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Management Advisory Services

Costs and Cost Concepts

Cost a measurement, in monetary terms, of the amount of resources used for some purpose. When
notified by a term that defines the purpose, cost becomes operational, e.g., selling cpst, acquisition cost,
variable cost, etc.

Cost Pool an account in which a variety of similar costs are accumulated prior to allocation to cost
objects. It is a group of costs associated with an activity. Example: overhead account.

Cost object the intermediate and final disposition of cost pools.

Example: product, job, process

Cost driver a factor that causes a change in the cost pool for a particular activity. It is used as a basis
for cost allocation; any factor or activity that has a direct cause-effect relationship

Activity any event, action, transaction, or work sequence that incurs costs when producing a product or
providing a service.

COST BEHAVIOR describes how a cost behaves or changes as the amount of cost driver changes.

Types of Costs as to Behavior:

1. Fixed Cost in total: constant within the relevant range as activity output changes; per unit:
changes as activity level changes
2. Variable Cost in total: varies in direct proportion to changes in activity output; per unit: remains
constant
3. Mixed Cost has both fixed and variable components.

Cost Behavior Assumptions:

1. Relevant Range Assumption

Relevant range refers to the band of activity within which the identifies cost behavior
patterns are valid. Any level of activity outside this range may have a different cost
behavior pattern.
2. Time Period Assumption
The cost behavior patterns identified are true only over a specified period of time.
Beyond this, the cost may show a different behavior.

Segregation of Fixed and Variable Elements of Mixed Costs:

1. High-Low Points Method the fixed and variable elements of the mixed costs are computed
from two data points (periods)the high and low periods as to activity level or cost driver.
2. Statistical Scattergraph Method various costs (the dependent variable) are plotted on a
vertical line (y-axis) and measurement figures (cost drivers or activity levels) are plotted on a
horizontal line (x-axis). A straight line is drawn through the points and, using this line, the rate of
variability and the fixed cost are computed.
3. Method of Least Squares (Regression Analysis) mathematically determines a line of best fit
or a linear regression line through a set of plotted points so that the sum of the squared deviations
of each actual plotted points so that the sum of the squared deviations of each actual plotted point
from the point directly above or below it on regression line is at minimum.
 This method uses the following equations in computing for the values of unit
variable cost and fixed cost:

Equation 1: Y = na + bx
Equation 2: x y = ax + b 2

COSTFORMULA: y=a+bx

Where: y denotes total cost. It is called the dependent variable because it is dependent on the
value of another variable, the activity level x.
a is an estimate of the fixed cost
b s an estimate of the variable cost per unit of activity.

EXERCISES:

1. Cost drivers and functions. The list of representative cost drivers in the right column of this table
are randomized with respect to the list of functions in the left column. That is, they do not match.

Function Representative Cost Driver

1. Accounting A. Number of invoices sent

2. Human resources B. Number of purchase orders
3. Data processing C. Number of research scientists
4.Research and development D. Hours of computer processing unit (CPU)
5. Purchasing E. Number of employees
6. Distribution F. Number of transactions processed
7. Billing G. Number of deliveries made

REQUIRED:

Match each function with its representative cost driver.

2. The following data have been collected for four different cost items.

Cost Item Cost at 100 units Cost at 120 units

W P6,000 P6,200
X P3,000 P3,000
Y P3,000 P3,600
Z P4,030 P4,800

Which of the following classifications of these cost items by cost behavior is correct?

Cost W Cost X Cost Y Cost Z

a. variable fixed mixed variable

b. mixed fixed variable mixed
c. variable fixed variable variable
d. mixed fixed variable variable

3. Variable costs, fixed costs, relevant range.

Sweetmonaman Candies manufactures tooth-breaker candies in a fully automated process. The
machine that produces candies was purchased recently and can make 4,100 per month. The
machine costs P9,000 and is depreciated using straight line depreciation over 10 years assuming
zero residual value. Rent for the factory space and warehouse, and other fixed manufacturing
overhead costs total P1,200 per month.

