© 2008 McGraw-Hill Ryerson Limited. Cost Behaviour Merchandisers Cost of Goods Sold Manufacturers Direct Material, Direct Labour, and Variable Manufacturing.

© 2008 McGraw-Hill Ryerson Limited.

Cost Behaviour

MerchandisersCost of Goods Sold

ManufacturersDirect Material, Direct Labour, and Variable

Manufacturing Overhead

Merchandisers and Manufacturers

Sales commissions and shipping costs

Service Organizations Supplies and travel

Examples of normally variable costs

Examples of normally fixed costs

Merchandisers, manufacturers, and service organizations

Real estate taxes, Insurance, Sales salariesDepreciation, Advertising


The Activity Base

Machinehours

Labourhours

Kilometresdriven

A measure of the event causing the incurrence of a variable cost – a cost driver

Unitsproduced


ExamplesAdvertising and Research and Development

ExamplesDepreciation on Buildings and

Equipment

Types of Fixed CostsFixed Costs

DiscretionaryMay be altered in the short term by current managerial decisions

CommittedLong-term, cannot be reduced in the short

term.


A mixed costhas both fixed and variable

components.

Mixed Costs


Fixed Monthly

Utility Charge

Variable

Utility Charge

Activity (Kilowatt Hours)

To

tal

Uti

lity

Co

stMixed Costs

X

Y

Total mixed cost


Total mixed cost Y

= a + bX

Fixed Monthly

Utility Charge

Variable

Utility Charge


To

tal

Uti

lity

Co

stMixed Costs

X

Y

The total mixed cost line can be expressed as an equation: Y = a + bX

Where: Y = the total mixed cost

a = the total fixed cost (thevertical intercept of the line)

b = the variable cost per unit ofactivity (the slope of the line)

X = the level of activity


Fixed Monthly

Utility Charge

Variable

Utility Charge


To

tal

Uti

lity

Co

st

Total mixed cost Y

= a + bX

Mixed Costs

bX

aX

Y

Example: Lori Yang leases an automated photo developer for $2,500 per year plus 2¢ per photo developed.

Equation of a straight line: Y = a + bX Y = $2,500 + $0.02X

So, Total mixed cost for 10,000 photos will be $2,500+ ($0.02*10,000) =$2,700 Lease Cost


The Analysis of Mixed Costs

Engineering Approach

Account Analysis

Scattergraph Method

Least-Square Regression Method

High-Low Method


WiseCo recorded the following production activity and maintenance costs for two months:

Using these two levels of activity, compute: the variable cost per unit; the fixed cost; and then express the costs in equation form Y = a + bX.

The High-Low Method

Units Cost

High activity level 9,000 9,700$ Low activity level 5,000 6,100 Change 4,000 3,600$


Unit variable cost =Change in

costChange in units

Units Cost


The High-Low Method


Units Cost


The High-Low Method

Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit


Units Cost


The High-Low Method

Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit Fixed cost = Total cost – Total variable cost

Fixed cost = $9,700 – ($0.90 per unit × 9,000 units)

Fixed cost = $9,700 – $8,100 = $1,600


Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit Fixed cost = Total cost – Total variable cost

Fixed cost = $9,700 – ($0.90 per unit × 9,000 units)

Fixed cost = $9,700 – $8,100 = $1,600 Total cost = Fixed cost + Variable cost (Y = a + bX) Y = $1,600 + $0.90X

Units Cost


The High-Low Method


If sales salaries and commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the variable portion of sales salaries and commission?

A. $0.08 per unit

B. $0.10 per unit

C. $0.12 per unit

D. $0.125 per unit

If sales salaries and commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the variable portion of sales salaries and commission?

A. $0.08 per unit

B. $0.10 per unit

C. $0.12 per unit

D. $0.125 per unit

Quick Check


If sales salaries and commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the fixed portion of sales salaries and commissions?

A. $ 2,000

B. $ 4,000

C. $10,000

D. $12,000

If sales salaries and commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the fixed portion of sales salaries and commissions?

A. $ 2,000

B. $ 4,000

C. $10,000

D. $12,000

Quick Check


Note• How does the high-low method work when you

have data for more than two periods?

• Select the two periods with the lowest and highest level of activity.

Patients Admitted

Costs of Admitting

March 2,510 15,204$ April 2,550 14,976$ May 2,480 14,680$ June 2,590 15,108$ July 2,670 15,060$

Low

High


The Scattergraph MethodDraw a line through the data points with about an

equal numbers of points above and below the line.

0 1 2 3 4

*

To

tal

Co

st i

n1,

000s

of

Do

llar

s

10

20

0

***

**

**

*

*

Activity, 1,000s of Units Produced

X

Y


The Scattergraph Method

Estimated fixed cost = $10,000

0 1 2 3 4

*

To

tal

Co

st i

n1,

000s

of

Do

llar

s

10

20

0

***

**

**

*

*


X

Y

The slope of this line is the variable unit cost. (Slope is the change in total cost

for a one unit change in activity).


The Scattergraph Method

Slope = Change in costChange in units

Horizontal distance is the change in activity.

0 1 2 3 4

*

To

tal

Co

st i

n1,

000s

of

Do

llar

s

10

20

0

***

**

**

*

*


X

Y

Vertical distance

is the change in cost.


• Software can be used to fit a regression line through the data points.

• The cost analysis objective is the same: Y = a + bx

Least-Squares Regression Method

Least-squares regression also provides a statistic, called

the adjusted R2, that is a measure of the goodness

of fit of the regression line to the data points.

Least-squares regression also provides a statistic, called

the adjusted R2, that is a measure of the goodness

of fit of the regression line to the data points.


0 1 2 3 4

To

tal

Co

st

10

20

0

Activity

****

**

****

Least-Squares Regression Method

R2 is the percentage of the variationin total cost explained by the activity.

R2 for this relationship is near100% since the data points are

very close to the regression line.X

Y


Note• Let’s plot the data for patient admitting costs.

$14,000

$14,200

$14,400

$14,600

$14,800

$15,000

$15,200

$15,400

2,450 2,500 2,550 2,600 2,650 2,700

Patients Admitted

Pat

ient

Adm

itti

ng C

osts


Note• Problems with the high-low method:

– Throws away information contained in all of the data other than the low and the high points.

– The low and high levels of activity tend to be unusual.

• You should always plot the data if you have more than two points to make sure it even makes sense to be using the high-low method.


The Contribution FormatTotal Unit

Sales Revenue 100,000$ 50$

Less: Variable costs 60,000 30

Contribution margin 40,000$ 20$

Less: Fixed costs 30,000

Net income 10,000$

The contribution margin format emphasizes cost behaviour. Contribution margin covers fixed costs

and provides for income.


The Contribution Format

Used primarily forexternal reporting.

Used primarily bymanagement.

© 2008 McGraw-Hill Ryerson Limited. Cost Behaviour Merchandisers Cost of Goods Sold Manufacturers Direct Material, Direct Labour, and Variable Manufacturing.

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