Chapter 6

Activity Analysis, Cost

Behavior, and Cost
Estimation

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Introduction

Cost Cost Cost

estimation behavior prediction

Process of Relationship Using knowledge

determining between of cost behavior
cost behavior, cost and to forecast
often focuses activity. level of cost at
on historical a particular
data. activity. Focus
is on the future.

6-2
Total Variable Cost Example
Your total Pay Per View bill is based on how many Pay Per View
shows that you watch.
Total Pay Per View Bill

Number of Pay Per View shows

watched 6-3
Variable Cost Per Unit Example
The cost per Pay Per View show is constant. For example, $4.95
per show.

Cost per Pay Per View

show

Number of Pay Per View

shows watched 6-4
Step-Variable Costs

Total cost remains

constant within a
narrow range of
activity.

Cost
Activity

6-5
Step-Variable Costs
Total cost increases to a
new higher cost for the
next higher range of
activity.

Cost
Activity

6-6
 Total Fixed Cost Example
Your monthly basic cable TV bill probably does not change no matter
how many hours you watch.
Monthly Basic
Cable Bill

Number of hours watched

6-7
Fixed Cost Per Unit Example
The average cost per hour decreases as more hours are spent
watching cable television.

Monthly Basic cable Bill

per hour watched

Number of hours watched

6-8
Step-Fixed Costs
Total cost doesn’t change for a wide range of activity,
and then jumps to a new higher cost for the next
higher range of activity.

90
Thousands of Dollars
Rent Cost in

60

30

0 1,000 2,000 3,000

Rented Area (Square Feet) 6-9
Semivariable Cost

A semivariable cost
is partly fixed and
partly variable.
Consider the
following
example:.

6-10
Semivariable Cost
The slope is
the variable
cost per unit
of activity.
Total Lease Cost

Variable Lease
Charge Per Hour

Fixed Monthly
Rental Charge
Rental Charge Per Hour
6-11
Curvilinear Cost Curvilinear
Cost Function
Total Cost

A straight-line
(constant unit
variable cost) closely
approximates a
curvilinear line within
Relevant Range the relevant range.

Activity
6-12
Curvilinear Cost Curvilinear
Cost Function
Total Cost

A straight-Line
(constant unit
variable cost) closely
approximates a
curvilinear line within
Relevant Range the relevant range.

Activity
6-13
Engineered, Committed, and Discretionary
Costs
Committed Discretionary
Long-term, cannot be May be altered in the
reduced in the short short term by current
term. managerial decisions.

Engineered
Physical relationship
with activity measure.

Depreciation on Advertising and

Buildings and Direct Research and
equipment Materials Development
6-14
Visual-Fit Method
A scatter diagram of past cost behavior
may be helpful in analyzing mixed costs.

6-15
 Visual-Fit Method
Plot the data points on a
graph (total cost vs. activity).
1,000’s of Dollars

20
* ** *
Total Cost in

* *
**
10 * *

0
0 1 2 3 4
Activity, 1,000’s of Units Produced
6-16
 Visual-Fit Method
Draw a line through the plotted data points so that about
equal numbers of points fall above and below the line.
1,000’s of Dollars

20
* ** *
Total Cost in

* *
**
10 * *

0
0 1 2 3 4
Activity, 1,000’s of Units Produced
6-17
 Visual-Fit Method

Estimated fixed cost = $10,000

1,000’s of Dollars

20
* ** *
Total Cost in

* *
** Vertical distance
10 * * is total cost,
approximately
$16,000.
0
0 1 2 3 4
Activity, 1,000’s of Units Produced
6-18
The High-Low Method
Owl Co recorded the following production activity & maintenance costs for
two months:

Units Cost
High activity level 9,000 $ 9,700
Low activity level 5,000 6,100

Using these two levels of activity, compute:

the variable cost per unit.
the total fixed cost.

6-19
 The High-Low Method
Units Cost
High activity level 9,000 $ 9,700
Low activity level 5,000 6,100
Change 4,000 $ 3,600

6-20
 The High-Low Method
Units Cost
High activity level 9,000 $ 9,700
Low activity level 5,000 6,100
Change 4,000 $ 3,600

in cost
Unit variable cost = in units

6-21
 The High-Low Method
Units Cost
High activity level 9,000 $ 9,700
Low activity level 5,000 6,100
Change 4,000 $ 3,600

Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit

6-22
 The High-Low Method
Units Cost
High activity level 9,000 $ 9,700
Low activity level 5,000 6,100
Change 4,000 $ 3,600

Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit

Fixed cost = Total cost – Total variable cost

6-23
 The High-Low Method
Units Cost
High activity level 9,000 $ 9,700
Low activity level 5,000 6,100
Change 4,000 $ 3,600

Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit

Fixed cost = Total cost – Total variable cost
Fixed cost = $9,700 – ($0.90 per unit × 9,000 units)

6-24
 The High-Low Method
Units Cost
High activity level 9,000 $ 9,700
Low activity level 5,000 6,100
Change 4,000 $ 3,600

Unit variable cost = $3,600 ÷ 4,000 units = $.90 per unit

Fixed cost = Total cost – Total variable cost
Fixed cost = $9,700 – ($.90 per unit × 9,000 units)
Fixed cost = $9,700 – $8,100 = $1,600

6-25
Least-Squares Regression Method
Regression is a statistical procedure used
to determine the relationship between variables such as
activity and cost.
Total Cost

The objective of
the regression
method is the
general cost equation:
Y = a + bX

Activity
6-26
Equation Form of Least-Squares
Regression Line

Y = a + bX

Total Cost is the The activity (X) is the

dependent variable. independent variable.

The intercept term (a) is The X term coefficient (b)

the estimate of fixed costs. is the estimate of variable
cost per unit of activity,
the slope of the cost line.
6-27
Least-Squares Regression Method
 Statistics courses and computer
courses deal with detailed
regression computations using
Microsoft Excel.
 Accountants and managers must
be able to interpret and use
regression estimates.

6-28
Multiple Regression
Multiple regression includes two or more independent variables:

Y = a + b1X1 + b2X2

Terms in the equation have the same

meaning as in simple regression with
only one independent variable.

6-29
Engineering Method
of Cost Estimation

Cost estimates are based on measurement

and pricing of the work involved.

6-30
Effect of Learning
on Cost Behavior
As I make more of these
things it takes me less
time for each one. It must
be the learning curve effect
that the boss was
talking about.
I’ve noticed the same
thing. And if you include
all the variable overhead
costs that are also
declining, that must be
the experience curve.
6-31
Learning Curve

Learning effects
are large initially.
Average Labor
Time per Unit

Learning effects
become smaller, eventually
reaching steady state.

Cumulative Production Output

6-32
Data Collection Problems
1. Missing data.
2. Outlier data points.
3. Mismatched time periods costs.
4. Trade-offs in choosing the time period.
5. Allocated and discretionary costs.
6. Inflation.

6-33