,000 MHs
Total factory overhead cost................. $14,250,000 $17,625,000
Deduct:
Indirect materials @ $100 per MH*... 5,000,000 7,500,000
Rent............................................... 6,000,000 6,000,000
Maintenance cost............................... $ 3,250,000 $ 4,125,000
* $5,000,000 ÷ 50,000 MHs = $100 per MH
2. High-low analysis of maintenance cost:

Machine- Maintenance
Hours Cost
High level of activity........ 75,000 $4,125,000
Low level of activity......... 50,000 3,250,000
Change........................... 25,000 $ 875,000
Variable cost element:
Fixed cost element:

Total cost at the high level of activity.................. $4,125,000
Less variable cost element
(75,000 MHs × $35 per MH)............................ 2,625,000
Fixed cost element............................................ $1,500,000
Therefore, the cost formula for maintenance is $1,500,000 per year plus
$35 per direct labor-hour or
Y = $1,500,000 + $35X

3. Total factory overhead cost at 70,000 machine-hours is:

Indirect materials
(70,000 MHs × $100 per MH)............... $ 7,000,000
Rent...................................................... 6,000,000
Maintenance:
Variable cost element
(70,000 MHs × $35 per MH).............. $2,450,000
Fixed cost element............................... 1,500,000 3,950,000
Total factory overhead cost..................... $16,950,000

1. Sales staff wages are a mixed cost with both fixed ($80,000 salary) and
variable components (commissions). However the variable component is
non-linear since the commission rate increases as sales dollar volume
increases.
2. Total wages will be as follows for a salesperson who sells $210,00 of the
company’s service:
Cumulative
Sales Wages
Fixed salary $80,000
Commissions:
First $100,000 in sales $100,000 $ 5,000
Next $50,000 in sales $150,000 $ 3,500
Next $50,000 in sales $200,000 $ 4,500
Final $10,000 in sales $210,000 $ 1,500
Total wages $94,500
3. A potential negative behavioural consequence of the commission struc-

ture used by Learn Fast is that sales staff may use high-pressure sales
tactics to increase sales and the related commissions. While this may be
good for the company in the short term (i.e., sales will grow) it may be
off-putting to clients to have to deal with aggressive sales staff. This
could hurt the company’s ability to do business with that client in the fu-
ture and or result in a negative reputation for the company. Alternat-
ively, the relative high portion of the sales staff compensation that is
fixed means that there may not be enough incentive, in the form of
commission, to provide the extra motivation it is designed to achieve.
4. Customer support staff wages are a mixed cost with both fixed ($78,000
salary) and variable components ($60 per hour). These wages are also
step-variable in the sense that as Learn Fast grows more customer sup-
port staff will need to be hired to keep up with the demand for technical
support services.

Problem 3-18 continued
5. Cost formula for weekly support staff wages:

Y = $1,500 + $60 (X–35)1
1
$1,500 = $75,000/50; X = number of hours worked in excess of 35-
hour standard work-week.
6. Total customer support staff wages for most recent annual period:
($75,000 x 2) + (1,000 x $60) = $210,000
Total annual customer support staff wages if new staff member is hired:
($75,000 x 2) + $70,000 = $220,000
The benefit of hiring the new support staff member is that will ease the
workload of the existing employees who are working nearly 10 hours
per week of overtime. It will also allow Learn Fast to better service the
expected growth in the customer-base since they will have an additional
capacity of 1,750 service hours (50 x 35 hours per week).
The key disadvantage is that the new staff member may not have
enough work to keep him or her busy until more customers are ac-
quired. Assuming a similar level of customer service activity as last year
for existing customers, the new employee will only be working 20 hours
per week (1,000/50). This will increase as new customers are attained
but this will take time. This is a key issue with step-variable cost such as
wages whereby additional capacity to serve customers comes in large
‘chunks’ (i.e., 35 hours per week).

Case 3-19 (30 minutes)
1. The completed scattergraph for the number of direct labour hours as
the activity base is presented below:
90,000
81,000
72,000
63,000
Overhead Cost
54,000
45,000
36,000
27,000
18,000
9,000
0
0 900 1,800 2,700 3,600 4,500 5,400 6,300
Direct Labour Hours

Case 3-19 (continued)
2. The completed scattergraph for the number of jobs as the activity base
is presented below:
90,000
81,000
72,000
63,000
Overhead Cost
54,000
45,000
36,000
27,000
18,000
9,000
0
0 100 200 300 400 500 600 700
Number of jobs

