1. Activity Cost Behavior
Prepared by
Douglas Cloud Pepperdine University

2. After studying this chapter, you should be able to:
Objectives
1. Define and describe fixed, variable, and mixed costs.
2. Explain the use of resources and activities and their relationship to cost behavior.
3. Separate mixed costs into their fixed and variable components using the high-low method, the scatterplot method, and the method of least squares.
After studying this chapter, you should be able to:

3. Objectives 4. Evaluate the reliability of the cost formula.
5. Explain how multiple regression can be used to assess cost behavior.
6. Define the learning curve, and discuss its impact on cost behavior.
7. Discuss the use of managerial judgment in determining cost behavior.

4. Fixed Costs
Fixed costs are costs that in total are constant within the relevant range as the level of the activity driver varies.

5. Fixed Costs
Two production lines can process 10,000 computers per year each. The workers on each line are supervised by a production-line manager who is paid $24,000 per year. For production up to 10,000 units, only one supervisor is needed. When production is between 10,001 and 20,000 computers being produced, two supervisors are required.

6. Fixed Costs Supervision Computers Processed 24,000 8,000 3.00
Total Fixed Cost Graph
$60,000
$50,000
$40,000
$30,000
$20,000
$10,000
Fixed Costs
Total Costs
F = $24000
Units Produced (000)
Supervision
Computers Processed
$24,000 4,000 $6.00
24,000 8,
24,000 10,
48,000 12,
48,000 16,
48,000 20,
Unit Cost

7. Fixed Costs Supervision Computers Processed 24,000 8,000 3.00
Total Fixed Cost Graph
$60,000
$50,000
$40,000
$30,000
$20,000
$10,000
Fixed Costs
Total Costs
F = $24000
Units Produced (000)
Supervision
Computers Processed
$24,000 4,000 $6.00
24,000 8,
24,000 10,
48,000 12,
48,000 16,
48,000 20,
Unit Cost

8. Fixed Costs Supervision Computers Processed 24,000 8,000 3.00
Total Fixed Cost Graph
$60,000
$50,000
$40,000
$30,000
$20,000
$10,000
F = $48,000
Fixed Costs
Total Costs
Units Produced (000)
Supervision
Computers Processed
$24,000 4,000 $6.00
24,000 8,
24,000 10,
48,000 12,
48,000 16,
48,000 20,
Unit Cost

9. Fixed Costs Supervision Computers Processed 24,000 8,000 3.00
Total Fixed Cost Graph
$60,000
$50,000
$40,000
$30,000
$20,000
$10,000
F = $48,000
Fixed Costs
Total Costs
Units Produced (000)
Supervision
Computers Processed
$24,000 4,000 $6.00
24,000 8,
24,000 10,
48,000 12,
48,000 16,
48,000 20,
Unit Cost

10. Variable costs are costs that in total vary in direct proportion to changes in an activity driver.

11. Variable Cost
A 3½-inch disk drive is added to each computer at a cost of $30 per computer. The total cost of disk drives for various levels of production is a follows:
Total Cost of Disk Driver
Number of Computers Produced
Unit Cost of Disk Drives
$120,000 4,000 $30
240,000 8,000 30
360,000 12,000 30
480,000 16,000 30
600,000 20,000 30

12. Variable Cost Y = VX Y = Total variable costs
V = Variable cost per unit
X = Number of units of the driver v

13. Number of Computers Processed
Variable Cost
Cost
(in thousands)
$600
480
360
240
120
Y = $30X v
4, , , , ,000
Number of Computers Processed

14. Units of Activity Driver
Nonlinearity of Variable Cost
Cost ($)
Relevant Range
Units of Activity Driver

15. Mixed costs are costs that has both a fixed and a variable component.

16. Mixed Costs Y = Fixed cost + Total variable cost Y = F + VX where
Y = Total cost
Mixed Costs

17. Mixed Costs
For Days Computer, the selling cost is represented by the following equation:
Y = $300,000 + $50X

18. Variable Cost of Selling
Mixed Costs
Days Computers, Inc.
Fixed Cost of Selling
Variable Cost of Selling
Total Cost
Computers Sold
Selling Cost Per Unit
$300,000 $ 200,000 $ 500,000 4,000 $125.00
300, , ,000 8,
300, , ,000 12,
300, ,000 1,100,000 16,
300,000 1,000,000 1,300,000 20,

19. Number of Computers Sold
Mixed Cost Behavior
Cost
(in thousands)
$1,500
1,300
1,100
900
700
500
300
Variable Costs
Fixed Cost
4, , , , ,000
Number of Computers Sold

20. Basic Terms
When a firm acquires the resources needed to perform an activity, it is obtaining activity capacity.
The amount of activity capacity needed which corresponds to the level where the activity is performed efficiency is called practical capacity.

