MGMT Acct Chapter 3

Managerial Accounting
Fourth Canadian Edition
Chapter 3
Cost Behaviour
Copyright © 2021 Pearson Canada Inc.

Objective 1
Describe key characteristics and graphs of various cost
behaviours.

Cost behaviour
Cost behaviour — how do changes in volume affect costs
There are three common cost behaviours:

1.Variable costs
2.Fixed costs
3.Mixed costs

Key Characteristics of Variable Costs
• Total variable costs change in direct proportion to changes
in volume
• Variable cost per unit remains constant
• Slope of the line represents variable cost per unit
Total variable cost (y) = Variable cost per unit of activity (v) x
Volume of activity (x) y = vx

Variable Costs (1 of 2)

Variable Costs (2 of 2)
Exhibit 3-1

Relevant Range
• The range of operations within which the total fixed costs
and the variable cost per unit remain constant
• Most commonly this is an issue of organizational capacity

Key Characteristics of Fixed Costs (1 of 2)
• Total fixed costs do not change over relevant range*
• Fixed costs per unit of activity vary inversely with changes
in volume
*Relevant range is the normal operating

range of activity

Key Characteristics of Fixed Costs (2 of 2)
Examples of fixed costs:
• Property taxes and insurance
• Depreciation and maintenance on parking ramp, hotel, and
room furnishings
• Pool, fitness room, and spa upkeep
• Cable TV and wireless internet access for all rooms
• Salaries of hotel department managers (housekeeping,
food service, special events, etc.)
• Committed fixed costs
• Discretionary fixed costs

Fixed Costs (1 of 2)

Fixed Costs (2 of 2)
Exhibit 3-3
y=f
Total fixed cost (y) = Fixed amount over a period of time (f)

Key Characteristics of Mixed Costs
• Total mixed costs increase as volume increases
• Mixed costs contain both variable and fixed cost
components
• Fixed component: Banff Rocky Mountain Resort’s utilities
are mixed costs because the hotel requires a certain
amount of utilities just to operate
• Variable component: the more guests at the hotel, the
more water, electricity, and gas are required.

Mixed Costs
Exhibit 3-5
If a hotel were completely empty, the

utilities would cost $2,000 per week.
These costs increase by $8 per guest.

Objective 2
Use cost equations to express and predict costs.

Cost Equation (1 of 2)
• Is a mathematical equation for a straight line that can be
used to predict total cost
• Total mixed costs increase as volume increases because
of the variable cost component.
• Mixed costs per unit decrease as volume increases
because of the fixed cost component.
• Total mixed cost graphs slope upward but do not begin at
the origin—they intersect the y-axis at the level of fixed
costs.

Cost Equation (2 of 2)
• Total mixed costs can be expressed as a combination of
the variable and fixed cost equations:
– Total mixed costs = variable cost component + fixed cost
component
y = vx + f
where
y = total mixed cost
v = variable cost per unit of activity (slope)
x = volume of activity
f = fixed cost over a given period of time (vertical
intercept)
Relevant Range (1 of 2)
• Band of volume where total fixed costs remain constant
• The hotel expansion, if carried out, will increase the hotel’s
fixed costs to a new level.
Exhibit 3-7

Relevant Range (2 of 2)
• Band of volume where variable costs per unit remain
constant
Exhibit 3-8
• With more capacity, negotiate greater volume discounts on

the toiletries, lowering variable toiletries cost per guest
Other Cost Behaviours (1 of 2)
Exhibit 3-10

Other Cost Behaviours (2 of 2)
• Curvilinear costs are not linear – they do not fit into any
neat pattern
• Approximate this type of cost as a mixed cost
Exhibit 3-11

Summary Problem 1 (1 of 3)
• Fitness-for-Life’s fixed operating costs were $10,000 per
month
• Variable operating costs were $1 per member per month
• Club’s existing facilities serve up to 750 members per
month
• Complete the following schedule for different levels

Monthly Operating Cost 100 Members 500 Members 750 Members

Total variable costs
Total fixed costs __________ ___________ __________
Total operating costs __________ ___________ __________
Variable cost per member
Fixed cost per member __________ ___________ __________
Average cost per member ‗‗‗‗‗‗‗‗‗‗‗ ‗‗‗‗‗‗‗‗‗‗‗ ‗‗‗‗‗‗‗‗‗‗‗

