Cost Behavior: Analysis and Use

Chapter 5Prepared byChitra Lekha Karmaker

.

The Activity Base (also called a cost driver)

A measure of what causes

the incurrence of a variable

cost

Unitsproduce

d

Miles driven

Machine

hours

Labor hours

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RelevantRange

A straight line closely approximates

a curvilinear variable cost line within the relevant range.

Activity

Total

Cost

Economist’sCurvilinear

Cost Function

The Linearity Assumption and the Relevant Range

Accountant’s Straight-Line Approximation (constant unit variable cost)

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Mixed Costs

Fixed MonthlyUtility Charge

Variable Cost per KW

Activity (Kilowatt Hours)

Total Utility

Cost

X

Y

Total

mixed

cost

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The Scattergraph MethodUse one data point to estimate the total level of activity and the total cost.

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Month Activity Level:

Patient-Days

MaintenanceCost

incurred( $)January 5600 7900February 7100 8500March 5000 7400April 6500 8200May 7300 9100June 8000 9800july 6200 7800

The Scattergraph Method

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a=?b=?Y=?

The High-Low Method – An ExampleThe The variable cost variable cost

per hourper hour of of maintenance is maintenance is equal to the equal to the

change in cost change in cost divided by the divided by the

change in change in hours.hours.= $6.00/hour$6.00/hour$2,400

400

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The High-Low Method – An Example

Total Fixed Cost = Total Cost – Total Total Fixed Cost = Total Cost – Total Variable CostVariable CostTotal Fixed Cost = $9,800 – ($6/hour Total Fixed Cost = $9,800 – ($6/hour × × 850 hours)850 hours)Total Fixed Cost = $9,800 – $5,100Total Fixed Cost = $9,800 – $5,100Total Fixed Cost = Total Fixed Cost = $4,700$4,700

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The High-Low Method – An Example

YY = $4,700 + $6.00 = $4,700 + $6.00XXThe Cost Equation for

Maintenance

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Find out the cost equation by High-Low Method.

Month Activity Level:Patient-Days

MaintenanceCost

incurred( $)

January 5600 7900February 7100 8500March 5000 7400April 6500 8200May 7300 9100June 8000 9800july 6200 7800

Least-Squares Regression Method

A method used to analyze mixed costs if a scattergraph plot reveals an

approximately linear relationship between the X and Y variables.

This method uses This method uses allall of the of thedata points to estimatedata points to estimatethe fixed and variablethe fixed and variablecost components of acost components of a

mixed cost.mixed cost. The goal of this method isThe goal of this method isto fit a straight line to theto fit a straight line to the

data that data that minimizes theminimizes thesum of the squared errorssum of the squared errors..

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Least-Squares Regression Method

The cost analysis objective is the same: Y = a + bX

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Formula:

Assignment:

Month No. of patients Admitted

Admitting Department costs ($)

May 1800 14700June 1900 15200July 1700 13700August 1600 14000

September 1500 14300October 1300 13100November 1100 12800December 1500 14600

Find out:1.Use the high-low method to establish the fixed & variable components of admitting costs.2. Express as a cost formula in the form Y=a+bX3. Using the least square regression method, estimate the fixed & variable components of admitting costs & express it in Y=a+bX.

End of Chapter 5

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