21. Flexible Resources Flexible resources are supplied as used and needed.
They are acquired from outside sources, where the terms of acquisition do not require any long-term commitment for any given amount of the resource.
Example: Materials and energy

22. Committed Resources
Committed resources are supplied in advance of usage.
They are acquired by the use of either an explicit or implicit contract to obtain a given quantity of resource, regardless of whether the amount of the resource available is fully used or not. Committed resources may have unused capacity.
Example: Buying or leasing a building or equipment

23. Committed Resources
Committed fixed expenses are costs incurred for the acquisition of long-term capacity.
Example: Plant, equipment, warehouses, vehicles, and salaries of top employees
Discretionary fixed expenses are shorter-term committed resources.
Example: The hiring of new receiving clerks

24. Step-Cost Behavior
A step cost function displays a constant level of cost for a range of output and then jumps to a higher level of cost at some point.

25. Step-Cost Behavior 20 40 60 80 100 120 $500 400 300 200 100 Cost
Activity Output (units)

26. Normal Operating Range (Relevant Range)
Step-Fixed Costs
Cost
$150,000
100,000
50,000
Normal Operating Range (Relevant Range)
2, , ,500
Activity Usage

27. Step-Fixed Costs
Cost of orders supplied = Cost of orders used Cost of unused orders
7,500($20)
= 6,000($20) + 1, 500($20)
$150,000
= $120,000 + $30,000
The $30,000 of excess engineering capacity means that a new product could be introduced without increasing current spending on engineering.

28. Methods for Separating Mixed Costs
The High-Low Method
The Scatterplot Method
The Method of Least Squares
Variable Component
Fixed Component

29. Y = F + VX Methods for Separating Mixed Costs Total activity cost
Fixed cost component
Variable cost per unit of activity
Measure of activity output

30. Step 1: Solve for variable cost (V)
The High-Low Method
Month Material Handling Costs No. of Moves
January $2,
February ,
March ,
April ,
May ,
June 5,
July 4,
August 6,
September 5,
October 6,
Step 1: Solve for variable cost (V)

31. The High-Low Method High Cost – Low Cost High Units – Low Units V =
Month Material Handling Costs No. of Moves
January $2,
February ,
March ,
April ,
May ,
June 5,
July 4,
August 6,
September 5,
October 6,
V =
High Cost – Low Cost
High Units – Low Units

32. The High-Low Method $7,500 – Low Cost 500 – Low Units V =
Month Material Handling Costs No. of Moves
January $2,
February ,
March ,
April ,
May ,
June 5,
July 4,
August 6,
September 5,
October 6,
V =
$7,500 – Low Cost
– Low Units

33. The High-Low Method $7,500 – $2,000 500 – 100 V =
Month Material Handling Costs No. of Moves
January $2,
February ,
March ,
April ,
May ,
June 5,
July 4,
August 6,
September 5,
October 6,
V =
$7, – $2,000 –

34. The High-Low Method $7,500 – $2,000 500 – 100 V = V = $13.75
$7, – $2,000 –
V = $13.75
Step 2: Using either the high cost or low cost, solve for the total fixed cost (F).