Why should the manager not use the average cost per
member to predict total costs at different levels?
100 Members 500 Members 750 Members
Total variable costs $ 100 $ 500 $ 750
Total fixed costs 10,000 10,000 10,000
Total operating costs $ 10,100 $ 10,500 $ 10,750
Variable cost per member $ 1.00 $ 1.00 $ 1.00
Fixed cost per member 100.00 20.00 13.33
Average cost per member $ 101.00 $ 21.00 $ 14.33

Sustainability and Cost Behaviour
E-banking and e-billing serves to reduce variable costs for
both the bank and society at large:
• reduced demand for printed bills reduces both the demand
for paper, ink/toner, shipping and disposal
• resulting is a reduction in the harvesting of trees,
production of dyes, use of fuel for transportation and
landfill space required
• costs are reduced to business and savings trickle down to
the customer

Objective 4
Use the high-low method to analyze cost behavior.

High-Low Method (1 of 2)
Step 1: Find variable cost per unit (slope) of cost line
Step 2: Find the fixed costs (vertical intercept)
Step 3: Create the cost equation
Advantage:
Easy to use
Disadvantage:
Only uses 2 data points

High-Low Method (2 of 2)
Exhibit 3-14

High-Low Method: (1 of 3)
Step 1: Find variable cost / unit (slope of the mixed cost line)
= Δ in cost (y) / Δ in volume (x)
Rise Change in cost y (high)  y (low)

Slope  Variable cost per unit of activity(v )   
Run Change in volume x (high)  x (low)
($209,600  $114,000)
 $8 per guest
(25,200 guests  13,250 guests)

Step 2: Find the fixed costs (vertical intercept)
= Total mixed cost – Total variable cost
Total mixed costs  Variable cost component  Fixed cost component

y  vx  f
$209,600  ($8 per guest  25,200 guests)  f

f  $8,000

Step 3: Create and use an equation to show the behaviour of
a mixed cost
y = total monthly utilities cost

x = number of guests
y = $8x + $8,000

Objective 6
Prepare contribution margin income statements for
service firms and merchandising firms.

Traditional Income Statement
• Organized by function
– Product costs comprised of Direct Material, Direct Labour and
Manufacturing Overhead
– Period costs comprised of Selling, General and Administrative
expenses
AAA FITNESS EQUIPMENT

Income Statement
Month Ended July 31
Sales revenue $ 52,500
Less: Cost of goods sold (27,300)
Gross profit 25,200
Less: Operating expenses (14,600)
Operating income $ 10,600

Contribution Margin Income Statement
• Organized by behaviour
– Variable Costs
– Fixed Costs
• Contribution Margin = Sales – Variable Costs
AAA FITNESS EQUIPMENT

Contribution Margin Income Statement
Month Ended July 31
Sales revenue $ 52,500
Less: Variable expenses (30,900)
Contribution margin 21,600
Less: Fixed expenses (11,000)

Objective 7 (Appendix 3A)
Use variable costing to prepare contribution margin
income statements for manufacturers.

Variable Costing
• Assigns only variable manufacturing costs to products
(DM, DL, Variable MOH) as well as other non-
manufacturing variable period costs
• Fixed manufacturing overhead = period cost
• For internal management decisions

Absorption Costing
• Required by financial reporting standards (ASPE and
IFRS) for external reporting
• Assign all manufacturing costs to products (DM, DL,

Variable MOH and Fixed MOH)
• Products “absorb” Fixed MOH
• Product costs include ALL inventoriable costs
• Traditional income statement

Absorption Costing vs Variable Costing
Absorption Costing Variable Costing
Product Costs Direct materials Direct materials
(Capitalized as Inventory of Direct labour Direct labour
until expensed as Cost Variable manufacturing overhead Variable manufacturing overhead
Goods Sold) Fixed manufacturing overhead
Period Costs Fixed manufacturing overhead
(Expensed in periods Variable nonmanufacturing costs Variable nonmanufacturing costs
incurred) Fixed nonmanufacturing costs Fixed nonmanufacturing costs
Focus External reporting— Internal reporting only

required by IFRS/ASPE
Income Statement Format Conventional income statement Contribution margin statement

Sportade Example (1 of 4)
Direct materials cost per case $ 6.00
Direct labour cost per case 3.00
Variable manufacturing overhead cost per case 2.00
Sales commission per case 2.50
Total fixed manufacturing overhead expenses 50,000
Total fixed marketing and administrative expenses $25,000

Sportade produced 10,000 cases of powdered Absorption Variable
mix as planned but sold only 8,000 cases at a Costing Costing
price of $30 per case.
Direct materials $ 6.00 $ 6.00
Direct labour 3.00 3.00
Variable manufacturing overhead 2.00 2.00
Fixed manufacturing overhead 5.00*
Total cost per case $16.00 $11.00
*50,000 fixed manufacturing overhead

