Determination of Cost
Behavior
Cost
What is Cost ?
Value of money occurred to produce something
or deliver a service.
Variable Cost Fixed Cost
Oost that change in relation to a chosen
activity or output
Cost that do not change with in the
relation to a chosen activity or out put $
Mixed Cost
Cost that have both fixed and variable
components: also called semi
variable costs
3
Why we Need to
Determine Cost
Behavior?
Your return to the past
enables you to better
understand and predict the
future, so that the best
decisions can be made
What is a Cost Function?
Managers are able to understand cost behavior through
cost functions.
a + b
Variable cost per unit
Intercept: Fixed (Slope of line)
cost
Y X
The The independent
dependent variable (Driver)
Variable
Cost Function
A cost function is a mathematical description of how a cost
changes with changes in the level of an activity relating to that
cost.
Assumptions in Cost-Behavior
Estimation
Managers often estimate cost functions based on two assumptions:
Assumption 1
Variations in single activity effects total
cost
Assumption 2
Cost behavior is approximated by a linear
cost function within the relevant range.
To understand Three Linear Cost Functions
La Playa Hotel offers an airline three alternative cost structures to accommodate its crew
overnight
Fixed
Variable
2. $8,000 per month
Y = $8,000 1. $60 per night per room usage
$8,000 is called a constant or intercept 2. Y = $60x
The slope of the cost function is zero 3. The slope of the cost function is $60.
Mixed
$3,000 per month plus $24 per room
This is an example of a mixed cost.
y = $3,000 + $24x
y = a + bx
Hot el
8
Graphical Presentation Of Cost
Variable Fixed Mixed
9
Criteria Of Classifying
Variable & Fixed Cost
Choice of Cost Object
Time Span
Relevant Range
Choice of Cost Object Example 10
If the number of taxis owned by a taxi company
is the cost object, annual taxi registration and
license fees would be variable costs.
If miles driven during a year on a particular taxi
is the cost object, registration and license fees
for that taxi are fixed costs.
11
Time Span
Whether a cost is variable or fixed with
respect to a particular activity depends on
the time span
More costs are variable with longer time
spans
Relevant Range
Variable and fixed cost behavior patterns are
valid for linear cost functions only within
the given relevant range.
Cost Estimation Approaches
02 03
01 04
Account Quantitative
Industrial Conference Analysis Analysis
Engineering method method methods
method
Industrial Engineering Method
Estimates cost functions by analyzing the relationship between inputs and outputs
Includes time studies Very thorough and costly and time Work-Measurement
detailed consuming Method
Detailed
Work
14
Conference Method
Gathered analysis and opinions about costs
and their drivers from various
departments
•Pools expert knowledge
•Reliance on opinions makes this
subjective
Accoun
t
Method
Estimates cost functions by classifying various cost
accounts as variable, fixed, or mixed using
experience and Judgments with respect to the
identified level of activity
Is reasonably accurate, cost-effective, and easy to use,
but is subjective
16
Avisha & Co.
Cost of goods What is the total
fixed cost?
sold = $130,000 $60,000 + $29,000 =
$89,000
02 04
H C
S X V
01 03 05
Total sales(1000 Commissions = 12% of sales What is the variable cost
Secretary’s salary = per unit ?
units) = $390,000 ($130,000 + $46,800) ÷ 1,000 = $176.80
$29,000 Manager’s salary = Commissions: $390,000 × .12 = $46,800
$60,000
Estimating A Cost
Function 5. Estimate the
cost function.
1. Choose the 3. Collect data
dependent variable.
6. Evaluate
2. Identify 4. Plot the Data
cost driver
High & Low Method
Simplest method of
s quantitative analysis
Uses only the highest
d and lowest observed
values
Variable cost is calculated by the
c ratio of Difference of high & low
cost & Driver
Fixed cost is
v calculated by linner
equation
High & Low Method Example
Y
Week Cost of Electricity Y Machine Hours X Calculate variable cost per unit X
13700 190
1
- = 8500
2 20900 275
- = 340
3 13000
13000 115
115 Variable cost per unit=25
4 18800 395 - Y = a +
5 14000 265 a = 21500 - 25(455) = 10125
b
21500 455 X - 25(115) = 10125
a = 13000
6 21500 455
Y = 10125 + 25X
7 16900 340
8 21000 305
Thank You
Questions?
