FAR EASTERN UNIVERSITY

INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE

Accountancy Department

ACT1123 – Strategic Cost Management

Cedrick John S. Tayson, CPA, CMA (U.S.) Passer

Handout No. 1 – Cost Concepts and Cost Estimation and Analysis

PART I – Cost Concepts
COST BEHAVIOR
Cost behavior refers to the way costs respond to changes in volume or activity.
COST FUNCTION
Y = a + bX
[Y] – total costs (dependent variable)
[a] – total fixed costs (Y-axis intercept)
[bX] – total variable costs
[X] – activity or cost driver (independent variable)
[b] variable cost per unit (slope of the line)
Discussion Problems

PROBLEM NO. 1

Chanyeol Company manufactures and sells a single product. A partially completed schedule of
costs over a relevant range of 20 to 60 units produced each week is given below:
Units Produced
20 units 40 units 60 units
TOTAL COSTS
Variable costs (A) ? ? ?
Fixed costs (B) ? P600 ?
Total costs (C) ? ? ?
PER UNIT COSTS
Variable costs (D) P2 ? ?
Fixed costs (E) ? ? ?

REQUIRED:
1. Determine the correct amounts of those with (?) mark.
2. Which specific costs (2) remain constant over the relevant range?
 FAR EASTERN UNIVERSITY
INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE
Accountancy Department

ACT1123 – Strategic Cost Management

Cedrick John S. Tayson, CPA, CMA (U.S.) Passer

3. Which specific costs (2) are directly related with production?

4. Which specific cost is inversely related with production?
5. Express the cost formula based on the line equation form ‘Y = a + bX.’
6. If AJ plans to produce 30 units, then how much is the expected total costs?

PART II – Cost Estimation and Analysis

COST ESTIMATION METHODS
1. High-Low Method
The fixed and variable portions of the mixed costs are computed from the highest
and lowest points based on activity or cost driver.

2. Graphic Method / Scatter Diagram Method

All observed costs at different activity levels are plotted on a graph. Based on a
sound judgment, a regression line is then fitted to the plotted points to represent
the line function.

3. Least-Squares Regression Method

A statistical technique that determines the "line of best fit" for all the data points by
minimizing the sum of the squared deviations between line and the data points.

4. Other cost estimation methods:

a. Industrial Engineering Method – study between physical inputs and outputs
especially meant for totally new activities; engineering estimates indicate what
how much costs should be.
b. Account Analysis Method – each account is classified as either fixed or variable
based on experience and judgment of accounting and other qualified personnel
in the organization.
c. Conference Method – costs are classified based on opinions from various
company departments such as purchasing, process engineering, manufacturing,
employee relations and so on.
 FAR EASTERN UNIVERSITY
INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE
Accountancy Department

ACT1123 – Strategic Cost Management

Cedrick John S. Tayson, CPA, CMA (U.S.) Passer

CORRELATION ANALYSIS
Correlation Analysis is used to measure the strength of linear relationship between two or more
variables. The correlation between two variables can be seen by drawing a scatter diagram.
Coefficient of Correlation (r) measures the relative strength of linear relationship between two
(2) variables. Its value ranges from – 1.0 to + 1.0:
“r” Linear Relationship Scatter Diagram/Graphical Representation
+1.0 Direct/Positive Upward Sloping Line to the Right
0 None No Apparent Pattern/Random Points
-1.0 Inverse/Negative Downward Sloping to the Right

"r" Linear Relationship Scatter Diagram/Graphical Representation +1.0 Direct/Positive Upward

Sloping Line to the Right 0 None No Apparent Pattern / Random Points -1.0 Inverse/Negative
Downward Sloping Line to the Right
Coefficient of Determination (“r2”) indicates the degree to which the behavior of independent
variable predicts the dependent variable. The closer r 2 is to 1.0, the better (i.e., more
confidence) the independent variable predicts the behavior of the dependent variable.
Correlation analysis does not establish cause-&-effect pattern; it merely indicates a linear
relationship.
Discussion Problems

PROBLEM NO. 1

SEVENTEEN Products has presented the following information for the past eight months
operations:

Month Units Total Costs

April 8,000 P30,400
May 6,400 25,800
June 3,800 18,300
July 5,600 23,200
August 7,000 26,000
September 8,400 29,800
 FAR EASTERN UNIVERSITY
INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE
Accountancy Department

ACT1123 – Strategic Cost Management

Cedrick John S. Tayson, CPA, CMA (U.S.) Passer

October 7,800 26,500

November 6,800 25,700

REQUIRED: Using the high-low method, determine the following:

1. Variable cost per unit

2. Total annual fixed costs
3. Monthly cost function
4. Estimated cost assuming 5,000 units will be produced next month

PROBLEM NO. 2

F3 Co. operates a fleet of delivery trucks in Manila. The company has determined that if a truck
is driven 120,000 kilometers during a year, the average operating costs is P4.80 per kilometer. If
a truck is driven only 80,000 kilometers during a year, the average operating cost increases to
P5.20 per kilometer.

REQUIRED:

1. Using the high-low method, estimate the variable and fixed cost elements of the annual
cost of truck operation.
2. 2. Express the variable and fixed costs in the form Y = a + bX.
3. 3. If a truck were driven 110,000 kilometers during a year, what total cost would you
expect Prime to incur?
 FAR EASTERN UNIVERSITY
INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE
Accountancy Department

ACT1123 – Strategic Cost Management

Cedrick John S. Tayson, CPA, CMA (U.S.) Passer

PROBLEM NO. 3

Suredead Hospital contains 450 beds. The average occupancy rate is 80% per month. In other
words, on average, 80% of the hospital’s beds are occupied by patients. At this level of
occupancy, the hospital’s operating costs are P32 per occupied bed per day, assuming a 30-day
month. This P32 figure contains both variable and fixed cost elements. During the month of
June, the hospital’s occupancy rate was only 60%. A total of P326,700 in operating cost was
incurred during the month.

REQUIRED:

1. Using the high-low method, estimate the variable cost per occupied bed on a daily basis
and the total fixed operating costs per month.
2. Assume an occupancy rate of 70% per month. What amount of total operating cost
would you expect the hospital to incur?

PROBLEM NO. 4

Below are cost and activity data for a particular cost over the last four periods. Your boss has
asked you to analyze this cost so that management will have a better understanding of how this
cost changes in response to changes in activity.
Activity Cost
Period 1 41 468
Period 2 43 484
Period 3 48 520
Period 4 46 499
 FAR EASTERN UNIVERSITY
INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE
Accountancy Department

ACT1123 – Strategic Cost Management

Cedrick John S. Tayson, CPA, CMA (U.S.) Passer

REQUIRED:

Using the least-squares regression method, estimate the cost formula for this cost.

PROBLEM NO. 5

Minwon Inc. used Excel to run a least-squares regression analysis, which resulted in the
following ouput:
Regression Statistics
Multiple R 0.7225
R Square 0.8500
Observations 30
Constant 38,000
Coefficient 5.75
Standard error 0.4641

REQUIRED:

1. What is Minwon's total fixed cost?

2. What is Minwon's variable cost per unit?
3. What total cost would Newport predict for a month in which they sold 5,000 units?
4. What proportion of variation in Minwon's cost is explained by variation in production?
 FAR EASTERN UNIVERSITY
INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE
Accountancy Department

ACT1123 – Strategic Cost Management

Cedrick John S. Tayson, CPA, CMA (U.S.) Passer

PROBLEM NO. 6

1. Referring at the following scatter diagrams, we can conclude that:

a. Cost A will be easier to predict than Cost B

b. Cost B will be easier to predict than Cost A
c. Cost B has no variable component
d. Cost A is out-of-control

2. If the coefficient of correlation (r) between two variables is +1, then a scatter diagram
will appear to be a regression line that
a. Slopes upward to the right
b. Slopes downward to the right
c. Slopes upward to the left
d. Slopes upward to the left or right
3. Which correlation coefficient represents strongest relationship between two variables?
a. +0.50
b. -0.80
c. -0.05
d. +1.02

PROBLEM NO. 7

Niki, Inc. uses a semi-automated process in its production. It is faced with a proposal to
completely automate its production. Below are data for these alternative methods: Complete
Automation Semi-Automated Materials cost per unit P12.00 P10.50 Labor cost per unit 3.00
15.00 Other variable cost/unit 4.50 3.00 Lease cost per year 75,000 30,000 Maintenance
cost/year 15,000 6,000
 FAR EASTERN UNIVERSITY
INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE
Accountancy Department

ACT1123 – Strategic Cost Management

Cedrick John S. Tayson, CPA, CMA (U.S.) Passer

REQUIRED:

What is the indifference point?

PROBLEM NO. 8

Total production costs for Olivia, Inc. are budgeted at P2,300,000 for 50,000 units of budgeted
output and P2,800,000 for 60,000 units of budgeted output. Because of the need for additional
facilities, budgeted fixed costs for 60,000 units are 25 percent more than budgeted fixed costs
for 50,000 units.

REQUIRED:

How much is Olivia’s budgeted variable cost per unit of output?

