Since 1977
MANAGEMENT ADVISORY SERVICES
MAS.2902 – Costs Behavior, Determination and Prediction
Cost classifications are used to define costs in terms of
their relationships to the following four items:
• Time of incurrence
• Reaction to changes in activity
• Classification on the financial statements
• Impact on decision-making
I. Cost behavior refers to the way costs respond to
changes in volume or activity.
II. Cost object is anything for which management
wants to collect or accumulate costs
III. Managers use assumptions about cost behavior
in almost every decision they make.
• When planning, managers use cost behavior to
determine how many units of products or
services must be sold to generate a targeted
amount of profit and how changes in planned
activities will affect operating income.
• When performing their duties, managers use
cost behavior to determine the impact of
their decisions on operating income.
• When evaluating and reporting on
performance, managers analyze how
changes in costs and sales affect
profitability.
IV. The behavior of costs
1. Variable costs. Total costs that change in
direct proportion to changes in productive
output (or other volume measures). However,
on a per unit basis, variable costs remain
constant as volume changes. The traditional
definition of variable costs assumes that a
linear relationship exists between costs and
the measure of capacity chosen.
2. Fixed costs are total costs that remain
constant within a relevant range of volume or
activity. Fixed unit costs vary inversely with
changes in activity or volume.
3. Mixed (semi-variable) costs have both variable
and fixed cost components.
Separating mixed costs into their variable and
fixed
1. Engineering method. Separates costs by
performing step-by-step analysis of tasks,
costs and processes involved. It is also called
a time and motion study.
2. Scatter diagram or visual fit method
• Used when there is doubt about the
behavior pattern of a particular cost.
• If the diagram suggests a linear
relationship, a cost line can be imposed.
The use of scatter diagram (visual fit)
usually reveals the presence of outliers.
3. High-low method
• Its disadvantage is that if one or both data
points are not representative of the
remaining data set, the estimate of
variable and fixed costs may not be
accurate.
• Its advantage is that it can be used when
only limited data are available.
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4. Regression analysis or the least-squares
method.
• Mathematically describe the relationship
between costs and activities
• Because all data observations are used, the
resulting linear equation is more
representative of cost behavior than either
the high-low or scatter diagram methods.
Contribution margin income statements
A. A contribution margin income statement is
formatted to emphasize cost behavior rather
than organizational functions.
B. Contribution margin (CM) is the amount that
remains after all variable costs are subtracted
from sales.
Operating leverage or cost structure. As part of
planning, the management should consider the
operating leverage, i.e., the relationship of fixed costs
to variable costs.
• Low operating leverage – It is characterized of
relatively lower amount of total fixed costs and
higher variable costs per unit. This cost
relationship involves less operating risk
because of having a lower amount of fixed
costs. However, because the amount of unit
variable cost is higher, the profit potential is
lower as the contribution margin per unit when
aggregated for the recovery of fixed cost and
generation of profit is relatively lower.
• High operating leverage – It refers to cost
relationship whereby the amount of fixed costs
is relatively higher with lower amount of
variable cost per unit. Hence, the profit
potential is higher but the operating risk is also
higher.
Note: The high operating leverage is suited for
higher activity level. If the company can only
operate at a lower level of activity, it is better to
employ low operating leverage because it so risky
to have higher amount of fixed costs that may not
be fully recovered by the amount of contribution
margin.
Indifference point. It is the level of volume at which
total costs, and hence the amount of profits, are
the same under both operating leverage. Based
on the indifference point, the manager can choose
between the cost-structure alternatives. If the
anticipated volume would exceed the
indifference point, the manager is likely to
choose higher operating leverage.
STRAIGHT PROBLEMS
PROBLEM 1. City Hardware operates within the Metro
Manila. The company has determined that if a truck is
driven 30,000 kilometers during a year, the average
operating costs is P15.00 per kilometer. If a truck is
driven only 20,000 kilometers during a year, the average
operating cost increases to P20.00 per kilometer.
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a. Using the high-low method, estimate the variable new supervisor totals P10,000. Calculate the fixed
and fixed cost elements of the annual cost of a truck cost and variable rate applicable to November 2019
operation. and the fixed cost and variable rate applicable to
b. Express the variable and fixed costs per truck in the March 2020?
form Y = a + bX. 3. What is the expected cost for the month of April
c. If the company using 5 delivery trucks were driven 2020 assuming that the center operates at 1,750-
130,000 kilometers during a year with each truck patient level?
driven at the relevant range, what total cost would
you expect City Hardware Company to incur? Problem 5. The controller of RS Company, a retail
store, is attempting to develop CVP relationships to be
PROBLEM 2 Islander Tours has incurred the following used for planning and control. He is not sure how this
bus maintenance costs during the recent tourist season. might be done and asks your assistance. Based on the
Month Kilometers Cost two income statements for June and July:
Traveled by Buses
June July
November 80,500 P1,039,500
December 106,000 1,344,600 Sales P50,000 P60,000
January 127,000 1,600,000
February 150,000 1,865,000 Cost of goods sold 30,000 36,000
March 200,000 2,450,000 Gross margin P20,000 P24,000
April 80,000 1,040,000
Operating expenses:
Required: Selling expenses P 7,400 P 7,700
1. Use the high-low method to estimate the variable
cost per tour kilometers traveled and the fixed cost Admin. expenses 6,200 6,400
per month. Total expenses P13,600 P14,100
2. Develop a formula to express the cost behavior
exhibited by the company’s maintenance cost. Income P 6,400 P 9,900
3. Predict the level of maintenance cost that would be
1. Determine the fixed and variable components
incurred during a month when 230,000 tour
of the different functional costs.
kilometers are driven.
2. Prepare a contribution margin income
statement based on sales of P70,000.
Problem 3. Recent monthly costs of maintenance
incurred by Silver Company are shown in the following
Problem 6. Don Rico, the owner of GLU Company, is
table.
trying to decide which of two machines to rent. He
needs a machine to sand the surfaces of a billiard table
Month Machine Hours Maintenance Costs
that GLU manufactures. The following data are related
January 160 P180,000
to the two alternatives.
February 170 185,000
March 160 182,000
Hand-Fed Automatic
April 180 200,000
Annual rental P24,000 P36,000
May 150 181,000
Other annual fixed
June 170 186,000
costs 120,000 150,000

