Chapter

Cost Management
 2-2

Financial and Management

Financial Management
Accounting Accounting
Focuses on reporting Measures, analyzes,
historical information and reports financial
to external parties and non-financial
such as investors, information that helps
government agencies, managers make
banks and suppliers. decisions to fulfill
organization goals.
 2-3

Cost Accounting and Management

Cost Accounting Cost Management

Measures, analyzes Refers to approaches
and reports financial and activities of
and non-financial managers to use
information relating to resources to increase
cost. value to customers
and achieve goals.
 2-4

Cost Classification by Cost Behavior

How
How aa cost
cost will
will react
react to
to
changes
changes in
in the
the level
level of
of
business
business activity.
activity.
Total
Totalvariable
variablecosts
costs
change
changewhen
whenactivity
activity
changes.
changes.
Total
Totalfixed
fixedcosts
costs remain
remain
unchanged
unchanged when
whenactivity
activity
changes.
changes.
 2-5

Total Variable Cost

Your total long distance telephone bill is

based on how many minutes you talk.
Total Long Distance
Telephone Bill

Minutes Talked
 2-6

Variable Cost Per Unit

The cost per long distance minute talked is

constant. For example, 10 cents per minute.

Telephone Charge
Per Minute

Minutes Talked
 2-7

Total Fixed Cost

Your monthly basic telephone bill probably
does not change when you make more local
calls.
Monthly Basic
Telephone Bill

Number of Local Calls

 2-8

Fixed Cost Per Unit

The average cost per local call decreases as
more local calls are made.

Monthly Basic Telephone

Bill per Local Call
Number of Local Calls
 2-9

Cost Classifications for Predicting

Cost Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
of activity.
Fixed Total fixed cost remains Fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
 2-10

Quick Check

Which of the following costs would be variable

with respect to the number of people who buy a
ticket for a show at a movie theater? (There
may be more than one correct answer.)
A. The cost of renting the film.
B. Royalties on ticket sales.
C. Wage and salary costs of theater
employees.
D. The cost of cleaning up after the show.
 2-11

Quick Check

Which of the following costs would be variable

with respect to the number of people who buy a
ticket for a show at a movie theater? (There
may be more than one correct answer.)

B. Royalties on ticket sales.

Fixed cost:
The cost of renting the film.
Wage and salary costs of theater employees.
The cost of cleaning up after the show.
 2-12

Mixed Cost
Refers to items of cost with fixed and variable
components. This type of cost must be separated for
planning and controlling purpose.
Techniques to separate:
1.Scatter Graph
2.High-Low Method
3.Least Square Method
Cost Function:
Total Cost = Total Fixed Cost + Total Variable Cost
y = a + bx
where: a is the total fixed cost
b is the variable cost per unit
x is the number of units/produce
 2-13

Scattergraph Plots An Example

Assume the following hours of maintenance work and the total maintenance costs for six months.
 2-14

The Scattergraph Method

Plot
Plot the
the data
data points
points on
on aa graph
graph
(Total
(Total Cost
Cost YY vs.
vs. Activity
Activity X).
X).
Y
Maintenance
Total

Cost

X
Hours of
 2-15

The High-Low Method An

Example

The variable cost per

hour of maintenance
is equal to the change
in cost divided by the
change in hours.

$2,400
= $6.00/hour
400
 2-16

The High-Low Method An

Example

Total Fixed Cost = Total Cost Total Variable Cost

Total Fixed Cost = $9,800 ($6/hour 850 hours)
Total Fixed Cost = $9,800 $5,100
Total Fixed Cost = $4,700
 2-17

The High-Low Method An

Example

The Cost Equation for Maintenance

Y = $4,700 + $6.00X
 2-18

Quick Check
Sales salaries and commissions are $10,000 when
80,000 units are sold, and $14,000 when 120,000 units
are sold. Using the high-low method, 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
 2-19

Quick Check
Sales salaries and commissions are $10,000 when
80,000 units are sold, and $14,000 when 120,000 units
are sold. Using the high-low method, what is the
variable portion of sales salaries and commission?
a. $0.08 per unit
b. $0.10 per unit
Units Cost
c. $0.12 per unit High level 120,000 $ 14,000
d. $0.125 per unit Low level 80,000 10,000
Change 40,000 $ 4,000
 2-20

Quick Check
Sales
Sales salaries
salaries and
and commissions
commissions areare $10,000
$10,000 when
when
80,000
80,000 units
units are
are sold,
sold, and
and $14,000
$14,000 when
when 120,000
120,000
units
units are
are sold.
sold. Using
Using the
the high-low
high-low method,
method, what
what is
is
the
the fixed
fixed portion
portion of
of sales
sales salaries
salaries and
and commissions?
commissions?
a.
a. $$ 2,000
2,000
b.
b. $$ 4,000
4,000
c.
c. $10,000
$10,000
d.
d. $12,000
$12,000
 2-21

