1. Analyzing Cost Behavior
Session Two
MBA 502B Managerial Accounting
University of Scranton, Dr. Robyn Lawrence

2. Classifying Costs
In GAAP system, costs are classified according to function
Cost of goods sold
Selling
Administrative
Another classification system generally improves internal (management) decisions—according to cost behavior.
S-II: Analyzing Cost Behavior, MBA 502B,
Univ. of Scranton, Dr. R. Lawrence

3. Cost Behavior The manner in which a cost changes
as a related activity changes
Variable Fixed Mixed
Activity Base:
Cost Driver: causes changes in the behavior of costs.
Cost Predictor: accompanied by consistent, observable changes in a cost item (correlated with)--predicts but may not cause the cost to change
Activity Base Examples:
miles driven – in a trucking company,
room occupancy – in a hotel,
number of customers called on – by a salesperson, or
number of patients—in a hospital.
Relevant (Normal or Practical) Range:
the range of interest; or
the range over which a company expects to operate during a year.
S-II: Analyzing Cost Behavior, MBA 502B,
Univ. of Scranton, Dr. R. Lawrence

4. Variable Costs
Vary in total directly and proportionately with changes in the activity level;
Remain the same per unit at every level of activity.
Number of Cost per Total
Weekday Minutes Minute Cost
$10
200
400
600
800
Number of Weekday Minutes
Total
Cost
$20
$80
$60
$40
$100 .
S-II: Analyzing Cost Behavior, MBA 502B,
Univ. of Scranton, Dr. R. Lawrence

5. Fixed Costs
Remain the same in total regardless of changes in the activity level (within the relevant range).
Per unit cost varies inversely with the activity level.
Number of Cost per Monthly
Units Produced Unit Rent
$500
200
400
600
800
Number of Units Produced
Total
Cost
$200
$800
$600
$400
$1,000 .
400
600
800
200
Cost
Per
Unit
1.00
2.00
3.00 .
S-II: Analyzing Cost Behavior, MBA 502B,
Univ. of Scranton, Dr. R. Lawrence

6. Variable versus Fixed Costs
Total Cost
Unit Cost
Varies in direct
proportion to
changes in activity
Remains constant
throughout the
relevant range
Variable
Cost
Varies inversely
with changes in
activity throughout
the relevant range
Remains constant
throughout
the relevant range
Fixed
Cost
S-II: Analyzing Cost Behavior, MBA 502B,
Univ. of Scranton, Dr. R. Lawrence

7. Mixed Costs . Contain both variable and fixed cost elements.
Changes in total but not proportionately with changes in the activity level.
200
400
600
800
Number of Miles Driven per Day
Cost
$100
$800
$600
$400
$1,000 . 50
Example: Assume that local rental terms for a 17-foot moving truck, including insurance, are $50 per day plus $.50 per mile. The per diem charge is a fixed cost with respect to miles driven in a day, while the mileage charge is a variable cost.
High-low method, Scattergraph method or OLS Regression can be used to identify/estimate the fixed and variable components.
S-II: Analyzing Cost Behavior, MBA 502B,
Univ. of Scranton, Dr. R. Lawrence

8. Practice Classifying Costs
Below costs are given for two periods (and two levels of activity). Classify the costs as to variable, fixed, or mixed.
January February
1,000 units 1,200 units Classification
Rent $ $ 700
Maintenance
Utilities
Insurance
Inspection
Supplies
Indirect Labor
Direct Materials
Fixed
Variable
Mixed
S-II: Analyzing Cost Behavior, MBA 502B,
Univ. of Scranton, Dr. R. Lawrence

9. High-Low Estimation Method
Essentially finding the slope (variable cost per activity unit)
and then the intercept (total fixed costs)
for a line going through two points:
EXAMPLE:
Production
Total cost
June
700 units
3,200
July
800
3,800
August
900
4,300
September
500
2,700
October
400
2,050
Find the slope (variable cost per activity):
Difference in Total Cost
Difference in Activity =
Variable Cost per
Unit of Activity
4,300 – 2,050 =
2,250
500 =
$4.50/unit
900 – 400
Find the intercept (total fixed costs):
Using the higher point:
4,300 – (900 x 4.50) = 4,300 – 4,050 = 250
Using the lower point:
2,050 – (400 x 4.50) = 2,050 – 1,800 = 250
Variable costs are $4.50 per unit and fixed costs are $250.
Cost formula: Total Costs = $250 + $4.50X
S-II: Analyzing Cost Behavior, MBA 502B,
Univ. of Scranton, Dr. R. Lawrence

10. Graphing Costs . . . Total Variable Costs $5,000 Total Costs $4,000
$5,000 .
(900, 4,300)
Total
Costs
Total Variable Costs
$4,000
Total Cost Line
$3,000 .
(400, 2,050)
$2,000
$1,000
250
Fixed
Costs .
Fixed Costs
100
200
300
400
500
600
700
800
900
Units Produced
S-II: Analyzing Cost Behavior, MBA 502B,
Univ. of Scranton, Dr. R. Lawrence

