1. Cost Behavior, Activity Analysis, and Cost Estimation
Module 14
Cost Behavior, Activity Analysis,
and Cost Estimation

2. Total variable costs (Y)
Increases as activity increases
Proportional to activity
Equals zero dollars when activity is zero
Example: Materials
b = Variable cost per unit
Total variable costs (Y)
Total activity (X)
Variable cost: Y = bX
Higher variable costs per unit create a steeper line slope.

3. Slope is zero, represented by a flat line.
Fixed Costs
a = Total fixed costs
Total fixed costs (Y)
Total activity (X)
Fixed cost: Y = a
Slope is zero, represented by a flat line.
No change as activity increases or decreases
Example: Depreciation

4. Contains both fixed and variable cost elements.
Mixed Costs
Increase in a linear fashion when activity increases
Positive in amount when activity is zero
Example: Maintenance
Total mixed costs (Y)
Total activity (X)
Contains both fixed and variable cost elements.
Variable portion
Fixed portion
b = Variable cost per unit
Mixed cost: Y = a + bX

5. Step Costs Increase in a step like fashion as activity increases
Example: Supervisors
Step cost: Y = ai
Total step costs (Y)
Total activity (X)

6. Relevant Range
A portion of a range of activity associated with the fixed cost of the current or expected capacity
A normal range of activity in which a company expects to operate, where the fixed costs remain linear, i.e., total cost remains the same

7. Classifying Fixed Costs
Classification depends on the immediate impact if the company attempts to change the fixed costs.
Committed fixed costs, known also as capacity costs, are required to maintain the current service or production capacity or to fill previous legal commitments.
Depreciation
Real-estate taxes
Discretionary fixed costs , known also as managed fixed costs, are set at a fixed amount each period by management.
Training
Advertising

8. Cost Estimation What is it? Identifying variable or fixed costs
The determination of the relationship between activity and cost
An important part of cost management
Identifying variable or fixed costs
Analyzing available accounting records
Interviews
Purpose of cost estimation
Cost prediction
i.e., forecasting future costs

9. Estimating Mixed Cost Components
Methods of estimating fixed and variable
cost components
Mixed Costs
Variable Costs
Fixed Costs
High-low method
Scatter diagrams
Least-squares regression analysis

10. High-Low Cost Estimation
Utilizes data from two time periods
A high activity period, and a low activity period
Step 1:
Select a representative high point and a representative low activity point.
Step 2:
Determine variable costs per unit:
Difference in total costs
Difference in activity
Variable Costs
Per Unit =
Step 3:
Subtract total variable costs from total fixed costs using either the high or low point:
Total Fixed Costs =
Total costs – [Variable cost per unit × number of units]

11. High-Low Example: Variable Costs
Low activity period
Number of Packaging
Shipments Costs
January 8,600 $25,000
February 9,800 26,000
March 11,600 31,600
April 11,200 33,000
High activity period
Variable cost per unit (b) =
$31,600 – $25,000
11,600 – 8,600
= $2.20
The variable cost of each unit produced is $2.20.

12. High Low Example Fixed Costs
Calculate fixed costs:
Variable cost per unit (b) = $2.20 per unit
a = Total costs – Variable costs
January
$25,000 = a + ($2.20 × 8,600 units)
a = $6,080
March
$31,600 = a + ($2.20 × 11,600 units)
a = $6,080
The same total fixed costs result using either the high or low activity point.

13. Scatter Diagrams
Examine scatter diagram for abnormal data. Use judgment on the cost line. Can draw any number of lines…
Plot data
Draw line through points.

14. Least-Squares Regression
A mathematical technique to fit a unique cost-estimating equation to all the observed data
Minimizes the vertical squared difference between the estimated and actual costs at each data point
Technique generally reliable
Can estimate errors
Accomplished using
Microsoft Excel®
Statistical software
Some calculators

15. Least-Squares Criterion
The least-squares method minimizes the sum of all squared vertical deviations between individual observations and the cost-estimating line.

16. Cautions in Developing Cost Estimate Equations
Managers are responsible for making decisions
Mathematical models do not make decisions; they are tools to aid decision making
Not all data are based on normal operating conditions, throw out the abnormal…
Nonlinear relationships could exist
Results should make sense and be explainable

17. Unit Level Activity Examples: Cost of raw materials
This activity is performed for each unit of product produced or sold, variable on units.
Examples:
Cost of raw materials
Cost of cutting a component
Cost of a box to package cereal
Sales commission

18. This activity is performed for each batch of product produced or sold.
Batch Level Activity
This activity is performed for each batch of product produced or sold.
Examples:
Cost of processing sales orders
Cost of equipment setup
Cost of moving a batch between work stations
Cost of inspecting batches

19. Product Level Activity
This activity is performed to support the production of each different type of product.
Examples:
Cost of product development
Cost of product marketing such as product-related advertising
Cost of specialized equipment

20. Facility Level Activity
This activity is performed to maintain general capabilities.
Examples:
Cost of maintaining factory building and grounds
Cost of non-specialized equipment
Cost of general advertising
Cost of factory supervisor