Quick Check
Sales
Sales salaries
salaries and
and commissions
commissions areare $10,000
$10,000 when
when
80,000
80,000 units
units are
are sold,
sold, and
and $14,000
$14,000 when
when 120,000
120,000
units
units are
are sold.
sold. Using
Using the
the high-low
high-low method,
method, what
what is
is
the
the fixed
fixed portion
portion of
of sales
sales salaries
salaries and
and commissions?
commissions?
a.
a. $$ 2,000
2,000
b.
b. $$ 4,000
4,000
c.
c. $10,000
$10,000
d.
d. $12,000
$12,000
 2-22

Least-Squares Regression Method

A method used to analyze mixed costs if a scattergraph
plot reveals an approximately linear relationship between
the X and Y variables.

This method uses all of the

data points to estimate
the fixed and variable
cost components of a
mixed cost. The goal of this method is
to fit a straight line to the
data that minimizes the
sum of the squared errors.
 2-23

Least-Squares Regression Method

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 also provides a statistic,

called the R22, which is a measure of the goodness
of fit of the regression line to the data points.
 2-24

Comparing Results From

the Two Methods

The
The two
two methods
methods just
just discussed
discussed provide
provide different
different
estimates
estimates of
of the
the fixed
fixed and
and variable
variable cost
cost components
components
of
of aa mixed
mixed cost.
cost.
This
This is
is to
to be
be expected
expected because
because each
each method
method uses
uses
differing
differing amounts
amounts of
of the
the data
data points
points to
to provide
provide
estimates.
estimates.
Least-squares
Least-squares regression
regression provides
provides the
the most
most accurate
accurate
estimate
estimate because
because itit uses
uses all
all the
the data
data points.
points.
 2-25

Formula: (High-Low)

Variable Cost/unit = Highest Cost - Lowest Cost

Highest AL - Lowest AL
Note:
Should there be conflict in the determination of
Highest and Lowest Costs vis--vis AL, the AL
prevails.

Total Fixed Cost = y bx

Note:
You may use the highest cost data or lowest cost
data
 2-26

Problem: (High-Low)
Chocolite Inc. produces a choco drink. It had the following
production costs and volume for the last five months.

Month Cost (y) Volume (x)

March 6,000 12
April 6,659 14
May 8,370 18
June 8,800 19
July 8,050 17

Using the High-Low method, compute:

1.Variable cost per case
2.Fixed cost per month
3.Total product cost if the volume of production reaches 21
cases of Chocolite drink.
 2-27

Problem: (Least-Square)
Chocolite Inc. produces a choco drink. It had the following
production costs and volume for the last five months.
Month Cost (y) Volume (x)
March 6,000 12
April 6,659 14
May 8,370 18
June 8,800 19
July 8,050 17

Using the Least-Square method, compute:

1.Variable cost per case
2.Fixed cost per month
3.Total product cost if the volume of production
reaches 120 cases of Chocolite drink.
 2-28
1-28
Suggested Answer
X Y XY X2
12 6,000 72,000 144
14 6,659 93,226 196
18 8,370 150,660 324
19 8,800 167,200 361
17 8,050 136,850 289
80 37,879 619,936 1,314

n=5
Equation 1: Y = na + bx
Equation 2: xy = xa + bx2
 2-29
1-29
Suggested Answer
Multiple = x/n = 80/5 = 16 or -16

Equation 1: Y = na + bx
[ 37,879 = 5a + b80 ] -16
Equation 2: xy = xa + bx2

619,936 = 80a + b1314

+ -606,064 = -80a - b1280
13,872 = 34b
b = 408
Equation 1: Y = na + bx
37,879 = 5a + b80
37,879 = 5a + 408(80)
37,879 = 5a + 32,640
5,239 = 5a
a = 1,047.80

Y = a + bx
Y = 1,047.80 + 408x
 2-30
1-30
Suggested Answer
Alternative Formula:

b = n xy - x y a = y - b x
n x2 - ( x)2 n

Equation 1: b= n xy - x y
n x2 -- ( x)2
5 (619,936) (80)(37,879)
5 (1314) 80 2
3,099,680 3,030,320
6,570 6,400
b= 408

Equation 2:
a= y - b x
n
= 37,879 80 (408)
5
a= 1,047.80
 2-31

Exercise: (High-Low and Least-Square)

Ceramics Inc. produces ceramic mugs . It had the following
production costs and hours spent for the last six months
Month Cost (y) Volume (x)
July 40,000 200
August 32,400 180
September 122,500 350
October 160,000 400
November 90,000 300
December 36,100 190

Using the two methods, compute and compare:

1.Variable cost per mug
2.Fixed cost per month
3.Total product cost if the hours spent reaches\d
500 hours.