Sweetmonman currently makes and sells 3,800 tooth-breakers per month. Sweetmonaman buys
just enough materials each month to make the tooth-breakers it needs to sell. Materials cost 30
cents per toothbreaker.
 Next year Sweetmonaman expects demand to increase by 100%. At this volume of materials
purchased, it wilt get a 10% discount on price. Rent and other fixed manufacturing overhead costs
will remain the same.

REQUIRED:
1. What is Sweetmonamans current annual relevant range of output?
2. What is Sweetmonamans current annual fixed manufacturing cost within the relevant range?
What is the annual variable manufacturing cost?
3. What will Sweetmonamans relevant range of output be next year? How if at all, will total
annual fixed and variable manufacturing costs change next year? (Assume that if it needs to,
Sweetmonaman could buy an identical machine at the same cost as the one it already has.)

4. Estimating a cost function, high-low method. Juan dela Cruz is examining customer- service
costs in the southern region of Kuryente Products. Kuryente Products has more than 200 separate
electrical products that are sold with a six-month guarantee of full repair or replacement with a
new product. When a product is returned by a customer, a service report is prepared. This service
report includes details of the problem and the time and cost of resolving the problem.

Weekly data for the most recent 9-week period are as follows:

Week Customer-Service Department Costs Number of Service Reports

1 P13,700 190
2 20,900 275
3 13,000 115
4 22,000 395
5 14,000 265
6 21,500 455
7 16,900 340
8 21,000 305
9 120,000 1,764

REQUIRED: Use the high-low method to compute thet function, relating customer-service
costs the number of service reports.

5. The controller of Leon Furniture, a retail store, wants to determine the variable and fixed cost
components of the companys costs and expenses. He has prepared income statements for recent
months, which he plans to use in conducting cost analysis.

Sales P80,000 P90,000

Cost of goods sold 48,000 54,000
Gross profit P32,000 P36,000
Operating expenses:
Selling P 8,500 P 8,800
Administrative 9,200 9,400
Total P17,700 P18,200
Profit P14,300 P17,800

Required:
a. Determine the fixed and variable components of cost of goods sold, selling expenses, and
administrative expenses.
b. Compute income if sales amount to P100,000.

6. Below is an examination of last years financial statements of Mickey Company. Units produced
and production costs for the first four (4) months of the year, which are representative for the
year, were as follows:

Month Units Total Production Costs

January 5 P200
 February 7 280
March 9 300
April 6 250

REQUIRED:

1. Using the least squares method, calculate the monthly fixed and variable components of the
total production costs

2. Using the estimates made in Number 1, compute the total cost for 8 units.

7. n analysis of past janitorial costs indicates that the average janitorial cost is P3.00 per machine
hour at an activity level of 20,000 machine hours and P2.40 per machine hour at an activity level
of 25,000 machine hours. Assuming that this activity is within the relevant range, what is the total
expected janitorial cost if the activity level is 23,000 machine hours?

8. The Monstax Company uses the high-low method to estimate the cost function. The information
for 2013 is provided below:

Machine-hours Labor Costs

Highest observation of cost driver 300 P7,500

Lowest observation of cost driver 160 4,000

What is the total cost for 250 hours?

9. Black Forest Clinic contains 600 beds. The average occupancy rate 90% per month. In other
words, an average of 90% of the clinics beds are occupied by patients. At this level of
occupancy, the clinics operating costs are P25 per occupied bed per day, assuming a 30-day
month. This P25 contains both variable and fixed cost elements.

During April, the clinics occupancy rate was only 80%. A total of 0600 in operating costs
was incurred during the month.

REQUIRED:
1. Using the high-low method, estimate the (a ) variable cost per occupied bed on a daily basis
and (b) the total fixed operating costs per month.

