Cost Drivers & Cost

Behaviors
 Cost Behavior Analysis
Cost Behavior Analysis is the study of how specific costs respond to changes in
the level of business activity.

● Some costs change; others remain the same

● Helps management plan operations and decide between alternative courses
of action
● Applies to all types of businesses and entities
● Starting point is measuring key business activities.
 Cost Behavior Analysis
Cost Behavior Analysis is the study of how specific costs respond to changes in
the level of business activity.

● Activity levels may be expressed in terms of:

○ Sales in Pesos (in a retail company)
○ Miles driven (in a trucking company)
○ Room occupancy (in a hotel)
○ Dance classes taught (by a dance studio)
● Many companies use more than one measurement bases
 Cost Behavior Analysis
Cost Behavior Analysis is the study of how specific costs respond to changes in
the level of business activity.

● Changes in the level or volume of activity should be correlated with changes

in costs.
● Activity level selected is called activity or volume index
● Activity index:
○ Identifies the activity that causes that causes changes in the behavior of costs.
○ Allows costs to be classified as variable, fixed, or mixed.
Variable Costs -
costs that change in
direct proportion to
activity level.

Fixed Costs - costs

that remain
constant regardless
of activity level.

Mixed Costs -
costs that have both
a variable element
and a fixed element.

Image Source: Openstax CC BY-NC-SA 4.0

 Variable Costs
Behavior of Total and Unit Variable Costs
XYZ Company manufactures laptop computers
that contain a P5,000 camera.
● The activity index is the number of laptops
produced.
● As XYZ manufactures laptops, the total
variable cost of cameras used increases.
● The variable cost per unit of camera is the
same regardless whether XYZ produces 2 or
5 laptops.
 Fixed Costs
Behavior of Total and Unit Fixed Costs

XYZ Company leases its facilities at a cost of

P100,000 per month.

● Total fixed costs of the facilities will remain

constant at every level of activity.
● But, on a per unit basis, the cost of rent
will decline as activity increases.
 Types of Fixed Costs

COMMITTED DISCRETIONARY

Long-term, cannot be May be altered in the

significantly reduced in the short-term by current
short term. managerial decisions.

Examples: Examples:
Depreciation Advertising
Real Estate Taxes Research & Development
 Question
Variable costs are costs that:

a. Vary in total directly and proportionately with changes in the activity level.
b. Remain the same per unit at every activity level.
c. Neither of the above
d. Both (a) and (b) above
 Relevant Range
● Throughout the range of possible levels of
activity, a straight-line relationship usually
does not exist for either variable costs or
fixed costs.
● Relationship between variable costs and
changes in activity level is often Image Source Quizlet

curvilinear.
● For fixed costs, the relationship is also
non-linear - some fixed costs will not
change over the entire range of activities,
while other fixed costs may change.

Image Source: Quora

 Mixed Cost
Mixed costs, also known as semi-variable costs, are business expenses that have
both fixed and variable components.

Examples:
Part of a mixed cost
changes with volume
Electric Bills
or usage, and part is
Telephone Bills
fixed over a particular
Heating Costs
period.
 ACTIVITY: Types of Costs
ABC Company reports the following total costs of two levels of production.

Classify each cost as variable, fixed, or mixed.

Variable

Fixed

Mixed
Cost Estimation Methods
 Cost Estimation Methods
1. Engineering estimates
2. Account Analysis
3. Statistical Regression Analysis
a. High-Low Method
b. Scatter Graph
c. Regression

https://docs.google.com/spreadsheets/d/1FKJhPPIm16NEwgVEa4RqI0_oS6Uls_EedrmOLkKKogc/edit#gid=0
 Regression Method
A method used to analyze mixed costs if a scattergraph plot reveals an
approximately linear relationship between the X and Y variables.

This method uses ALL of the data The goal of this method is to fit a
points to estimate the fixed and variable straight line to the data that minimizes
cost components of a mixed cost the sum of the squared errors.

https://docs.google.com/spreadsheets/d/1FKJhPPIm16NEwgVEa4RqI0_oS6Uls_EedrmOLkKKogc/edit#gid=0
 Multiple R:
● Correlation Coefficient. Tells us if there is
a relationship between the dependent
and independent.
● R is between 1 and -1.
● As R approaches 1 or -1, this mean the
model is a good predictor.
● As multiple R approaches 0, no
relationship.

R Square: Standard Error: Intercept = Fixed Cost

● Coefficient of determination: How well X ● How tightly the actual data
explains Y. points fit. Smaller the X Variable 1 = Unit Variable Cost
● The proportion of viability in Y explaining better.
by knowing something about X.
● As it approaches 1 - more explanatory Observation:
power ● How many data points we
● As it approaches 0 - less explanatory used
power. Predictor variable are not related
 Data Problems

● Missing Data
● Outliers
● Allocated and discretionary costs
● Inflation
● Mismatched time periods
● Trade-offs in choosing the time period

Managers should be aware of problems in the data. There is no substitute for experience when
estimating how costs and activities are related.
 Strengths and Weaknesses of Cost Estimation Methods

Method Strengths Weaknesses

Engineering ● Based on studies of what future costs Not particularly useful when the physical relation
should be rather than what past costs between inputs and outputs is indirect.
have been Can be costly to use

Account Analysis ● Provides a detailed expert analysis of Subjective

the cost behavior in each account

Regression Method ● Uses all the observations of cost data The regression model requires that several
● The line is statistically fit to the relatively strict assumptions be satisfied for the
observation results to be valid.
● Provides a measure of goodness of fit
of the line to the observations
● Relatively easy to use with computers
and sophisticated calculations.