Don Rico expects the variable cost per table to be P40

Required: Use the least-squares regression to estimate
using the hand-fed machine and P32 using the automatic
the cost behavior of company’s maintenance costs.
machine. He also expects annual volume of 3,000
Express the cost behavior in equation form.
tables.
Problem 4. Cebu Medical Center has collected data on
Required:
all of its activities for the past seven months. Data for
1. Determine the total annual cost to manufacture
the cardiac nursing care follow:
4,000 table under each alternative.
Hours of 2. Determine the annual volume of tables at which
Cost Nursing Care total manufacturing cost would be the same for each
September 2019 P69,500 1,700 type of machine.
October 2019 64,250 1,550
November 2019 52,000 1,200 PROBLEM 7. ASSIGNMENT (DO IT YOURSELF)
December 2019 66,000 1,600 1. What is the difference between variable costs and
January 2020 83,000 1,800 fixed costs?
February 2020 66,550 1,330 a. Variable costs per unit change in variable
March 2020 79,500 1,700 increments while fixed costs per unit change in
equal increments.
Required: b. Total variable costs are variable over the
1. Using the high-low method, calculate the variable relevant range and fixed over the long term
rate per hour and the fixed cost for the nursing care while fixed costs never change.
activity. c. Variable costs per unit are fixed over the
2. Upon looking into the events that happened at the relevant range while fixed costs per unit are
end of 2019, you find that the cardiology ward variable over the relevant range.
bought a cardiac-monitoring machine for the nursing d. Variable costs per unit fluctuate while fixed
station. A decision was also made to add a new cost per unit stays the same.
supervisory position for the evening shift. Monthly
depreciation on the monitor and the salary of the

