1 COST BEHAVIOR PATTERNS Chapter 2 Accounting Principles II AC Fall Semester, 1999

2 Basic Cost Behavior Patterns Variable Costs Fixed Costs Mixed Costs

3 Variable Costs Variable costs move in total in direct proportion to the change in activity output Thus for a variable cost, a linear relationship between the activity cost and the associated driver is assumed Thus, the % increase in the total variable cost & the % increase in the associated driver is assumed the same –Formula: TVC = $50 x No. of Units of Driver Important to determine the relevant range –relevant range is the range over which the assumed cost relationship is valid

4 Fixed Cost A cost which remains constant over the relevant range It is a cost which whose magnitude is unaffected by changes in the level of activity –Formula: TFC = $80,000 It should be noted that fixed cost per unit varies with changes in the level of activity, while the variable costs per unit do not change as the activity level changes

5 Step-Cost Behavior A step cost has the property of displaying a constant level of cost for a range of activity usage (output) and then jumping to a higher level of cost at some point Step-Variable Costs –Costs that follow a step-cost behavior with narrow steps –Usually approximated with a strictly variable cost assumption Step-Fixed Costs –Costs that follow a step-cost behavior with wide steps before a jump to a higher level

6 The Need For Cost Separation Generally, the only information the accounting system provides is the total cost of an activity and a measure of activity usage –Example: for maintenance accounting data is generated which indicates the total cost of maintenance and the number of maintenance hours worked. But the system does not reveal the amount of the cost that was variable and the amount that was fixed. It is therefore necessary to separate the total costs into its fixed and variable components There are various methods for doing this, including the high-low method, the scatterplot method, and the method of least squares They will not be covered in this course

7 Additional Cost Classifications Controllable vs. Uncontrollable Historical vs. Future Differential or Incremental Opportunity and Imputed

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