3. For several reasons, the number of direct labour-hours should be used
as the activity base for predicting overhead costs. First, the
scattergraphs suggest that it is easier to approximate the relationship
between labour-hours and overhead costs with a straight line than it is
for total number of jobs completed in a month. Although both activity
measures appear to have linear relationship with overhead costs, direct
labour-hours appears to a better fit. Second, jobs differ with respect to
complexity with more complex jobs requiring more direct labour-hours
since they take longer to complete. Thus more complex jobs would likely
result in the incurrence of more variable overhead costs such as
electricity. Evidence of the differing mix of job complexity is indicated by
the fact that during several months, around 500 jobs were completed
(January, July, September, and December) but overhead ranged from
$75,045 to $83,434 across those months. Third, management has the
flexibility to change the mix of welders used across jobs. More
experienced welders are more efficient and waste less indirect materials
suggesting labour-hours may be a better predictor of overhead costs.
4.
Direct Labour-
Hours Overhead Costs
August—High level of activity............ 6,114 $81,582
May—Low level of activity................. 1,914 60,162
Change........................................... 4,200 $ 21,420
Variable cost per unit of activity:
Change in cost = $21,420 = $5.10 per DLH

Change in activity 4,200 DLHs
Total cost at the high level of activity................... $81,582.00

Less variable cost element 31,181.40
($5.10 per unit × 6,114 hours)
Fixed cost element............................................. $ 50,400.60
Therefore, the cost formula is:
$ Y = $50,400.60 + $5.10X, where X represents the number of direct
labour-hours.
Case 3-20 (60 minutes)
1. High-low method:
Hours Cost
High level of activity........ 25,000 $99,000
Low level of activity......... 10,000 64,500
Change........................... 15,000 $34,500
Variable element: $34,500 ÷ 15,000 DLH = $2.30 per DLH

Fixed element:
Total cost—25,000 DLH......................... $99,000
25,000 DLH × $2.30 per DLH............. 57,500
Fixed element...................................... $41,500
Therefore, the cost formula is: Y = $41,500 + $2.30X.
2. The scattergraph is shown below:

Y
$100,000
$95,000
$90,000
$85,000
Over
head
$80,000
Cost
s $75,000
$70,000
$65,000
$60,000 X
8,000 10,000 12,000 14,000 16,000 18,000 20,000 22,000 24,000 26,000
Direct Labor-Hours

2. The scattergraph shows that there are two relevant ranges—one below
19,500 DLH and one above 19,500 DLH. The change in equipment lease
cost from a fixed fee to an hourly rate causes the slope of the regression
line to be steeper above 19,500 DLH, and to be discontinuous between
the fixed fee and hourly rate points.
3. The cost formula computed with the high-low method is faulty since it is
based on the assumption that a single straight line provides the best fit
to the data. Creating two data sets related to the two relevant ranges
will enable more accurate cost estimates.
4. High-low method:
Hours Cost
High level of activity........ 25,000 $99,000
Low level of activity*....... 20,000 80,000
Change........................... 5,000 $19,000
*Note: this is the next highest data point after 19,500 hours (i.e. the
second ‘relevant range’)
Variable element: $19,000 ÷ 5,000 DLH = $3.80 per DLH

Fixed element:
Total cost—25,000 DLH......................... $99,000
25,000 DLH × $3.80 per DLH............. 95,000
Fixed element...................................... $4,000
Expected overhead costs when 22,500 machine-hours are used:

Variable cost: 22,500 hours × $3.80 per hour............ $85,500
Fixed cost............................................................... 4,000
Total cost................................................................ $89,500

Exercise 3A-1 (continued)
1.
The scattergraph plot is shown below:
$5,000
$4,500
$4,000
$3,500
$3,000
Utility Costs
$2,500
$2,000
$1,500
$1,000
$500
$0
40 60 80 100 120 140 160 180
Number of Scans
The scattergraph shows that the number of scans and total utility costs are
closely related and the relationship appears to be linear over the range of
50 to 160 scans.
2. A spreadsheet application such as Microsoft® Excel or a statistical

software package can be used to compute the slope and intercept of the
least-squares regression line. The results are:
Intercept (fixed cost)................ $924

Slope (variable cost per scan).... $20.69
R2............................................ 0.96
Therefore, the cost formula for monthly utility costs is:
Y = $924 + $20.69X
Note that the R2 is 0.96, which means that 96% of the variation in
monthly utility costs is explained by the number of scans. This is a very
high R2 and indicates a very good fit.

