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COST BEHAVIOR: ANALYSIS AND USE
I. Questions
1. a. Variable cost: A variable cost is one that remains constant on a per
unit basis, but which changes in total in direct relationship to changes
in volume.
b. Fixed cost: A fixed cost is one that remains constant in total amount,
but which changes, if expressed on a per unit basis, inversely with
changes in volume.
c. Mixed cost: A mixed cost is a cost that contains both variable and
fixed cost elements.
2. a. Unit fixed costs will decrease as volume increases.
b. Unit variable costs will remain constant as volume increases.
c. Total fixed costs will remain constant as volume increases.
d. Total variable costs will increase as volume increases.
3. a. Cost behavior: Cost behavior can be defined as the way in which
costs change or respond to changes in some underlying activity, such
as sales volume, production volume, or orders processed.
b. Relevant range: The relevant range can be defined as that range of
activity within which assumptions relative to variable and fixed cost
behavior are valid.
4. Although the accountant recognizes that many costs are not linear in
relationship to volume at some points, he concentrates on their behavior
within narrow bands of activity known as the relevant range. The relevant
range can be defined as that range of activity within which assumptions as
relative to variable and fixed cost behavior are valid. Generally, within
this range an assumption of strict linearity can be used with insignificant
loss of accuracy.
5. The high-low method, the scattergraph method, and the least-squares
regression method are used to analyze mixed costs. The least-squares
regression method is generally considered to be most accurate, since it
9-1
9-2
9-4
b
f
e
i
e
h
l
a
j
k
c or d
g
= P1.134
Fixed costs:
P4,700 = Fixed Cost + P1.134 x 4,050
9-5
= P237.50
Fixed costs:
P4,700 = Fixed Cost + P237.50 x 19
Fixed Cost = P187.50
Equation Two: Total Cost = P187.50 + P237.50 x openings
= P202.78
Fixed costs:
P4,700 = Fixed Cost + P202.78 x 19
Fixed Cost = P847.18
Equation Three: Total Cost = P847.18 + P202.78 x openings
Predicted total cost for a 3,200 square foot house with 14 openings using
equation one:
9-6
9-7
Figure 9-B
9-8
P10,250
400
750
650
1,250
18,500
P31,800
P17,800
66,750
180
P84,730
9-9
9-10
Requirement 2
There seems to be a positive linear relationship for the data between P2,500
and P4,000 of advertising expense. Llanes analysis is correct within this
relevant range but not outside of it. Notice that the relationship between
advertising expense and sales changes at P4,000 of expense.
III. Problems
Problem 1
Requirement (a)
High level of activity..........................
Low level of activity...........................
Difference......................................
Miles
Driven
120,000
80,000
40,000
Total Annual
Cost*
P13,920
10,880
P 3,040
Variable
Mixed
Fixed
Mixed
Fixed
Fixed
Requirement 2
Analysis of the mixed expenses:
Units
4,500
3,000
1,500
Shipping
Expense
P56,000
44,000
P12,000
Salaries
and Comm.
Expense
P143,000
107,000
P 36,000
P56,000
P20,000
Salaries and
Comm.
Expense
P143,000
36,000
108,000
P 35,000
Salaries and comm. expense: P35,000 per month plus P24 per unit or
Y = P35,000 + P24X.
Requirement 3
LILY COMPANY
Income Statement
For the Month Ended June 30
Sales in units...................................................
4,500
Sales revenues.................................................
P630,000
Less variable expenses:
Cost of goods sold (@P56)......................... P252,000
Shipping expense (@P8)............................ 36,000
Salaries and commission expense
(@P24)................................................... 108,000 396,000
Contribution margin........................................
234,000
9-13
20,000
70,000
35,000
9,000
42,000
176,000
P 58,000
Problem 3
Requirement 1
Number of
Leagues (X)
5
2
4
6
3
20
Year
2004
2005
2006
2007
2008
Total Cost
(Y)
P13,000
7,000
10,500
14,000
10,000
P54,500
1,700
(Y) - b(X)
n
P4,100
XY
P 65,000
14,000
42,000
84,000
30,000
P235,000
X2
25
4
16
36
9
90
Therefore, the variable cost per league is P1,700 and the fixed cost is
P4,100 per year.