 FAR EASTERN UNIVERSITY
INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE
Accountancy Department

ACT1123 – Strategic Cost Management

Cedrick John S. Tayson, CPA, CMA (U.S.) Passer

Practice Problems

Use the following information for the next two questions:

Castelo, Villasin and Barrera is a large, local accounting firm located in Cebu. Belle Castelo, one
of the Firm’s founders, appreciates the success her firm has enjoyed and wants to give
something back to her community. She believes that an inexpensive accounting services clinic
could provide basic accounting services for small businesses located in the province. She wants
to price the services at cost. Since the clinic is brand new, it has no experience to go on. Belle
decided to operate the clinic for two months before determining how much to charge per hour
on an ongoing basis. As a temporary measure, the clinic adopted an hourly charge of P50, half
the amount charged by Castelo, Villasin and Barrera for professional services. The accounting
services clinic opened on January 1. During January, the clinic had 120 hours of professional
service. During February, the activity was 150 hours. Costs for these two levels of activity usage
are as follows:

Professional hours 120 hours 150 hours

Salaries – Senior accountant P2,500 P2,500
Salaries – Office accountant 1,200 1,200
Internet and software 700 850
subscriptions
Consulting by senior partner 1,200 1,500
Depreciation (equipment) 2,400 2,400
Supplies 905 1,100
Administration 500 500
Rent (offices) 2,000 2,000
Utilities 332 365

1. The clinic’s monthly fixed costs amount to:

a. P8,600
b. P9,025
c. P425
d. P12,189
2. Apple Baby, the chief paraprofessional of the clinic, has estimated that the clinic will
average 140 professional hours per month. If the clinic is to be operated as a nonprofit
organization, how much will it need to charge per professional hour?
 FAR EASTERN UNIVERSITY
INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE
Accountancy Department

ACT1123 – Strategic Cost Management

Cedrick John S. Tayson, CPA, CMA (U.S.) Passer

a. P97.81
b. P87.06
c. 82.77
d. P22.60

Use the following information for the next four questions.

A local church wants to rent a hall for P3,000 a day to hold a Bingo fundraiser. Every session of
bingo requires a caller for P200. There are supplies that are needed that cost P3 per person
playing bingo. On average each bingo player spends P20 and 1,000 people attend each session.
P10,000 in prizes are awarded each session.
3. Total costs for 1 session can be classified as:
Fixed Costs Variable Costs
a. P13,200 P3
b. P3,000 P13,200
c. P13,200 P3,000
d. P10,000 P3,200

4. The church conducts 1 Bingo session per month. Over the course of the year, which cost
would not act as a variable cost based on just holding one more session?
a. Hall Rental
b. Caller Salary
c. Cost of Supplies
d. Prize Money
5. If the church conducts 12 sessions and 1,000 people attend in each session, then the
average cost per session is?
a. 9,600
b. 15,200
c. 14,700
d. 16,200
6. The church is thinking of holding 2 Bingo sessions per day with 1,000 people attending
each session. If they hold the 2 sessions, then the average cost per session is?
a. 9,600
b. 15,200
c. 14,700
d. 16,200
 FAR EASTERN UNIVERSITY
INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE
Accountancy Department

ACT1123 – Strategic Cost Management

Cedrick John S. Tayson, CPA, CMA (U.S.) Passer

7. At an activity level of 10,000 units, variable costs totaled P35,000 and fixed costs totaled
P20,800. If 16,000 units are produced and this activity is within the relevant range, then:
a. total cost would equal P89,280.
b. total unit cost would equal P4.80.
c. fixed cost per unit would equal P5.58.
d. total costs would equal P55,800
8. Martial Company uses the high-low method to derive the cost formula for electrical
power cost. According to the cost formula, the variable cost per unit of activity is P 3 per
machine hour. Total electrical power cost at the high level of activity was P 7,600 and
the low level of activity was P 7,300. If the high level of activity was 1,200 machine-
hours, then what was the low level of the activity?
a. 800 machine-hours
b. 1,000 machine-hours
c. 900 machine-hours
d. 1,100 machine-hours
9. Which of the following costs is most likely a variable cost?
a. P 4 per unit at 10 units; P 4 per unit at 20 units; P 4 per unit at 30 units
b. P 12 per unit at 10 units; P 6 per unit at 20 units; P 4 per unit at 30 units
c. P 3 per unit at 10 units; P 2.5 per unit at 20 units; P 2.33 per unit at 30 units
d. P 4 per unit at 10 units; P 3 per unit at 20 units; P 2.67 per unit at 30 units
10. The following data pertains to activity and costs for two months:
June July
Activity level in units 10,000 20,000
Variable costs P20,000 P?
Fixed costs 15,000 ?
Mixed costs 10,000 ?
Total costs P45,000 P70,000
Assuming that these activity levels are within the relevant range, the mixed costs for
July were:
a. P10,000
b. P35,000
c. P15,000
d. P40,000