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MAS-LECTURE NOTES ARMIN GLENN ARANETA, CPA

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 cost, 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 the 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
Cost behavior- describes how a cost behaves or changes as the amount of cost driver changes.

TYPES OF COST 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 identified
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.

SEGRATION 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 point from the point directly above or below it on the 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 + b∑x
Equation 2: ∑xy = a∑x + b∑x²

COST FORMULA: 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 = is an estimate of the variable cost per unit of activity.
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EXERCISES:

1. Identify the following cost items according to their cost behavior.

Cost Item Cost at 100 units Cost at 120 units

A P6,000 P6,200
R P3,000 P3,000
M P3,000 P3,600
I P4,000 P4,800
N P9,000 P10,800

2. Tamismonaman Candies manufactures tooth-breaker candies in a fully automated process. The machine
that produces candies was purchased recently and can make 4100 per month. The machine costs P9000
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 P1200 per month.

Tamismonaman currently makes and sells 3800 tooth-breakers per month. Tamismonaman buys just
enough materials each month to make the tooth-breakers it needs to sell. Materials cost 30c per tooth-
breaker.

Next year, Tamismonaman expects demand to increase by 100%. At this volume of materials purchased,
it will get a 10% discount on price. Rent and other fixed manufacturing overhead cost will remain the
same.

REQUIRED:

A. What is Tamismonaman ‘s current annual relevant range of output?

B. What is Tamismonaman’s current annual fixed manufacturing cost within the relevant range? What is
the annual variable manufacturing cost?
C. What will Tamismonaman’s 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, Tamismonaman could
buy an identical machine at the same cost as the one it already has.)

3. Katniss Everdeen is examining customer-service costs in the southern region of Hunger Products.
Hunger 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 costumer, 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 Cost 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 the cost function, relating customer-service costs to
the number of service reports.
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4. Below is an examination of last year’s financial statements of Tinkerbell Company. Units produced and
production costs for the first four months of the year, which are representative for the year, where 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 estimate made in number 1, compute the total cost for 8 units.

“By learning you will teach; by teaching you will understand.”

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