COST ACCOUNTING

Separating Mixed Cost

Absorption and Variable Costing
COST ACCOUNTING

Separating Mixed Cost

Items of cost with fixed and variable components. Mixed costs vary with the level of production, though not in
direct relation to it, probably because part of the cost is fixed while the rest is variable. Two types of mixed
costs exist - sem variable costs and step costs

There are different methods of separating mixed costs into xed and variable components: (l) Scatter Graph, (2) High-Low
point, (3) and Method of Least Square. We will illustrate the use of high-low point method and method of least square.

High-Low Point Method

Summary of electricity cost and labor hours
Months Labor Hours Cost of Electricity
Months Labor Hours Cost of Electricity
Highest (Oct) 47 726
January 28 625
February 24 565 Lowest (Feb) 24 565
March 30 630 Difference 23 161
April 33 640 Thus, Variable rate per labor hour is 7 (161/23).
May 38 685
Highest Low
June 34 640
Total Cost 726 565
July 35 655 VC (7x47) (329) Outlier = Ignored
August 40 700 (7x24) (168)
September 42 715 Fixed cost 397 397
October 47 726
Formula: y = a + bx
November 43 700
(Y)Total Cost = a(Fixed) + b(Variable)x( Activity level)
December 42 630
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COST ACCOUNTING X Y XY X²
28 625 17,500 784
24 565 13,560 576
Separating Mixed Cost 30 630 18,900 900
Method of Least Square 33 640 21,120 1,089
38 685 26,030 1,444
34 640 21,760 1,156
35 655 22,925 1,225
40 700 28,000 1,600
42 715 30,030 1,764
47 726 34,122 2,209
43 700 30,100 1,849
42 630 20,160 1,024
426 7,911 284,207 15,620
Months Labor Hours Cost of Electricity
January 28 625 b = 284,207 - 12(35.5)(659.25)
a = 659.25 - 6.77(35.5)
February 24 565 15,620 - 12(35.5)²
= 659.25 - 240.34
March 30 630 = 3,366.50 = 418.91
April 33 640 497
May 38 685 = 6.77
June 34 640
July 35 655 High-Low Least Square
August 40 700 Formula: y = a + bx Formula: y = a + bx
September 42 715 y = 397 + 7(x) y = 418.91 + 6.77(x)
October 47 726
November 43 700
December 42 630
COST ACCOUNTING

Absorption Costing vs Variable Costing

Absorption costing treats the costs of all manufacturing components (direct material, direct labor,
variable overhead, and xed overhead) as inventoriable, or product, costs in accordance with GAAP. It is
also known as Full Costing.
Variable costing is a cost accumulation method that includes only direct material, direct labor, and
variable overhead as product costs. This method treats xed manufacturing overhead (FOH) as a period
cost. It is also known as Direct Costing.
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COST ACCOUNTING

Variable Costing

In preparing nancial reports,

costs can be accumulated and
presented in different ways.
Th is is typically u se d in
managerial reporting and can
help make daily decisions on
capacity expansion and special
orders. Facilitate decision-
making by exclu ding xe d
manufacturing overhead costs,
which can create problems due
to h o w xe d co st s are
allocated to each product.
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 COST ACCOUNTING

Variable Costing
Break-even Point and Cost-Volume-Profit Analysis

Sales/Revenue xxx
Variable Cost Break-even Point
Product xxx The break-even point is the point at which total
cost and total revenue are equal, meaning there is
Period/Selling xxx (xxx) no loss or gain for your small business.
Contribution Margin xxx
Fixed Cost Thus, at BEP, the company generates neither a
pro t nor a loss on operating activities. Companies,
Product xxx however, do not wish merely to “break even” on
Period/Selling xxx (xxx) operations. The BEP is calculated to establish a
point of reference. Knowing BEP, managers are
Income before tax xxx better able to set sales goals that should result in
pro ts from operations rather than losses.
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COST ACCOUNTING

Variable Costing
Break-even Point and Cost-Volume-Profit Analysis

1. What is the total contribution margin per unit?

2. How many garden sheds must the company sell to break
even?
3. If the company wants to earn a pre-tax pro t of
200,000, how many garden sheds must it sells?
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 COST ACCOUNTING

Variable Costing
Break-even Point and Cost-Volume-Profit Analysis

Margin of Safety Degree of Operating Leverage

W h e n m a k i n g d e c i s i o n s a b o ut b u s i n e s s
opportunities and changes in sales mix, managers
often consider the margin of safety (MS), which is
the excess of budgeted or actual sales over break-
even sales. Th e MS is the amount that sales can
drop before reaching the BEP and, thus, provides a
measure of the amount of “cushion” against losses.
This measures how a percentage change in sales
from the current level will affect company
pro ts. In other words, DOL indicates how
sensitive the company’s pro t is to sales volume
increases and decreases.
DOL = CM / Pro t before tax

Margin of safety in units = Actual sales in units - Break-even sales in units

Margin of safety in $ = Actual sales in $ - Break-even sales in $
Margin of safety % = Margin of safety in units - Actual unit sales
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