 $5 per case
10,000 cases

SPORTADE
Income Statement (Absorption Costing)
Month Ended March 31
Sales revenue (8,000  $30) $ 240,000
Deduct: Cost of goods sold:
Beginning finished goods inventory $ 0
Cost of goods manufactured (10,000  $16) 160,000
Cost of goods available for sale 160,000
Ending finished goods inventory (2,000  $16) (32,000)
Cost of goods sold (128,000)
Gross profit 112,000
Deduct: Operating expenses [(8,000  $2.50) + $25,000] (45,000)

SPORTADE
Contribution Margin Income Statement (Variable Costing)
Month Ended March 31
Sales revenue (8,000  $30) $ 240,000
Deduct: Variable expenses:
Variable cost of goods sold:
Beginning finished goods inventory $ 0

Variable cost of goods manufactured (10,000  $11) 110,000
Variable cost of goods available for sale 110,000
Ending finished goods inventory (2,000  $11) (22,000)
Variable cost of goods sold 88,000
Sales commission expense (8,000  $2.50) 20,000 (108,000)

Contribution margin 132,000
Deduct: Fixed expenses:
Fixed manufacturing overhead 50,000
Fixed marketing and administrative expenses 25,000 (75,000)

Conventional vs Contribution Margin
Income Statements
Conventional Income Statement Contribution Margin Income Statement
Sales revenue Sales revenue
Deduct Cost of Goods Sold: Deduct Variable Expenses:
Variable manufacturing cost of goods sold Variable manufacturing cost of goods sold
Fixed manufacturing cost of goods sold Variable nonmanufacturing expenses
= Gross profit = Contribution margin

Absorption Costing and Manager Incentives
• When inventories remain constant, absorption costing
income and variable costing income are the same
• When inventories increase, absorption costing income is
higher than variable costing income
• When inventories decrease, absorption costing income is
lower than variable costing income
• Therefore…managers may increase production to build up
inventory to maximize income and therefore their own
bonus

Objective 8 (Appendix 3B)
Use segmented reporting to utilize the contribution
margin income statement format in an organization with
two or more divisions.

Segmented Income Statements
• Consolidated financial statements are always used for
external reporting
• Often, managers need more information, and used
segmented information for internal reporting only
• Helps managers to evaluate performance of different
products, services or departments
• Evaluates performance based only on costs that would be
saved if the segment (i.e. a specific product, service or
department) ceased to exist

Traceable Costs vs. Common Fixed Costs
• While fixed costs are often allocated to sub-units in a
traditional income statement, they can lead to false
assumptions such as the belief that elimination of a
segment will result in greater profits.
• Common fixed costs—which would not be eliminated in
the event of dropping a segment—should not be included
in evaluating segment performance.
• Only traceable fixed costs will be eliminate if a segment
is dropped.

Segmented Income Statement – Exhibit 3-26
MAPLEWOOD EQUESTRIAN CENTRE
Segmented Income Statement
for the Year Ended December 31, 2020
Boarding Lessons Totals
Sales $115,500 $248,500 $364,000
Variable costs (36,000) (47,000) (83,000)
Contribution margin 79,500 201,500 281,000
Traceable fixed costs (27,000) (45,000) (72,000)
Segment margin $ 52,500 $156,500 209,000
Common costs (167,000)
$ 42,000

Selecting Segments and Levels of
Segmentation
• Segments are selected depending on how useful the
information will be to managers
• Product lines, geographic regions, size of outlets, or other
distinct groupings
• The level of detail of information available and required will
largely determine the level of segmentation
• Segments can be subdivided further (i.e. the Boarding
segment can be divided into those using indoor full-service
board and those using outdoor board for horses that do not
have an indoor stall)

Quick Check

Quick Check Question (1 of 8)
1. The cost per unit decreases as volume increases for
which of the following cost behaviours?
a. variable costs and fixed costs
b. fixed costs and mixed costs
c. variable costs and mixed costs
d. only fixed costs

Quick Check Answer (1 of 8)
1. The cost per unit decreases as volume increases for
which of the following cost behaviours?
a. variable costs and fixed costs
b. fixed costs and mixed costs
c. variable costs and mixed costs
d. only fixed costs