Exercise 3A-2 (30 minutes)
1. Using Microsoft Excel to conduct the regression analysis:
Fixed cost: $40,980
Variable cost: $6.17 per machine hour.
Cost prediction model: Y = $40,980 + $6.17X
2. Estimated costs if 3,000 machine hours are used:
$40,980 + $6.17(3,000) = $59,490
3. I would not feel confident using the cost prediction model from part 1
because 8,000 machine hours appears to be outside the relevant range
of activity.

Exercise 3A-3 (30 minutes)
1. A spreadsheet application such as Microsoft® Excel or a statistical

software package can be used to compute the slope and intercept of the
least-squares regression line. The results are:
Intercept (fixed cost)................ $206

Slope (variable cost per unit)..... $14.08
R2............................................ 0.98
Therefore, the cost formula is $206 per week plus $14.08 per unit.
Note that the R2 is 0.98, which means that 98% of the variation in
quality control costs is explained by the number of units produced. This
is a very high R2 and indicates a very good fit.
2. Total expected quality control costs if 20 units are produced:

Variable cost: 20 units × $14.08 per unit............... $281.60
Fixed cost........................................................... 206.00
Total expected cost.............................................. $487.60
3. It seems very plausible that as more units are produced, quality control
costs would increase since each unit produced goes through a quality
control process.

Problem 3A-4 (45 minutes)
1. A spreadsheet application such as Excel or a statistical software package

can be used to compute the slope and intercept of the least-squares
regression line for the above data. The results are:
Intercept (fixed cost).................. $38,501
Slope (variable cost per direct $5.27
labour hour)............................
2
R .............................................. 96%
Therefore, the variable cost per direct labour hour is $5.27 and the fixed
cost is $38,501 per month.
Note that the R2 is very high with 96% of the variation in total overhead
cost explained by direct labour hours. This is a very high R 2 and
indicates a very good fit.
2. Y = $38,501 + $5.27X, where Y is total manufacturing overhead and X

is the number of direct labour hours.
3. The estimated total overhead cost in a month with 3,900 labour hours
would be:
Fixed cost......................................................... $ 38,501
Variable cost (3,900 labour hours × $5.27 per
hour)............................................................. 20,553
Total cost.......................................................... $59,054
The estimate differs from the $58,400 incurred in December because a

regression model is based on fitting the regression line as close to the
actual data points as possible. It is almost always the case that the line
cannot be perfectly fit so there will be a difference “error” between the
estimated amount and the actual amount for any given level of the
independent variable. However, if the regression line is a good fit with
the data these errors are generally small. In this case the difference
between the estimated and actual amounts at 3,900 labour hours is only
$654 or about 1% above the actual. This difference would be
considered tolerable by managers.

1. The scattergraph is shown below.
$60,000 Chart Title
$50,000
$40,000
Guiding Expense
$30,000
$20,000
$10,000
$0
0 1,000 2,000 3,000 4,000 5,000
Customers
The scattergraph reveals several interesting points about the behavior of

guiding expenses:
• The relation between guiding expenses and number of customers is
approximated reasonably well by a straight line. (However, there
appears to be a slight downward bend in the plot as the customers
increase—evidence of increasing returns to scale. This could relate to
Chief Adventures getting quantity discounts on drinks and snacks
above certain volume levels.

Problem 3A-5 (continued)
• The data points are all fairly close to the straight line. This indicates
that most of the variation in guiding expenses is explained by the
number of customers. As a consequence, there probably wouldn’t be
much benefit to investigating other possible cost drivers for the
guiding expenses.
• Most of the guiding expenses appear to be fixed. This seems
reasonable given the information in the problem about the numerous
fixed expenses related to operating Chief Adventures.
2. It does seem economically plausible that the variable guiding expenses
would be related to the number of customers. For example, costs such
as drinks and snacks for the customers would likely be highly related to
the number of customers taken on tours in a given month. Thus, using
number of customers to predict guiding expenses makes sense.
3. Using Microsoft® Excel, the least-squares regression method yields

estimates of $5.25 per customer for the variable cost and $38,601 per
month for the fixed cost. The R2 is 96%. The high R2 is not surprising
given the scattergraph results in part 1 and the fact that it is
economically plausible that guiding expenses and number of customers
would be highly related.
4. Total variable costs for the tour:

Guide labour (2 guides x 3 hours each x
$20 per hour).................................... $120.00
Variable expenses (6 customers x $5.25
each from part 3 regression model).. . . 31.50
Total variable cost per guest.................. $151.50
The minimum amount Chief Adventures should charge for the tour is
$151.50 to ensure the variable costs (including guide wages) are
covered. Any amount charged above that will contribute towards
recovering some of the fixed costs of approximately $38,601 incurred
each month (per requirement 3 above).

