Chap005_PPT

Chapter 5
Cost Behavior
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Cost Behavior Patterns
Cost behavior describes the way total cost

behaves, or changes, when some measure of
activity changes.
The range of activity within which assumptions
about cost behavior hold true is the relevant
range.
When analyzing cost behavior, we must limit
our analysis to the relevant range.
Learning Objective 5-1
Identify costs as variable, fixed, step, or mixed.
Identify Costs as Variable, Fixed,
Step, or Mixed (1 of 5)
Total variable costs increase as activity increases.

Variable cost per unit is constant as activity increases.
DM, DL cost (workers are paid on piece-rate basis)
Total fixed costs remain constant as activity increases.

Fixed cost per unit declines as activity increases.
Step-variable costs rise in multiple steps across the relevant

range.
Step-fixed costs are fixed over a fairly wide range of activities.
Identify Costs as Variable, Fixed, Step,
or Mixed (5 of 5)
Mixed costs contain a fixed portion that represents the
base amount that will be incurred regardless of activity. An
example would be a cell phone plan with a fixed charge
each month plus a charge based on minutes used.
s t
Co
Cost of Cell Phone
d
ixe Variable cost per
t a lM minute
To
Usage
Fixed monthly charge

Number of minutes used
Linear Assumption (1 of 4)
Linear Approaches to Estimate Cost Behavior (2 of 4 )
y = a + b(x)
Total cost = Total fixed cost + (Variable cost per unit ×
Activity)
• y = total cost, which is plotted on the vertical axis,
and is called the dependent variable.
• a = total fixed cost, an amount that will be incurred
regardless of the activity level, and is called the
intercept or the constant.
• b = the slope of the line, the unit variable cost, which
tells us how much the total cost (y) will increase for
each unit increase in activity (x).
• x = the activity that causes total cost (y) to change.
Activity (x) is also called the cost driver, or the
independent variable.
There are three different methods to analyze

mixed costs, all using the linear assumption
as a base.
1. Scattergraph
2. High-Low method
3. Least-Squares regression
Hypothetical Starbucks data.
Prepare a scattergraph to depict the

relationship between total cost and activity.
Creating a Scattergraph in Excel
Hypothetical data from a Starbucks location.
Use the high-low method to estimate cost

behavior.
High-Low Method (1 of 5)
Difference in Total Cost (y — y )
Variable Cost per Unit   1 2
Difference in Activity (x — x )
1 2
$15,750 — $13,250 $2,500
Variable Cost per Unit    $0.25 per Unit
15,000 — 5,000 10,000
Using the high point (February figures) to estimate

Total Fixed Cost = $15,750 – ($0.25 × 15,000)
Total Fixed Cost = $12,000
Using the low point (May) to estimate

Total Fixed Cost = $13,250 – ($0.25 × 5,000)
Total Fixed Cost = $12,000
Excel calculations for our hypothetical Starbucks location.
To estimate total overhead cost for

serving 8,000 customers
Use simple and multiple regression to estimate

cost behavior.
Least-Squares Regression Method
(1 of 5)
Simple Regression Using Excel

Y = 11,933 + 0.2716(X)
(2 of 5)
Predicting future overhead costs for serving 8,000 customers
Least-Squares Regression Method (3 of 5)
Multiple Regression Using Excel

Y = 3,059 + 0.18(X1) + 1.62(X2)
(4 of 5)
Linear Equation for Multiple Regression Analysis
(5 of 5)
Using multiple regression to predict future overhead cost.
Summary of Linear Methods
Linear Methods Advantages and Disadvantages
Exercise 1 (M5-10)
Jenny Beauty is in skin treatment business and the following are the operating data
for the first half of the year:
Month No. of Appointments Total Cost

Jan 250 $5,000
Feb 300 6,000
Mar 500 6,200
Apr 225 5,300
May 150 5,450
Jun 175 5,230
Required: Estimate the cost behavior using the High-Low Method
Prepare and interpret a contribution margin

income statement.
Contribution Margin Income
Statement (1 of 2)
Contribution Margin Income Statement for 15,000 Units Sold
Contribution margin is the difference between sales revenue

and variable costs.
Contribution Margin Income
Statement (2 of 2)
Calculation of Total Contribution Margin
Unit Contribution Margin
Unit contribution margin ($4.00) is the difference

between the unit sales price ($5.00) and the unit
variable cost ($1.00).
Contribution Margin Ratio (1 of 3)
Contribution Margin (2 of 3)
Assume that the manager of our Starbucks

Coffee shop want to spend an extra $3,000
each month for local advertising. She believes
the additional advertising will increase monthly
sales revenue by $5,000.
Should she do it?
Contribution Margin Ratio (3 of 3)
Increased sales $5,000
Less: Increased Variable costs (sales * 20%) 1,000
Increased contribution margin ($5,000 x 80%) 4,000
Less: Increased fixed costs 3,000
Increased net operating income $1,000
Learning Objective 5-S1
Compare variable costing to full absorption

costing.
Variable Versus Full Absorption Costing
Reconciling Variable and Full
Absorption Costing (1 of 5)
Costs and production information used in reconciliation example.
Difference in net operating income due to different treatment of

fixed manufacturing overhead.
Production = 10,000 units; Sales = 10,000 units
Production = 10,000 units; Sales = 12,000 units
Exercise 2 (E5-20)
Anita Kaur runs a courier service in downtown
Seattle. She charges clients $0.5 per mile driven.
Anita has determined that if she drives 3,300 miles
(4,400 miles) in a month, her total operating cost
is $875 ($1,095).
Required:
1. Using the high-low method, determine Anita’s
variable and fixed operating cost components.
2. Prepare a contribution margin income
statement for Anita’s service assuming she
drove 3,700 miles last month.

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Chapter 5

Cost behavior describes the way total cost

Identify costs as variable, fixed, step, or mixed.

Total variable costs increase as activity increases.

Total fixed costs remain constant as activity increases.

Step-variable costs rise in multiple steps across the relevant

Fixed monthly charge

There are three different methods to analyze

Hypothetical Starbucks data.

Prepare a scattergraph to depict the

Hypothetical data from a Starbucks location.

Use the high-low method to estimate cost

Using the high point (February figures) to estimate

Using the low point (May) to estimate

Excel calculations for our hypothetical Starbucks location.

To estimate total overhead cost for

Use simple and multiple regression to estimate

Simple Regression Using Excel

Multiple Regression Using Excel

Linear Equation for Multiple Regression Analysis

Using multiple regression to predict future overhead cost.

Linear Methods Advantages and Disadvantages

Month No. of Appointments Total Cost

Required: Estimate the cost behavior using the High-Low Method

Prepare and interpret a contribution margin

Contribution margin is the difference between sales revenue

Unit contribution margin ($4.00) is the difference

Assume that the manager of our Starbucks

Should she do it?

Less: Increased Variable costs (sales * 20%) 1,000

Increased contribution margin ($5,000 x 80%) 4,000

Less: Increased fixed costs 3,000

Increased net operating income $1,000

Compare variable costing to full absorption

Difference in net operating income due to different treatment of

Production = 10,000 units; Sales = 10,000 units

Production = 10,000 units; Sales = 12,000 units

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