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2. Cost drivers are
a. Activities that cause costs to increase as the
activity increases.
b. A mechanical basis such as machine hours,
computer time, or square footage, used to
assign costs to activities.
c. Methods used to control costs.
d. Accounting measurements used to determine
whether performance is meeting standards.
3. The relationship between cost and activity is
termed:
a. cost estimation.
b. cost prediction.
c. cost behavior.
d. cost analysis.
4. When graphed, a typical variable cost appears as
A:
a. horizontal line.
b. vertical line.
c. diagonal line that slopes downward to the
right.
d. diagonal line that slopes upward to the right.
5. Norman Company pays a sales commission of 5%
on each unit sold. If a graph is prepared, with the
vertical axis representing per-unit cost and the
horizontal axis representing units sold, how would
a line that depicts sales commissions be drawn?
a. As a straight diagonal line, sloping upward to
the right.
b. As a straight diagonal line, sloping downward
to the right.
c. As a horizontal line parallel to X-axis.
d. As a vertical line.
6. Which of the following is a fixed cost that would be
considered a direct cost?
a. a cost accountant’s salary when the cost
objective is a unit of product.
b. the rental cost of a warehouse to store
inventory when the cost objective is the
Purchasing Department.
c. a production supervisor’s salary when the cost
objective is the Production Department.
d. Board of Directors’ fees when the cost
objective is the Marketing Department.
7. Costs that remain the same over a wide range of
activity, but jump to a different amount outside
that range, are termed:
a. step-fixed costs
b. semivariable costs.
c. step-variable costs.
d. mixed costs.
8. A cost that has both a fixed and variable
component is best termed a:
a. step-fixed cost.
b. step-variable cost.
c. semivariable cost.
d. curvilinear cost.
9. The relevant range is that range of activity:
a. where a company achieves its maximum
efficiency.
b. where units produced equal units sold.
c. where management expects the firm to
operate.
d. where the firm will earn a profit.
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10. A variable cost that has a definitive physical
relationship to the activity measure is called a(n):
a. discretionary cost.
b. engineered cost.
c. managed cost.
d. programmed cost.
11. Costs that result from a company's ownership or
use of facilities and its basic organizational
structure are termed:
a. discretionary fixed costs.
b. committed fixed costs.
c. discretionary variable costs.
d. committed variable costs
12. High R2 measure in regression analysis is preferred
because:
a. it indicates a good fit of the regression line
through the data points.
b. it shows that a great deal of the change in the
dependent variable is explained by change
in the independent variable.
c. it means that the independent variable is a
good predictor of the dependent variable.
d. it means that the cost analyst can be relatively
confident in his or her cost predictions.
e. all of the preceding statements are true.
13. If a scattergraph contains points that do not fall in
a perfect line,
a. the relationship between the variables is not
good enough to warrant fitting a line to the
data.
b. this is an indication that there is no
relationship whatsoever between the variables.
c. the visual fit method and high-low methods
should not be used, but least-squares
regression can be used.
d. a straight line can still be used to approximate
the relationship if a general linear trend can be
discerned.
14. The cost estimation method that gives the most
mathematically precise cost prediction equation is
a. the high-low method.
b. the scatter-diagram method.
c. the contribution margin method.
d. regression analysis.
15. R-squared is a measure of
a. the spurious relationship between cost and
activity.
b. the fixed cost component.
c. the variable cost per unit of activity.
d. how well the regression line accounts for the
changes in the dependent variable.
Use the following to answer questions 16-18:
The management of Casablanca Manufacturing
Corporation believes that machine-hours is an
appropriate measure of activity for overhead cost
Shown below are machine-hours and total overhead
costs for the past six months:
Machine- Overhead
Hours Cost
Jan 150,000 P339,000
Feb 140,000 P328,000
Mar 160,000 P350,000
Apr 130,000 P319,500
May 170,000 P362,500
Jun 200,000 P400,000
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Assume that the relevant range includes all of the a. fixed cost
activity levels mentioned in this problem. b. mixed cost
c. step-variable cost
16. If Casablanca expects to incur 185,000 machine d. true variable cost
hours next month, what will the estimated total
overhead cost be using the high-low method? 24. The Ernie Company has provided information
a. P212,750 c. P359,750 concerning its 2016 projections as follows:
b. P382,750 d. P381,700
Net sales P10,000,000
17. What is Casablanca's independent variable? Fixed manufacturing costs 1,000,000
a. the year
b. the machine hours Ernie projects variable manufacturing costs of 60
c. the total overhead cost percent of net sales. Assuming no change in
d. the relevant range inventory, what will the projected cost of goods
. sold be?
18. What is Casablanca's dependent variable? The: a. P5,000,000
a. month b. P6,000,000
b. machine hours c. P7,000,000
c. total overhead cost d. P8,000,000
d. the relevant range
25. Anthony Company has projected cost of goods sold
19. The following production and average cost data of P4 million, including fixed costs of P800,000.
per unit for two levels of monthly production Variable costs are expected to be 75% of net
volume have been supplied by a company that sales. What will the projected sales be?
produces a single product: a. P4,266,667
2,000 4,000 b. P4,800,000
Production volume units units c. P5,333,333
Direct materials P88.40 P88.40 d. P6,400,000
Direct labor P20.60 P20.60
Manufacturing OH P86.90 P55.30 26. Stella, Inc. must perform maintenance on its
production machinery after every 10,000 units
The best estimate of the total monthly fixed produced. Production varies between 12,000 and
manufacturing cost is: 30,000 units a year. The cost of this maintenance
a. P221,200 c. P173,800 would be classified as a
b. P391,800 d. P126,400 a. variable cost c. step cost
b. fixed cost d. mixed cost
Use the following to answer question No. 20 - 23:
Galaxy Amusement Park is open from 8:00 am till 27. Holly, which uses the high-low method, had an
midnight every day of the year. Galaxy charges its average cost per unit of P10 at its lowest level of
patrons a daily entrance fee of P300 per person which activity when sales equaled 10,000 units and an
gives them unlimited access to all of the park's 35 average cost per unit of P6.50 at its highest level
rides. of activity when sales equaled 20,000 units. Holly
would estimate fixed costs as
20. Galaxy gives out a free T-shirt to every 100th a. P70,000. c. P8.25.
customer entering the park. The cost of this T- b. P16.50. d. P100,000.
shirt would best be described as a:
a. fixed cost 28. Citrus, Inc. used the high-low method to estimate
b. step-fixed cost that its fixed costs are P210,000. At its low level of
c. step-variable cost activity, 100,000 units, average cost was P2.60
d. true variable cost per unit. What would Citrus predict its average
cost per unit to be when production is 200,000
21. For liability insurance, Galaxy pays a set monthly units?
fee plus a small additional amount for every patron a. P1.05 c. P2.60
entering the park. The cost of liability insurance b. P1.55 d. P5.20
would best be described as a:
a. fixed cost 29. A mixed cost function has a constant component
b. mixed cost of P20,000. If the total cost is P60,000 and the
c. step-variable cost independent variable has the value 200, what is
d. true variable cost the value of the slope coefficient?
a. P200 c. P400
22. Galaxy employees a certified operator for each of b. P600 d. P40,000
its 35 rides. Each operator is paid P200 per hour.
The cost of the certified operators would best be The following data apply to questions 30 and 31.
described as a: Tory Company derived the following cost relationship
a. fixed cost from a regression analysis of its monthly
b. mixed cost manufacturing overhead cost.
c. step-variable cost
d. true variable cost y = P80,000 + P12X
where: y = monthly manufacturing overhead cost
23. Galaxy donates P10 of every entrance fee to a X = machine-hours
local homeless shelter. This charitable contribution
would best be described as a:

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The standard error of estimate of the regression is a. P700,000 c. P614,000

P6,000. b. P672,000 d. P586,000

The standard time required to manufacture one six- 36. A company wants to open a new store in one of
unit case of Tory’s single product is four machine- two nearby shopping malls. In Mall A, the rent will
hours. Tory applies manufacturing overhead to be P250,000 per year. In Mall B, the rent will be
production on the basis of machine-hours, and its 4% of gross revenues. Assuming that revenues
normal annual production is 50,000 cases. and all other elements under consideration are the
same for both malls, at what level of revenues will
30. Tory’s estimated variable manufacturing overhead the company be indifferent between the two malls?
cost for a month in which scheduled production is a. P1,000,000 c. P 4,000,000
10,000 cases would be b. P6,250,000 d. P12,500,000
a. P80,000. c. P160,000.
b. P480,000. d. P320,000. 37. Eat N Eat Shop operates sandwiches on the go in
shopping malls. The average selling price of a
31.Tory’s predetermined fixed manufacturing sandwich is P100. And the average cost of each
overhead rate would be sandwich is P80. A new mall is opening where Eat
a. P4.80/MH. c. P3.20/MH. N Eat wants to locate a shop but the location
b. P4.00/MH. d. P1.60/MH. manager is not sure about the rent method to
accept. The mall operators offer two options for
32. A management accountant performs a linear shop rentals as follows:
regression of maintenance cost vs. production 1. Paying a base rent of P40,000 plus 8% of
using a computer spreadsheet. The regression revenue received, or
output shows an "intercept" value of P322,897. 2. Paying a base rent of P20,000 plus 14% of
How should the accountant interpret this revenue received up to a maximum of P80,000
information? Eat N Eat will be indifferent between options 1
a. Y has a value of P322,897 when X equals zero. and 2 when its level of sales is
b. X has a value of P322,897 when Y equals zero.
a. 1,000 c. 900
c. The residual error of the regression is
b. 750 d. 3,333
P322,897.
d. Maintenance cost has an average value of
38. Edifer Tools, Inc. uses a semi-automated process in
P322,897.
its production. It is faced with a proposal to
completely automate its production. Below are data
33. In preparing the annual profit plan for the coming
for these alternative methods:
year, Wilkens Company wants to determine the
Complete Semi-
cost behavior pattern of the maintenance costs.
Automation Automated
Wilkens has decided to use linear regression by
Materials cost per
employing the equation y =a + bx for maintenance
unit P12.00 P10.50
costs. Based on the prior year's data regarding
Labor cost per unit 3.00 15.00
maintenance hours and costs, the result of the
Other variable cost
regression analysis are given below.
per unit 4.50 3.00
Average cost per hour P9.00
Lease cost per year 75,000 30,000
A 684.65
Maintenance cost
B 7.2884
per year 15,000 6,000
Standard error of a 49.515
The cost indifference point is at
Standard error of b .12126
a. 3,300 units c. 6,000 units
Standard error of the estimate 34.469
b. 3,000 units d. 6,300 units
R2 .99724
39. Litton Productions, Inc. owns and operates a chain of
Based upon the data derived from the regression
movie theaters. The theaters in the chain vary from
analysis, 420 maintenance hours in a month would
low volume, small town to high volume, Big
mean the maintenance costs (rounded to the
City/downtown theaters. Management is considering
nearest peso) would be budgeted at
installing machines that will make popcorn on the
a. P3,780 c. P3,790
premises. This proposed feature would be properly
b. P3,600 d. P3,746
advertised and is intended to increase patronage at
the company’s theaters.
34. In regression analysis, which of the following
These machine are available in two different sizes
correlation coefficients represents the strongest
with the following details:
relationship between the independent and
Economy Regular
dependent variables?
Annual capacity (in boxes) 50,000 120,000
a. 1.03 c. -.89
Costs
b. -.02 d. .75
Annual machine rental P 80,000 P110,000
Popcorn cost per box 1.30 1.30
35. Cook Co.'s total costs of operating five sales
Cost of each box 0.80 0.80
offices last year were P500,000, of which P70,000
Other variable costs/box 2.20 1.40
represented fixed costs. Cook has determined that
total costs are significantly influenced by the
The level of output in boxes at which the Economy
number of sales offices operated. Last year's costs
Popper and the Regular Popper would earn the same
and number of sales offices can be used as the
profit (loss) is
bases for predicting annual costs. What would be
a. 50,000 c. 37,500
the budgeted costs for the coming year if Cook
b. 65,000 d. 40,000
were to operate seven sales offices?

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40. Alma Corporation has developed the following

flexible budget formula for annual indirect labor
costs:
Total Cost = P180,000 + P4.50 per machine hr.
Operating budgets for the current month are based
upon 20,000 machine hours of planned machine
time. Indirect labor costs included in this monthly
planning budget are:
a. P 90,000 c. P180,000
b. P105,000 d. P270,000

– end -

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