1a.
Units Utilities
Produced Cost
(X) (Y)
60,000 $200,000
44,000 $180,000
84,000 $240,000
48,000 $300,000
72,000 $400,000
100,000 $420,000
120,000 $340,000
112,000 $480,000
A spreadsheet application such as Excel or a statistical software package

Intercept (fixed cost)................ $113,407
Slope (variable cost per unit)..... $2.58
R2............................................ 0.47
Therefore, the cost formula using units produced as the activity base is
$113,407 per month plus $2.58 per unit produced, or
Y = $113,407 + $2.58X.
Note that the R2 is 0.47, which means that only 47% of the variation in
utility costs is explained by the number of units produced.

Case 3A-6 (continued)
b. The scattergraph plot of utility costs versus units produced appears
below:
500
Chart Title
450
400
350
300
250
200
Utilities Cost (000s)
150
100
50
0
0 20 40 60 80 100 120 140
Units Produced (000s)

2a.
DLHs Utilities Cost

(X) (Y)
15,000 $200,000
9,000 $180,000
12,000 $240,000
18,000 $300,000
30,000 $400,000
27,000 $420,000
24,000 $340,000
33,000 $480,000
A spreadsheet application such as Excel or a statistical software package

Intercept (fixed cost)................ $68,000
Slope (variable cost per unit)..... $12
R2............................................ 0.93
Therefore, the cost formula using direct labour-hours as the activity
base is $68,000 per quarter plus $12 direct labour-hour, or
Y = $68,000 + $12X.
Note that the R2 is 0.93, which means that 93% of the variation in utility
costs is explained by the number of direct labour-hours. This is a very
high R2 and is an indication of a good fit.

b. The scattergraph plot of utility costs versus direct labour-hours
appears below:
500 Chart Title

450
400
350
300
250
Utilities Cost (000s)
200
150
100
50
0
0 5 10 15 20 25 30 35
Direct Labour-Hours (000s)

3. The company should probably use direct labour-hours as the activity
base, since the fit of the regression line to the data is much tighter than
it is with units produced. The R2 for the regression using direct labour-
hours as the activity base is twice as large as for the regression using
units produced as the activity base. However, managers should look
more closely at the costs and try to determine why utilities costs are
more closely tied to direct labour-hours than to the number of units
produced.

4. It is plausible that both units produced and direct labour hours would be
related to utilities costs. However, because different models require
different amounts of direct labour, it seems more plausible to expect a
strong association between labour hours and utilities costs. Using units
produced as the independent variable assumes no difference in labour
hour requirements across the various models. Not surprisingly, the
results of the regression analysis are consistent with the qualitative
assessment of economic plausibility with a much higher R 2 value for the
model using direct labour hours.


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Chapter 3

Cost Behaviour: Analysis and Use

Discussion Case 3-1

The relevant range in this example is 1,000 admissions to 2,000

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1. Units Shipped Shipping Expense

2. Variable cost element:

3. Fixed cost element:

5. Total shipping expense = $800 + $350(7)

6. Fixed expense is $800.

7. Variable expense = $350(10)

Price per unit $5,000

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9. Total contribution margin = 7 x $1,450 per unit

10. Operating income = Contribution margin – fixed costs

11. Contribution margin would decrease by:

13. Variable shipping expenses for 12 units:

14. Total shipping expenses for 12 units:

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2. The average cost of a smoothie declines as the number of smoothies

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2. It appears that shipping expenses are linearly related to the number of

3. Based on a visual inspection of the scattergraph it seems that shipping

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2. The cost formula is Y = $600 + $600X

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Taking into account the difference in behaviour between variable and

Sales (15,000 hours × $40 per hour)............................ $600,000

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Sales (700 x $2,000) $1,400,000

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1. Kilometers Total Annual

Variable cost per kilometer:

Fixed cost per year:

3. Fixed cost......................................................... $ 4,200

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1. Blood Tests Costs

Variable cost per blood test:

Fixed cost per month:

2. Expected blood test costs when 2,300 tests are performed:

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Number of Blood Tests Performed

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Difference in rooms occupied:

Change in cost = $2,064,000 = $1,290 per room

$1,290 per room ÷ 30 days = $43 per room per day.

2. Monthly operating costs at 80% occupancy (above)... $8,064,000

3. 4,000 rooms × 60% = 2,400 rooms occupied.

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For March manufacturing overhead cost is:

For June manufacturing overhead cost is:

Variable cost per unit:

Fixed cost per month:

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3. Cost of goods manufactured if 7,000 units are produced: