Chapter 3

Introduction to Management Accounting
2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton
3-1
ice Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgs
Introduction to Management
Accounting
Chapter 3
Measurement of Cost
Behavior
3-2
Linear-cost Behavior
Costs are assumed to be fixed or
variable within the relevant
range of activity
3-3
Mixed-Cost Behavior Patterns

Mixed costs contain elements of both
fixed- and variable-cost behavior.
The fixed-cost element is unchanged
over a range of cost-driver activity.
The variable-cost element varies
proportionately with cost-driver activity.
3-4
Mixed-Cost Behavior Patterns

Parkview Medical Center
Predicted costs = fixed + variable
costs (patient-days)
Predicted
costs = $10,000 + $5(4,000)
Predicted costs =
$30,000
3-5
Learning
Objective 2
Managements Influence on Cost

Behavior
Choice of process and product design

Quality levels
Product features
Distribution channels
3-6
Cost-Control Incentives
Managers use their
knowledge of cost
behavior to set
cost expectations.
Employees may
Receive rewards that
are tied to meeting
these expectations.
3-7
Learning
Objective 3
Cost Functions
Planning and controlling the activities

of an organization require accurate
and useful estimates of future
fixed and variable costs.
3-8
Cost Functions
Understanding relationships between costs
and their cost drivers allows managers to...
Make better operating, marketing,
And production decisions
Plan and evaluate actions
Determine appropriate costs for
short-run and long-run decisions.
3-9
Cost Functions
The first step in estimating or predicting
costs is measuring cost behavior as a
function of appropriate cost drivers.
The second step is to use these cost

measures to estimate future costs at
expected levels of cost-driver activity.
3 - 10
ce Hall Business Publishing, Introduction to Management Accounting 14/e, Horngren/Sundem/Stratton/Schatzberg/Burgs
Cost Function Equation

Let:
Y = Total cost
F = Fixed cost
V = Variable cost per unit
X = Cost-driver activity in number of units
The mixed-cost function is called a linear-cost function.

Mixed-cost function:
Y = F + VX
Y = $10,000 + $5.00X
3 - 11
Developing Cost Functions

Plausibility:
The cost function must be believable.
Reliability:
A cost functions estimates of costs
at actual levels of activity must reliably
conform with actually observed costs.
3 - 12
Learning
Objective 5
Methods of Measuring Cost

Functions
1.
2.
3.
4.
5.
Engineering analysis
Account analysis
High-low analysis
Visual-fit analysis
Least-squares regression analysis
3 - 13
Engineering Analysis
Engineering analysis measures cost behavior
according to what costs should be,
not by what costs have been.
Engineering analysis entails a systematic

review of materials, supplies, labor,
support services, and facilities
needed for products and services.
3 - 14
Account Analysis
The simplest method of account analysis selects a plausible

st driver and classifies each account as a variable or fixed co
st
Parkview Medical Center

Amount
Fixed
Variable
ervisors salary and benefits

$ 3,800
$3,800
rly workers wages and benefits
14,674
$14,
pment depreciation and rentals
5,873
5,873
pment repairs
5,604
5,604
ning supplies
7,472
7,472
l maintenance costs
$37,423
$9,673
$27,750
3 - 15
Account Analysis Example

3,700 patient-days
Fixed cost per month = $9,673
Variable cost per patient-day
= $27,750 3,700
= $7.50 per patient-day
Y = $9,673 + ($7.50 patient-days)
3 - 16
High-Low Method
Plot historical data points on a graph.
Focus on the highest- and lowest-activity points.
High month: April
Maintenance cost: $47,000
Number of patient-days: 4,900
Low month: September
Maintenance cost: $17,000
Number of patient-days: 1,200
3 - 17
High-Low Method Example
The point at which the line intersects the Y axis is the

intercept, F, or estimate of Fixed Costs, and the slope of the
line measures the variable cost.
3 - 18

What is the variable cost (V)?
Using algebra to solve for variable and fixed costs.
Variable costs = Change in costs

change in activity
V = ($47,000 $17,000) (4,900 1,200)
= $30,000 3,700 = $8.1081
3 - 19

What is the fixed cost (F)?
F = Total mixed cost total variable cost
At X (high) F = $47,000 - ($8.1081 4,900 patient days)
= $47,000 $39,730
= $7,270 a month
At X (low) F = $17,000 = ($8.1081 1,200 patient days)
= $17,000 $9,730
= $7,270 a month
Cost function measured by high-low
method:
Y = $7,270
per month + ($8.1081 patient-days)
3 - 20
Visual-Fit Method
In the visual-fit method, the cost analyst
visually fits a straight line through a plot
of all of the available data, not just
between the high point and the
low point, making it more reliable
than the high-low method.
3 - 21
Least-Squares Regression Method

Regression analysis measures
a cost function more objectively
by using statistics to fit a cost
function to all the data.
Regression analysis measures
cost behavior more reliably than
other cost measurement methods.
3 - 22
The End
End of Chapter 3
3 - 23

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Introduction to Management Accounting

Mixed-Cost Behavior Patterns

Mixed-Cost Behavior Patterns

Managements Influence on Cost

Choice of process and product design

Planning and controlling the activities

The second step is to use these cost

Cost Function Equation

The mixed-cost function is called a linear-cost function.

Developing Cost Functions

Methods of Measuring Cost

Engineering analysis entails a systematic

The simplest method of account analysis selects a plausible

Parkview Medical Center

ervisors salary and benefits

Account Analysis Example

High-Low Method Example

The point at which the line intersects the Y axis is the

High-Low Method Example

Variable costs = Change in costs

High-Low Method Example

Least-Squares Regression Method

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