Cost Behavior
Cost behavior describes how costs change when activity levels change.
Activity examples:
Change in total as activity changes.
Characteristics
Direct materials
$5 per unit
Units 100
Relevant Range
The range within which assumptions about cost behavior remain valid.
Example:
A factory designed to produce 10,000 units.
Cost behavior assumptions may fail beyond that level.
Cost Estimation Methods
a) Engineering Method
Uses technical analysis.
b) Account Analysis
Examines historical records.
c) Scattergraph Method
Plots costs against activity.
b) High-Low Method
Most commonly tested.
High-Low Method
Step 1
Identify highest and lowest activity levels.
Step 2
Compute variable cost per unit.
Formula:
Variable Cost per Unit
= (Highest Cost − Lowest Cost) ÷ (Highest Activity − Lowest Activity)
Example
Highest Activity: 10,000 hours = $50,000
Lowest Activity: 5,000 hours = $30,000
Variable Cost: = ($50,000 − $30,000) ÷ (10,000 − 5,000)
= $20,000 ÷ 5,000
= $4 per hour
Step 3
Calculate fixed cost.
Fixed Cost = Total Cost − (Variable Cost × Activity)
Fixed Cost = $50,000 − ($4 × 10,000)
= $10,000
Cost Equation: Y = $10,000 + $4X
Contribution Margin Concept
Contribution Margin = Sales − Variable Costs
Represents the amount available to cover fixed costs and profit.
Key Terms
Variable Cost = Changes with activity
Fixed Cost = Remains constant in total
Mixed Cost = Fixed + Variable
Relevant Range = Normal operating range
Cost Driver = Activity causing costs
Always remember:
Variable Cost → Total changes
Fixed Cost → Per-unit changes
Mixed Cost → Both components
Cost behavior describes how costs change when activity levels change.
Activity examples:
- Units produced
- Machine hours
- Labor hours
Change in total as activity changes.
Characteristics
- Total cost changes
- Cost per unit remains constant
Direct materials
$5 per unit
Units 100
Total Cost $500
For 200 units, total cost will be $1000.
Fixed Costs
Remain constant in total within the relevant range.
Examples:
Contain both fixed and variable components.
Examples:
Total Cost = Fixed Cost + Variable Cost
Fixed Costs
Remain constant in total within the relevant range.
Examples:
- Rent
- Property taxes
- Salaries
- Total fixed cost remains constant
- Fixed cost per unit decreases as production increases
Contain both fixed and variable components.
Examples:
- Utility bills
- Telephone bills
Total Cost = Fixed Cost + Variable Cost
Relevant Range
The range within which assumptions about cost behavior remain valid.
Example:
A factory designed to produce 10,000 units.
Cost behavior assumptions may fail beyond that level.
Cost Estimation Methods
a) Engineering Method
Uses technical analysis.
b) Account Analysis
Examines historical records.
c) Scattergraph Method
Plots costs against activity.
b) High-Low Method
Most commonly tested.
High-Low Method
Step 1
Identify highest and lowest activity levels.
Step 2
Compute variable cost per unit.
Formula:
Variable Cost per Unit
= (Highest Cost − Lowest Cost) ÷ (Highest Activity − Lowest Activity)
Example
Highest Activity: 10,000 hours = $50,000
Lowest Activity: 5,000 hours = $30,000
Variable Cost: = ($50,000 − $30,000) ÷ (10,000 − 5,000)
= $20,000 ÷ 5,000
= $4 per hour
Step 3
Calculate fixed cost.
Fixed Cost = Total Cost − (Variable Cost × Activity)
Fixed Cost = $50,000 − ($4 × 10,000)
= $10,000
Cost Equation: Y = $10,000 + $4X
Contribution Margin Concept
Contribution Margin = Sales − Variable Costs
Represents the amount available to cover fixed costs and profit.
Key Terms
Variable Cost = Changes with activity
Fixed Cost = Remains constant in total
Mixed Cost = Fixed + Variable
Relevant Range = Normal operating range
Cost Driver = Activity causing costs
Always remember:
Variable Cost → Total changes
Fixed Cost → Per-unit changes
Mixed Cost → Both components