11. Scattergraph Estimation
Plot all of the observations
Draw the most representative line.
Pick two points on the line & use high-low method to determine variable and fixed costs
$5,000 .
(700, 3,200)
(900, 4,300)
(800, 3,800)
(400, 2,050)
(500, 2,700)
Total
Costs
$4,000
$3,000
$2,000
$4,250 - $3,000
= 1,250/300 =
variable cost per unit
$1,000
$3,000 – x 600
= 3,000 – 2,500 = 500
Total Fixed Costs
100
200
300
400
500
600
700
800
900
Units Produced
Total Cost = 4.17X + 500
S-II: Analyzing Cost Behavior, MBA 502B,
Univ. of Scranton, Dr. R. Lawrence

12. OLS Regression Method MS Excel Ordinary Least Squares Output:
For slope (variable cost per unit) use =INDEX(LINEST(known_y's,known_x's)1)
For the intercept (total fixed costs) use =INDEX(LINEST(known_y's,known_x's)2)
For the full regression output use =LINEST(known_y's,known_x's,const,stats)
For Example:
m = 4.227
(Variable cost per unit)
b =
(Total fixed costs)
Total Cost =
4.227X
S-II: Analyzing Cost Behavior, MBA 502B,
Univ. of Scranton, Dr. R. Lawrence

13. Comparison of Methods to Calculate Mixed Cost Components
High-low method
Uses the total costs incurred at the high and low levels of activity to calculate the variable cost per unit and the total fixed costs using the line formula.
Advantage: easy to calculate.
Disadvantages:
relies on the representativeness of the high point and the low point.
does examine whether a line (linear model) is appropriate.
Scattergraph Method
Plots observations, draws in the “best” line and calculates the line’s values.
Advantage: examines whether there is a linear relationship.
Disadvantage: the line drawn might be different from person to person.
Ordinary Least Squares Regression
Estimates a line that minimizes sum of the squared differences between the actual y-values and the average of the y-values.
Advantages:
uses all of the points—efficient estimator;
provides more information about how much of the variability is explained by the line.
harder to use and explain
overly affected by outliers.
S-II: Analyzing Cost Behavior, MBA 502B,
Univ. of Scranton, Dr. R. Lawrence

14. Nonlinear Cost Behavior
Total Mixed costs are fixed over some range then vary over the succeeding range.
Total
Cost
Example: Monthly phone fee plus per call fee if number of calls exceed a preset number.
Step-Fixed are fixed for a range, then jump and remain fixed for a range…
Example: A salaried supervisor for every ten employees
Total
Cost
Curvilinear (variable) do not have a linear pattern
Example: Total cost of direct labor where overtime is sometimes involved.
Total
Cost
S-II: Analyzing Cost Behavior, MBA 502B,
Univ. of Scranton, Dr. R. Lawrence

15. Linear Estimation of Nonlinear Cost Behavior
Curvilinear (variable)
Total Mixed
Step-Fixed
Total
Cost
Total
Cost
Total
Cost
Relevant Range is the range over which a company expects to operate during a year.
Within this range, a relationship approximating a straight-line might exist.
S-II: Analyzing Cost Behavior, MBA 502B,
Univ. of Scranton, Dr. R. Lawrence

16. Why Does Cost Behavior Matter?
Determining Cost Behavior:
Improves cost forecasts at different levels of activity.
Management’s volume response differs for variable versus fixed costs. For example:
If fixed costs are $1,000 for the relevant range of 1 to 100 units, then if 10 units are produced, the unit cost is $100; if 100 units are produced, the unit cost is $10.
With fixed costs, unit costs change proportionately--there is incentive to produce more units with fixed costs to lower unit costs.
If variable costs are $1 per unit, then the unit cost will be $1 per unit whether 1 or 100 are produced. Unit costs will not decline if more units are produced.
S-II: Analyzing Cost Behavior, MBA 502B,
Univ. of Scranton, Dr. R. Lawrence

17. Analyzing Cost Behavior
This Ends
Session 2:
Analyzing Cost Behavior
S-II: Analyzing Cost Behavior, MBA 502B,
Univ. of Scranton, Dr. R. Lawrence

18. Concluding Activities
Read Chapter 11: pp
Suggested homework:
E11-1 [Classify costs]
E11-2 [Identify cost graphs]
E11-3 [Identify activity bases]
E11-6 [Relevant range; calculating variable & fixed costs]
E11-7 [High-low method; making an estimate]
E11-8 [High-low method]
P11-1 [Classify costs]
Submit to the Session Two Dropbox your solutions to the following:
Required: For each of the different costs given below, indicate whether it is a variable, fixed, or mixed cost. Use the high-low technique to estimate the variable cost per unit and the total fixed costs for each.
Cost 400 hours 550 hours
A $ $ 875 B
C 1, ,980
D 3, ,250
E 1, ,000 F G H
S-II: Analyzing Cost Behavior, MBA 502B,
Univ. of Scranton, Dr. R. Lawrence