CHAPTER 2

COST BEHAVIOR PATTERN

ENGR IRISH VILLALOBOS

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Learning Objectives

• Cost Behavior
• Variable, Fixed and Mixed Cost
• Analysis of Mixed cost
• Contribution Margin
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Cost Behavior
refers to how a cost will react
to changes in the level of
activity.
Most Common Classification
• Variable Cost
• Fixed Cost
• Mixed cost
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Variable Cost
Costs that change in direct proportion with
changes in the activity level

Example 2.1
Your total long distance bill is based on how
many minutes you talk (the more you talk the
higher the bill)
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Example 2.1
Your total long distance bill is based on how
many minutes you talk (the more you talk the
higher the bill)
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Variable Cost per Unit

The variable cost per unit remains the
same regardless of the level of activity.

Example 2.2
Your total long distance bill is constant
(15 pesos per 1 min)
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Example 2.2
Your total long distance bill is constant
(15 pesos per 1 min)
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Fixed Cost
Costs that do not change in total as the level
of business activity changes

Example 2.3
Your monthly basic bill is probably fixed and
does not change when you make more local
calls.
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Example 2.3
Your monthly basic bill is probably fixed and
does not change when you make more local
calls.
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Fixed Cost per Unit

The fixed cost per unit does change as the
activity level changes.

Example 2.4
The fixed cost per local call decreases as
more local call are made
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Example 2.4
The fixed cost per local call decreases as
more local call are made
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COST BEHAVIOUR
Example of normally Variable Costs
Merchandiser Service Organizations
Cost of Goods Sold Supplies and Travels

Manufacturers Merchandiser and

Direct Materials, Direct Labour, Manufacturer
and Variable Manufacturing Sales Commissions and Shipping
Over head Costs
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COST BEHAVIOUR
Example of normally Fixed Costs

Merchandiser, Manufacturer and Service

Organization
Real estate taxes, Insurance, Sales Salaries Depreciation
and Advertising
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Mixed Cost
• Some costs exhibit cost behavior that is a
combination of both a fixed element and a
variable element.

• A mixed cost contains a fixed portion of cost

incurred even when the facility is idle, and a
variable portion that increases directly with
volume.
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Example 2.5
The rental charges of a machine might
include 500 per month plus 100 per day of
use.
Variable
000
3 Fixed
00
20
000
1
0
1 5 10 15 20 25 30
Y = a + bx
Y = 500 + 100(30)
Y = 3500
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Sample Case:
A construction worker works everyday for 500.00 pesos in 8 hour a
day, during his heavy load the worker needs to take an overtime
duty. His overtime pay is 30% of his rate per hour, if the worker had
an additional 3 hours for 5 consecutive regular days how much did
he earn after the said period?

FC Fixed Cost = 2500

VC Variable Cost = 81.25
Variable
X Total Hours= 15 Cost
Fixed
Total Cost = 2500 + (81.25x15) Cost
TC = 3718.75
Total Cost
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Analysis of Mixed Cost

In
In account
account analysis,
analysis, each
each account
account is is
classified
classified asas either
either variable
variable or
or fixed
fixed based
based
on
on the
the analyst’s
analyst’s knowledge
knowledge of of how
how
the
the account
account behaves.
behaves.

The
The engineering
engineering approach
approach classifies
classifies costs
costs
based
based upon
upon anan industrial
industrial engineer’s
engineer’s evaluation
evaluation
of
of production
production methods,
methods, and
and material,
material, labor,
labor, and
and
overhead
overhead requirements.
requirements.
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2 ways to Analyze a Mixed Cost

• Scatter Graphing

• High – Low Method

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2 ways to Analyze a Mixed Cost

• Scatter Graphing

- is technique entails plotting the available cost

vs. activity information on a graph.

- The cost analyst draws a line that appears

to best fit the data. The line represents the
estimated cost behavior pattern.
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2 ways to Analyze a Mixed Cost

• Scatter Graphing
• Sample
- Assume the following hours of maintenance
work and the total maintenance costs for six
months.
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• Scatter Graphing
• Sample
- Assume the following hours of maintenance
work and the total maintenance costs for six
months.
Scattergraph Method
$10,000
$9,500
$9,000
$8,500
$8,000
$7,500
$7,000
400 500 600 700 800 900
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2 ways to Analyze a Mixed Cost

• High – Low Method

- In the high-low method, only two of the data

points are used to determine the fixed and
variable cost components.
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2 ways to Analyze a Mixed Cost

• High – Low Method
• Sample
- Assume the following hours of maintenance
work and the total maintenance costs for six
months. 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
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2 ways to Analyze a Mixed Cost

• High – Low Method
• Sample
- Assume the following hours of maintenance
work and the total maintenance costs for six
months.
Total Fixed Cost = Total Cost – Total Variable Cost
$2,400 Total Fixed Cost = $9,800 – ($6/hour × 850 hours)
= $6.00/hour
400 Total Fixed Cost = $9,800 – $5,100
Total Fixed Cost = $4,700

The Cost Equation for

Maintenance
Y = $4,700 + $6.00X
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2 ways to Analyze a Mixed Cost

Determine the fixed and variable components of a mixed cost using
scatter graphs, and the high-low method
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2 ways to Analyze a Mixed Cost

Determine the fixed and variable components of a mixed cost using
scatter graphs, and the high-low method

Scatter Graph

SCATTE $12,000

R $10,000

GRAPH
Overhead Costs

$8,000

$6,000

$4,000

$2,000

$0
0 1,000 2,000 3,000 4,000 5,000 6,000

Machine Hours
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2 ways to Analyze a Mixed Cost

Determine the fixed and variable components of a mixed cost using
scatter graphs, and the high-low method

Scatter Graph
Fixed cost = 2000
At March
SCATTE $12,000 X=2500 ; machine hours
Y= 6200 ; estimated cost
R $10,000

Variable Cost = 6200 – 2000 = 4200

GRAPH
Overhead Costs

$8,000

Variable Cost per Machine Hour

$6,000
= 4200/2500 = 1.68 per hour
$4,000
TC = FC + ( VC per MH x MH)
$2,000
TC = 2000 + ( 1.68 x 2500 )
TC = 6200
$0
0 1,000 2,000 3,000 4,000 5,000 6,000 TC =2000 + ( 1.68 x MH )
Machine Hours
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2 ways to Analyze a Mixed Cost

Determine the fixed and variable components of a mixed cost using
scatter graphs, and the high-low method
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Contribution Margin
is a presentation format used for the income statement,
where all variable cost are aggregated and deducted
from revenue in order to arrive at a contribution margin.
after which all fixed costs are deducted from the contribution
margin in order to arrive at the net profit or loss.
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Contribution Margin
The Traditional Format and Contribution Format

Used primarily for Used primarily by

external reporting. management.
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Uses of Contribution Format

The contribution income statement format is used as an internal
planning and decision-making tool. We will use this approach for:
1.Cost-volume-profit
1.Cost-volume-profit analysis
analysis ..
2.Budgeting
2.Budgeting ..
3.Segmented
3.Segmented reporting
reporting of
of profit
profit data
data ..
4.Special
4.Special decisions
decisions such
such as
as pricing
pricing and
and make-or-buy
make-or-buy analysis
analysis ..
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