IPE 4439
Principles of Economics
and Cost Accounting
Course Teacher: Sharmin Akter Urmee
Lecturer, Department of MPE
Room No: 111, Old Academic Building
CHAPTER 3
Cost Behavior:
Analysis and Use
What are the different cost Behaviour
patterns that management should
understand?
What approaches can be used to develop
cost-prediction models?
Cost Structure
The relative proportion of fixed, variable, and
mixed costs found in an organization.
Types of Cost Behaviour Patterns
• Variable Costs
The Activity Base
An activity base is a measure of whatever causes a variable cost
to be incurred.
Some of the most common activity bases are direct labour-
hours, machine-hours, units produced, and units sold.
Extent of Variable Cost
• A public utility like Hydro One, with large investments in equipment, tends
to have few variable costs.
• A manufacturing company like Paradigm and merchandising company, by
contrast, often has many variable costs;
• Service companies, such as the restaurant chain Harvey ’s, have significant
variable costs because of their raw material costs. On the other hand,
service companies involved in consulting, auditing, engineering, dental,
medical, software development, and architectural activities have very large
fixed costs.
True Variable versus Step-Variable Costs
True Variable Costs:
Direct materials is a true or proportionately variable cost because the
amount used during a period varies in direct proportion to the level of
production activity.
Step-Variable Costs:
The cost of a resource that is obtainable only in large amounts
(such as maintenance workers) and that increases or decreases only in
response to fairly wide changes in activity is known as a step-variable cost.
True Variable versus Step-Variable Costs
The Linearity Assumption and the Relevant
Range
A curvilinear cost can
be reasonably
approximated with a
straight line within
the band of activity
known as the
relevant
range.
Types of Cost Behaviour Patterns
• Fixed Cost
Types of Fixed Costs
• Committed fixed costs
Fixed costs that are difficult to adjust in the short term
and that relate to the investment in facilities,
equipment, and the basic organizational structure of a
firm.
• Discretionary fixed costs
Fixed costs arising from annual decisions by
management to spend in certain areas, such as
advertising and research.
The Trend toward Fixed Costs
• The trend in many companies is toward greater fixed costs
relative to variable costs.
• For example, grocery clerks at Loblaws and Sobeys used to
key in prices by hand on cash registers. Now, stores are
equipped with bar code readers that enter price and other
product information automatically, and many have self-
checkout stations where customers pay for their purchases
without the involvement of store personnel.
Fixed Costs and the Relevant Range
Types of Cost Behaviour Patterns
• Mixed Cost
Types of Cost Behaviour Patterns
• Mixed Cost
Diagnosing Cost Behaviour with a Scattergram
Plot
how will i determine fixed , variable and mixed or total cost from here?
Diagnosing Cost Behaviour with a Scattergram
Plot
More Than One Relevant Range
The High–Low Method or Least-Squares
Regression Method.
The high–low method is based on the rise-over-run formula for the slope of a straight
line. If the relationship between cost and activity can be represented by a straight
line, then the slope of the straight line is equal to the variable cost per unit of activity.