2. Which of the following would generally be considered a
committed fixed cost for a retailing firm?
a. cost of annual sales meeting for all employees
b. cost of sponsoring the local golf tournament for charity
c. lease payments made on the store building
d. cost of a trip to Cancun given to the employee who is
Employee of the Year

2. Which of the following would generally be considered a
committed fixed cost for a retailing firm?
a. cost of annual sales meeting for all employees
b. cost of sponsoring the local golf tournament for charity
c. lease payments made on the store building
d. cost of a trip to Cancun given to the employee who is
Employee of the Year

4. How is the high point selected for the high-low method?
a. The point with the highest total cost is chosen.
b. The point that has the highest costs and highest
volume of activity is always chosen.
c. The point with the highest volume of activity is chosen.
d. Both the high point and the low point are selected at
random.

4. How is the high point selected for the high-low method?
a. The point with the highest total cost is chosen.
b. The point that has the highest costs and highest
volume of activity is always chosen.
c. The point with the highest volume of activity is
chosen.
d. Both the high point and the low point are selected at
random.

6. The contribution margin income statement
a. arrives at operating income by subtracting operating
expenses from gross profits.
b. is required for external reporting.
c. provides owners with cash flow information.
d. is useful to managers in decision-making and planning.

6. The contribution margin income statement
a. arrives at operating income by subtracting operating
expenses from gross profits.
b. is required for external reporting.
c. provides owners with cash flow information.
d. is useful to managers in decision-making and
planning.

7. The only difference between variable costing and
absorption costing lies in the treatment of
a. fixed manufacturing overhead costs.
b. variable manufacturing overhead costs.
c. direct materials and direct labour costs.
d. variable nonmanufacturing costs.

7. The only difference between variable costing and
absorption costing lies in the treatment of
a. fixed manufacturing overhead costs.
b. variable manufacturing overhead costs.
c. direct materials and direct labour costs.
d. variable nonmanufacturing costs.

8. A multinational company that produces three brands of
tires (in both all-season and winter varieties) and 20
different wheel designs (in both steel and alloy) in North
America and Europe could segment their income
statements in all of the following segments except for
a. tires and wheels.
b. winter tires, summer tires, steel wheels, and alloy
wheels.
c. North American Region and European Region.
d. North American Region and Tires.

8. A multinational company that produces three brands of
tires (in both all-season and winter varieties) and 20
different wheel designs (in both steel and alloy) in North
America and Europe could segment their income
statements in all of the following segments except for
a. tires and wheels.
b. winter tires, summer tires, steel wheels, and alloy
wheels.
c. North American Region and European Region.
d. North American Region and Tires.

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Managerial Accounting

Fourth Canadian Edition

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

There are three common cost behaviours:

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

*Relevant range is the normal operating

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

If a hotel were completely empty, the

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

• With more capacity, negotiate greater volume discounts on

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

Monthly Operating Cost 100 Members 500 Members 750 Members

Total fixed costs __________ ___________ __________

Total operating costs __________ ___________ __________

Variable cost per member

Fixed cost per member __________ ___________ __________

Average cost per member ‗‗‗‗‗‗‗‗‗‗‗ ‗‗‗‗‗‗‗‗‗‗‗ ‗‗‗‗‗‗‗‗‗‗‗

Copyright © 2021 Pearson Canada Inc.

Total fixed costs 10,000 10,000 10,000

Total operating costs $ 10,100 $ 10,500 $ 10,750

Variable cost per member $ 1.00 $ 1.00 $ 1.00

Fixed cost per member 100.00 20.00 13.33

Average cost per member $ 101.00 $ 21.00 $ 14.33

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

Rise Change in cost y (high)  y (low)

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Total mixed costs  Variable cost component  Fixed cost component

$209,600  ($8 per guest  25,200 guests)  f

Copyright © 2021 Pearson Canada Inc.

y = total monthly utilities cost

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

AAA FITNESS EQUIPMENT

Copyright © 2021 Pearson Canada Inc.

AAA FITNESS EQUIPMENT

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

Copyright © 2021 Pearson Canada Inc.

• Assign all manufacturing costs to products (DM, DL,

Copyright © 2021 Pearson Canada Inc.

(Capitalized as Inventory of Direct labour Direct labour

until expensed as Cost Variable manufacturing overhead Variable manufacturing overhead

Goods Sold) Fixed manufacturing overhead

Period Costs Fixed manufacturing overhead

(Expensed in periods Variable nonmanufacturing costs Variable nonmanufacturing costs

Total fixed costs ____ _ ______

Total operating costs ____ _ ______

Fixed cost per member ____ _ ______