35. The High-Low Method Y = F + V(X) $7,500 = F + $13.75(500) $625 = F
High End
$7,500 = F $13.75(500)
$625 = F
Y = F V(X)
Low End
$2,000 = F $13.75(100)
$625 = F
The cost formula using the high-low method is:
Total cost = $625 + ($13.75 x # of moves)

36. The Scatterplot Method
Graph A--Anderson Company
Material Handling Cost
$9,000 –
8,000 –
7,000 –
6,000 –
5,000 –
4,000 –
3,000 –
2,000 –
1,000 – 5 8 10 6 9 7 2 3 4 1
| | | | |
Number of Moves

37. The Scatterplot Method Material Handling Cost
Graph B--High-Low Line
Material Handling Cost
$9,000 –
8,000 –
7,000 –
6,000 –
5,000 –
4,000 –
3,000 –
2,000 –
1,000 – 5 8 10 6 9 7 2 3 4 1
| | | | |
Number of Moves

38. The Scatterplot Method Material Handling Cost
Graph C—One Possible Scattergraph LIne
Material Handling Cost
$9,000 –
8,000 –
7,000 –
6,000 –
5,000 –
4,000 –
3,000 –
2,000 –
1,000 – 5 8 10 6 9 7 2 3 4 1
| | | | |
Number of Moves

39. The Scatterplot Method
Graph A--Nonlinear Relationship
Activity
Cost
Activity Output

40. The Scatterplot Method
Graph B--Upward Shift in Cost Relationship
Activity
Cost
Activity Output

41. The Scatterplot Method
Graph C--Presence of Outliers
Activity
Cost
Outlier
Outlier
Activity Output

42. The Method of Least Squares
Annual Cost Predicted Cost Deviation Deviation Squared
$2,000 $2,
3,090 2, ,100
2,780 2, ,400
1,990 3,200 -1,10 1,464,100
7,500 6, ,000
5,300 4, ,000
4,300 3, ,000
6,300 5, ,000
5,600 6, ,000
6,240 5, ,600
Total measure of closeness 5,068,200
$3,090
- 2,300
790 x 790

43. Material Handling Cost
The Method of Least Squares
Line Deviations
Material Handling Cost
$9,000 –
8,000 –
7,000 –
6,000 –
5,000 –
4,000 –
3,000 –
2,000 –
1,000 – 5 8 10 6 9 7 2 3 1 4
| | | | |
Number of Moves

44. The Method of Least Squares
Spreadsheet Data for Anderson Company

45. The Method of Least Squares
Regression Output for Anderson Company

46. The Method of Least Squares
The results give rise to the following equation:
Material handling cost
= $ ($12.39 x number of items)

47. Coefficient of Correlation
Positive Correlation
r approaches +1
Machine Hours
Utilities Costs
Machine Hours
Utilities Costs

48. Coefficient of Correlation
Negative Correlation
r approaches –1
Hours of Safety Training
Industrial Accidents
Hours of Safety Training
Industrial Accidents

49. Coefficient of Correlation
No Correlation
r ~ 0
Hair Length
Accounting Grade
Hair Length
Accounting Grade

50. Multiple Regression Y = F + V1 X1 + V2 X2 X1 = Number of moves
X2 = The total distance

51. Multiple Regression Material Handling Number Pounds
Month Cost of Moves Moved
January $2, ,000
February 3, ,000
March 2, ,800
April 1,
May 7, ,000
June 5, ,000
July 4, ,000
August 6, ,000
September 5, ,000
October 6, ,400

52. Multiple Regression Y = $507 + $7.84X + $0.11X2
= $507 + $7.84(350) + $0.11(17,000)
= $507 + $ $1,870
= $5,121

53. The Learning Curve and Nonlinear Behavior

54. Cumulative Cumulative Cumulative Individual Units
Number Average Time Total Time: Time for nth
of Units per Unit in Hours Labor Hours Unit-Labor Hours
(1) (2) (3) = (1) x (2) (4)
2 80 (0.8 x 100)
4 64 (0.8 x 80)
(0.8 x 64)
,048.64
Data for Cumulative Average Time Learning Curve with 80 Percent Learning Rate

55. Graph of Cumulative Total Hours Required and the Cumulative Average time per Unit
1,200 –
1,000 –
800 –
600 –
400 –
200 –
0 –
Total Hours
Units

56. Cumulative Individual Unit Cumulative Cumulative
Number Time for nth Unit Total Time: Average Time per
of Units in Labor Hours Labor Hours Unit-Labor Hours
(1) (2) (3) (4) = (3)/(1)
2 80 (0.8 x 100)
4 64 (0.8 x 80)
(0.8 x 64)
Data for an Incremental Unit-Time Learning Curve with an 80 Percent Learning Rate

57. Managerial Judgment
Managerial judgment is critically important in determining cost behavior and is by far the most widely used method in practice.

58. End of
Chapter