Requirement 2
Y = P4,100 + P1,700X
Requirement 3
The expected value total would be:
Fixed cost.............................................................. P 4,100
Variable cost (7 leagues x P1,700)......................... 11,900
9-14
P14,000
P12,000
P10,000
P8,000
P6,000
P4,000
P2,000
P-
0
1
2
3
4
5
6
Problem 4 (Regression
Analysis,
Service
Company)
Requirement 1
Figure 9-C plots the relationship between labor-hours and overhead costs and
shows the regression line.
y = P48,271 + P3.93 X
Economic plausibility. Labor-hours appears to be an economically plausible
driver of overhead cost for a catering company. Overhead costs such as
9-15
scheduling, hiring and training of workers, and managing the workforce are
largely incurred to support labor.
Goodness of fit. The vertical differences between actual and predicted costs
are extremely small, indicating a very good fit. The good fit indicates a strong
relationship between the labor-hour cost driver and overhead costs.
Slope of regression line. The regression line has a reasonably steep slope
from left to right. The positive slope indicates that, on average, overhead
costs increase as labor-hours increase.
Requirement 2
The regression analysis indicates that, within the relevant range of 2,500 to
7,500 labor-hours, the variable cost per person for a cocktail party equals:
Food and beverages
P15.00
Labor (0.5 hrs. x P10 per hour)
5.00
Variable overhead (0.5 hrs. x P3.93 per labor-hour)
1.97
Total variable cost per person
P21.97
Requirement 3
To earn a positive contribution margin, the minimum bid for a 200-person
cocktail party would be any amount greater than P4,394. This amount is
calculated by multiplying the variable cost per person of P21.97 by the 200
people. At a price above the variable costs of P4,394, Bobby Gonzales will be
earning a contribution margin toward coverage of his fixed costs.
Of course, Bobby Gonzales will consider other factors in developing his bid
including (a) an analysis of the competition vigorous competition will limit
Gonzales ability to obtain a higher price (b) a determination of whether or not
his bid will set a precedent for lower prices overall, the prices Bobby
Gonzales charges should generate enough contribution to cover fixed costs and
earn a reasonable profit, and (c) a judgment of how representative past
historical data (used in the regression analysis) is about future costs.
Figure 9-C
Regression Line of Labor-Hours on Overhead Costs for Bobby Gonzales
Catering Company
9-16
=
=
Constant (a)
Difference in cost
Difference in labor-hours
P529,000 P400,000
7,000 4,000
P43.00
Cost function
P340,000
357,000
P(17,000)
3,000
Month 2
P400,000
400,000
P
0
4,000
Month 3
Month 4
P435,000
443,000
P477,000
486,000
P (8,000)
5,000
P (9,000)
6,000
Month 5
Month 6
P529,000
529,000
P
0
7,000
P587,000
572,000
P15,000
8,000
The data are shown in Figure 9-D. The linear cost function overstates costs
by P8,000 at the 5,000-hour level and understates costs by P15,000 at the
8,000-hour level.
Requirement 3
Based on
Actual
Based on
Linear Cost
Function
P38,000
35,000
P 3,000
P38,000
43,000
P (5,000)
9-18
A
D
B
A
B
B
C
D
C
A
11.
11.
12.
13.
14.
15.
16.
17.
18.
19.
C*
C*
C
A
D
C
D
B
C
C
21.
22.
23.
24.
25.
26.
27.
28.
29.
30.
C
D
C
A
D
B
D
B
A
D
31.
32.
33.
34.
35.
36.
37.
38.
39.
40.
D
B
A
B
A
D
B
C
B
D
41. B
42. D
43. C
* Supporting Computations:
11. (10,000 x 2) (P3,000 x 2) P5,000 = P9,000
12. [(P20 + P3 + P6) x 2,000 units] + (P10 x 1,000 units) = P68,000
9-19