2. Assume an occupancy rate of 85% per month. What amount of total operating costs would you
expect the clinic to incur?

10. Makina Companys total overhead costs at various levels of activity are presented below:

Month Machine Hours Total Overhead Cost

April 140,000 P198,000
May 120,000 174,000
June 160,000 222,000
July 180,000 246,000

Assume that the total overhead costs above consist of utilities, supervisory salaries, and
maintenance. The breakdown of these costs at the 120,000 machine-hour level of activity is:

Utilities (V) P 48,000

Supervisory salaries (F) 21,000
Maintenance (M) 105,000
Total overhead costs P174,000

V = variable; F = fixed; M = mixed

 Makina Companys management wants to break down the maintenance cost into its basic
variable and fixed cost elements.

REQUIRED:

1. As shown above overhead costs in July amounted to P246,000. Determine how much of this
consisted of maintenance cost.

2. By means of the high-low method, estimate a cost formula for maintenance.

3. Express the companys total overhead costs in the linear equation form Y = a +bX.

4. What total overhead costs would you expect to be incurred at an operating activity level of
150,000 machine-hours?

11. The chief statistician of Aloha Company has developed the following cost formula:

Y = P50,000+ 2L + 3M

Where: Y = total monthly manufacturing overhead cost

L = labor hours
M = machine hours

The measure of goodness of fit is good and no evidence of multicolinearity exists. The company
will use 10,000 labor hours and 3,000 machine hours next month.

REQUIRED:
1. Determine the total manufacturing overhead costs that Aloha should incur next month.
2. Aloha makes a product that has P6.00 in materials costs. It requires two hours of labor time and
30 minutes of machine time. Laborers earn P10 per hour. What is the products per unit variable
manufacturing cost?

3. Suppose that Aloha could reduce the labor time for the product described in requirement 2 by
30 minutes, to 1.50 hours. Machine time will remain the same. By how much would the per unit
variable manufacturing cost fall?

12. M. Munda Company produces and sells rattan baskets. The number of units produced and the
corresponding total production costs for six months, which are representatives for the year, are as
follows:

Month Units Produced Production Costs

April 500 P4,000
May 700 8,000
June 900 6,000
July 600 7,500
August 800 8,500
September 550 7,250

12a. The cost function derived by the simple least squares method

a. is linear.
b. is curvilinear.
c. is parabolic.
d. must be tested for minimum and maximum points.
 12b. Using the least squares method, the variable production cost per unit is approximately

a. P 5. c. P0.27.
b. P10. d. P3.74.

12c. Using the least squares method, the monthly fixed production cost is approximately

a. P 1,500. c. P 4,350.
b. P18,000. d. P52,200.

12d. If the high-low points method is used, the results when compared with those under the
method of least squares, are
Variable Cost Per Unit Total Fixed Costs
a. Equal Equal
b. Higher by P1.26 Lower by P2,850
c. Lower by P1.26 Higher by P2,850
d. Higher by P5 Lower by P1,500

13. Meemon Company manufactures and sells a single product. A partially completed schedule of the
companys total and per unit costs over the relevant range of 30,000 to 50,000 units produced and
sold annually is given below:

Units produced and sold 30,000 40,000 50,000

Total costs:
Variable costs P180,000 ? ?
Fixed costs 300,000 ? ?
Total P480,000 ? ?
Cost per unit:
Variable ? ? ?
Fixed cost ? ? ?
Total ? ? ?

Required:
a. Complete the schedule of the companys total and unit costs above.
b. Compute income, assuming that the company produces and sells 45,000 units during a year at a
selling price of P16 per unit.

14. A company makes prestige high-end watches in small lots. The company has been in operation
since 1990. One of the companys products, a platinum diving watch, goes through an etching
process. The company has observed etching costs as follows over the last six weeks:
Week Units Total Etching Costs
1 4 P18
2 3 17
3 8 25
4 6 20
5 7 24
6 2 16
30 P120

For planning purposes, management would like to know the amount of variable etching cost per
unit and the total fixed etching cost per week.

Required:
1. Using the least squares regression method, estimate the variable and fixed elements of etching
costs.
2. Express the cost data in (1) above in the form Y = a + bX.
3. If the company processes five (5) units next week, what would be the expected total etching
cost?

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