Cost Behavior

Cost Behavior
Hansen/Mowen, Cornerstones of Cost Management, 4th Edition. © 2018 Cengage. All Rights Reserved. May
not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Cost Behavior
• Used to describe whether a cost changes when the level of output changes
• Fixed costs do not change as output changes
• Variable costs increase in total with an increase in output and decrease in
total with a decrease in output
Hansen/Mowen, Cornerstones of Cost Management, 4th Edition. © 2018 Cengage. All Rights Reserved. May not
be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Cost objects
• Item for which managers want cost information
• For manufacturing or merchandising firms, it is usually the tangible product
• For service firms, it is usually the service provided
Measures of output
• Activity drivers explain changes in activity costs by measuring changes in
activity output (usage)
o General categories
• Unit-level drivers
• Non-unit-level drivers
Fixed Costs (1 of 3)
• Costs that in total are constant within the relevant range as the level of the
associated driver varies
• JCM Audio Systems, Inc. produces speakers for home audio systems
o One department produces voice coils
o There are two production lines that can each make up to 100,000 voice coils per
year
o Production-line manager is paid $60,000 per year
o For production up to 100,000 units, only one manager is needed; above that (up
to 200,000 units), two managers are needed
JCM Audio Systems, Inc.
Supervision Voice Coils Unit Cost

Cost Produced
$ 60,000 40,000 $1.50
60,000 80,000 0.75
60,000 100,000 0.60
120,000 120,000 1.00
120,000 160,000 0.75
120,000 200,000 0.60
The total cost of supervision remains the same within the relevant range, but
the unit cost decreases as production increases
Variable costs (1 of 2)
• Costs that, in total, vary in direct proportion to changes in an activity driver
• Total cost of direct materials for each level of production varies, but the unit
cost stays the same
Variable costs (2 of 2)
JCM Audio Systems, Inc.
Total Direct Materials Voice Coils Produced Unit Direct Materials

Cost of Voice Coils Cost of Voice Coils
$120,000 40,000 $3
240,000 80,000 3
360,000 120,000 3
480,000 160,000 3
600,000 200,000 3
Total cost of supervision increases or decreases within the relevant range, but
the unit cost stays the same
EXHIBIT 3.2 - Variable Cost Behavior
Mixed Costs
• Costs that have both a fixed and a variable component
• Example - JCM’s sales costs are mixed
o There are 10 sales representatives, each earning $30,000 plus receive a
commission of $5 per speaker sold that can be represented by the following
equation:
Step-Cost Behavior (1 of 3)
• 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
Activities and Mixed Cost Behavior
• Activities have characteristics of both flexible and committed resources
o Example
• A power department acquires long-term capacity for supplying power by investing in
a building and equipment - Resources acquired in advance
• It acquires fuel to produce power as needed - Resources acquired as needed
Need for cost separation
• Accounting records show only total cost and associated output of a mixed
cost item
o Total cost should be separated into fixed and variable components
Account Analysis Method
• Used to estimate costs by classifying accounts in the general ledger as:
o Fixed
o Variable
o Mixed
High-Low Method (1 of 2)
• Takes two points (the high and the low by volume of activity) and determines
the slope and the intercept
o Slope is variable rate
o Intercept is fixed cost
High-Low Method (2 of 2)
• Advantages
o Objective in nature
o Simple to calculate
• Disadvantages
o High and low points may be outliers that represent atypical cost-activity
relationships
o Other pairs of points may be more representative
Scatterplot Method
• Uses a scattergraph to visually assess the relationship between cost and
output
o Intercept is fixed cost
o Slope is variable rate
• Assesses the validity of the assumed linear relationship
Scatterplot Method
• Advantages
o Allows for visual inspection of the data
o Identifies nonlinearity, outliers, and shifts in the cost relationship
• Disadvantages
o Lacks objective criterion for choosing the best-fitting line
o Subjective in nature
Managerial Judgment
• Most widely used method in practice in determining cost behavior
• Managers may:
o Use their experiences and observations to determine fixed and variable costs
o Identify mixed costs and use experience to determine what part is fixed, thus
denoting the rest as variable
• Yields good results when the manager has a good understanding of the
processes

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