ST VINCENT DE FERRER COLLEGE OF CAMARIN, INC.

B.S. ACCOUNTANCY
Management Advis!" Se!vi#es
MS $%& COST BE'AVIOR
(e" Te!ms and Cn#e)ts t (n*
Cst C+assi,i#atins ,! -!edi#ting Cst Be.avi!
Costs may be classified by how they behave in total when the activity level changes:
The relevant range is the range of activity levels throughout which the assumptions for cost behavior are
valid. Outside the relevant range, total fixed costs may change and/or variable costs per unit may change.
The activity level or allocation base is a measure of the activity that causes total variable cost to change.
Common activity bases are: direct labor hours, machine hours, units produced, and units sold.
Committed fixed costs relate to costs that the company will incur over the longterm. These costs, such as
depreciation expense, property tax expense and insurance expense, cannot be changed during short
periods of time and are only somewhat under the control of management.
Discretionary fixed costs usually arise from annual decisions by management and can be changed during
short periods of time such as advertising, research and public relations.
ixed costs contain both variable and fixed cost elements. !or example, a company"s selling expenses
may include fixed expenses, such as the advertising costs and the base salary of the sales manager# and
variable costs, such as sales commissions paid to the regional salesmen.
Cnt!i/0tin Ma!gin In#me Statement
The traditional income statement separates expenses by function emphasi$ing the distinction between
production, administration and selling expenses. %ross margin is the first &ey measure of profitability.
The contribution margin income statement separates expenses by behavior, emphasi$ing the distinction
those revenues and expenses that change when the level of activity changes and those that are unaffected
by changes in the level of activity. Contribution margin is the first &ey measure of profitability.
(e" T)i#s t (n*
'eparating ixed Costs into !ixed and (ariable )lements
*n order to predict the profits of a company, it is necessary to separate all costs into either fixed costs or
variable costs. any costs are clearly variable, such as direct labor, or, clearly fixed, such as rent.
ixed costs must be separated into their fixed and variable elements using one of three methods and a
regression line developed to predict total mixed costs at various levels of activity.
The e+uation of the regression line ta&es the form:
,age 1 of 1$
Least S20a!es Reg!essin Met.d
- rigorous, mathematical approach in which a series of data points are used to develop a regression line
to predict total costs.
S#atte!g!a). Met.d
,lots a series of data points for the mixed costs and the activity which produced these costs. The . axis is
dollars of mixed cost and the / axis is the activity level.
- regression line is drawn by best guess through one of the data points and a point on the . axis with an
approximately the same number of data points above and below the line.
The point where the line crosses . axis represents the fixed cost, the only cost incurred at $ero activity.
!or any data point, the difference between the total mixed cost and the fixed cost is total variable cost
and total variable cost divided by the activity level for the data point is variable cost per unit.
'ig.3L* Met.d
,age 4 of 1$
,age 5 of 1$
Va!ia/+e and A/s!)tin Csting
-bsorption costing includes variable and fixed manufacturing costs in unit product costs and inventory.
The fixed manufacturing overhead included in inventory is the predetermined fixed overhead rate 0 units
in inventory.
The fixed manufacturing overhead included in inventory is deferred or not recogni$ed as an expense
until the units are sold in a subse+uent period.
(ariable costing includes only variable manufacturing costs in unit product costs and inventory.
(ariable costing treats fixed manufacturing costs as period costs.
Compared to absorption costing, variable costing has a lower product costs per unit and higher period
costs.
The effect on operating income of treating fixed manufacturing overhead as a product cost 1absorption
costing2 versus a period cost 1variable costing2 may be summari$ed as follows:
,age 6 of 1$
33End33
SET OF E7ERCISES
,age % of 1$
T!0e ! Fa+se 80estins
4. The relevant range is the range in which costs remain variable.
5. - variable cost increases in total as the volume increases.
6. - fixed cost will stay constant on a per unit basis as the volume increases.
7. The e+uation for a mixed cost is total fixed costs 8 variable cost per unit units of activity.
9. Contribution margin is defined as sales revenue less variable costs.
:. Contribution margin plus variable cost per unit e+uals total sales revenue.
;. The unit contribution margin tells how much each additional unit sold will contribute to covering variable
costs.
<. *f volume increases, all costs will increase
M0+ti)+e 80estins
4. - cost that changes in total in direct proportion to changes in activity is a1n2
a2 absorption cost.
b2 contribution margin.
c2 fixed cost.
d2 variable cost.
5. *f sales revenue doubles, variable costs will
,age 9 of 1$
a2 decrease in total.
b2 increase in total.
c2 decrease on a per unit basis.
d2 increase on a per unit basis.
6. - cost that remains the same, in total, regardless of changes in activity level is a
a2 variable cost.
b2 fixed cost.
c2 mixed cost.
d2 step3variable cost.
7. *f sales revenue doubles, fixed costs will
a2 decrease in total.
b2 increase in total.
c2 decrease on a per unit basis.
d2 increase on a per unit basis.
9. - mixed cost
a2 is fixed over a wider range of activity than a step cost.
b2 is a fixed cost over the relevant range and a variable cost everywhere else.
c2 contains both fixed and variable components.
d2 always increases on a per unit basis.
:. The per3unit amount of three different production costs for =ones, *nc., are as follows:
,roduction Cost - Cost > Cost C
5?,??? ,45.?? ,49.?? ,5?.??
<?,??? ,45.?? ,44.59 ,9.??
@hat type of cost is each of these three costsA
a2 Cost - is fixed, Cost > is mixed, Cost C is variable.
b2 Cost - is fixed, Cost > is variable, Cost C is mixed.
c2 Cost - is variable, Cost > is mixed, Cost C is fixed.
d2 Cost - is variable, Cost > is fixed, Cost C is mixed.
;. - graph of the relationship between total cost and activity level is called a
a2 relevant range.
b2 scattergraph.
c2 contribution margin graph.
d2 dependent variable.
<. >ud uses the high3low method of estimating costs. >ud had total costs of ,9?,??? at its lowest level of
activity, when 9,??? units were sold. @hen, at its highest level of activity, sales e+ualed 45,??? units, total costs
were ,;<,???. >ud would estimate variable cost per unit as
a2 ,4?.??
b2 ,:.9?
c2 ,7.??
d2 ,;.96
B. 'mith, which uses the high3low method, had average costs per unit of ,4? at its lowest level of activity when
sales e+ualed 4?,??? units and average costs per unit of ,:.9? at its highest level of activity when sales e+ualed
57,??? units. 'mith would estimate fixed costs as
a2 ,:?,???
b2 ,4:.9?
c2 ,<.59
d2 ,4??,???.
4?. -rnold Corp has a selling price of ,5?, variable costs of ,49 per unit, and fixed costs of ,59,???. -rnold
expects profit of ,6??,??? at its anticipated level of production. @hat is -rnoldCs unit contribution marginA
,age : of 1$
a2 ,9.??
b2 ,4?.??
c2 ,5;.9?
d2 ,5?.??
33End;
S+0tin < -!a#ti#e -!/+em
,age = of 1$
S+0tin < T!0e ! Fa+se
4. !alse because not only do total variable costs remain variable, but both variable costs per unit and total fixed
costs remain constant.
5. True
6. !alse because fixed costs remain constant in total and decrease per unit as volume increases.
7. True
9. True
:. !alse because both revenue and contribution margin are stated in total whereas variable cost is stated per unit.
The statement would be true if all three were stated per unit or in total.
,age > of 1$
;. !alse because contribution margin contributes to covering fixed costs.
<. !alse because if volume increases, only variable costs will increase.
S+0tin < M0+ti)+e C.i#e
4. D
5. >
6. >
7. C
9. C
:. C
;. >
<. C
B. -
4?. -
,age 1$ of 1$