Manerial accounting 11e garrison noreen brewer chap005

11th Edition
Chapter 5

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Cost Behavior:
Analysis and Use
Chapter Five

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Types of Cost Behavior Patterns
Recall the summary of our cost behavior
discussion from an earlier chapter.

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The Activity Base
Units
Units
produced
produced

Machine
Machine
hours
hours
A
A measure
measure of
of what
what
causes
causes the
the
incurrence
incurrence of
of aa
variable
variable cost
cost

Miles
Miles
driven
driven
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Labor
Labor
hours
hours

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True Variable Cost Example

Total Long Distance
Telephone Bill

A variable cost is a cost whose total dollar amount
varies in direct proportion to changes in the activity
level. Your total long distance telephone bill is
based on how many minutes you talk.

Minutes Talked
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Types of Cost Behavior Patterns
Recall the summary of our cost behavior
discussion from an earlier chapter.

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Variable Cost Per Unit Example

Per Minute
Telephone Charge

A variable cost remains constant if expressed on
a per unit basis. The cost per minute talked is
constant. For example, 10 cents per minute.

Minutes Talked
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Extent of Variable Costs
The proportion of variable costs differs across
organizations. For example . . .
A public utility with
large investments in
equipment will tend
to have fewer
variable costs.

A manufacturing company
will often have many
variable costs.

A service company
will normally have a high
proportion of variable costs.

A merchandising company
usually will have a high
proportion of variable costs
like cost of sales.

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Examples of Variable Costs
1. Merchandising companies – cost of goods sold.
2. Manufacturing companies – direct materials,
direct labor, and variable overhead.
3. Merchandising and manufacturing companies –
commissions, shipping costs, and clerical costs
such as invoicing.
4. Service companies – supplies, travel, and
clerical.

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True Variable Cost

Cost

Direct materials is a true or proportionately variable

cost because the amount used during a period will
vary in direct proportion to the level of production
activity.

Volume
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Step-Variable Costs

Cost

A resource that is obtainable only in large chunks (such
as maintenance workers) and whose costs increase or
decrease only in response to fairly wide changes in
activity is known as a step-variable cost.
cost

Volume
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Step-Variable Costs

Cost

Small
Small changes
changes in
in the
the level
level of
of production
production are
are
not
not likely
likely to
to have
have any
any effect
effect on
on the
the number
number of
of
maintenance
maintenance workers
workers employed.
employed.

Volume
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Step-Variable Costs

Cost

Only fairly wide changes in the activity level will
cause a change in the number of maintenance
workers employed

Volume
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The Linearity Assumption and the Relevant Range

Total Cost

Economist’s
Curvilinear Cost
Function
Relevant
Range

A
A straight
straight line
line
closely

closely
approximates
approximates aa
curvilinear
curvilinear
variable
variable cost
cost
line
line within
within the
the
relevant
relevant range.
range.

Accountant’s Straight-Line
Approximation (constant
unit variable cost)
Activity

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Types of Cost Behavior Patterns
Let’s look at fixed cost behavior on the next
screens.

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Total Fixed Cost Example

Monthly Basic
Telephone Bill

A fixed cost is a cost whose total dollar amount remains
constant as the activity level changes. Your monthly
basic telephone bill is probably fixed and does not
change when you make more local calls.

Number of Local Calls
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Types of Cost Behavior Patterns
Recall the summary of our cost behavior
discussion from an earlier chapter.

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Fixed Cost Per Unit Example

Monthly Basic Telephone
Bill per Local Call

Average fixed costs per unit decrease as the activity
level increases. The fixed cost per local call
decreases as more local calls are made.

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Number of Local Calls
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Types of Fixed Costs

Committed
Committed

Discretionary
Discretionary

Long-term,
Long-term, cannot
cannot be
be
significantly
significantly reduced
reduced

in
in the
the short
short term.
term.

May
May be
be altered
altered in
in the
the
short-term
short-term by
by current
current
managerial
managerial decisions
decisions

Examples

Examples
Examples

Depreciation on
Equipment and
Real Estate Taxes

Advertising

Advertising and
and
Research
Research and
and
Development
Development

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The Trend Toward Fixed Costs
The trend in many industries is toward
greater fixed costs relative to variable costs.
As
As machines
machines take
take over
over
many
many mundane
mundane tasks
tasks
previously
previously performed
performed
by
by humans,

humans,
““knowledge
knowledge workers
workers””
are
are demanded
demanded for
for
their
their minds
minds rather
rather
than
than their
their muscles
muscles
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Knowledge
Knowledge workers
workers
tend
tend to
to be
be salaried,
salaried,
highly-trained
highly-trained and
and
difficult

difficult to
to replace.
replace. The
The
cost
cost to
to compensate
compensate
these
these valued
valued employees
employees
is
is relatively
relatively fixed
fixed
rather
rather than
than variable.
variable.
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Is Labor a Variable or a Fixed Cost?
The behavior of wage and salary costs can
differ across countries, depending on labor
regulations, labor contracts, and custom.
In France, Germany, China, and Japan management has
little flexibility in adjusting the size of the labor force.
Labor costs are more fixed in nature.

In the United States and the United Kingdom management
has greater latitude. Labor costs are more variable in nature.

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Rent Cost in
Thousands of Dollars

Fixed Costs and Relevant Range

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90
Relevant

60

Range

30
0

0

Total
Total cost
cost doesn’t

doesn’t
change
change for
for aa wide
wide
range
range of
of activity,
activity,
and
and then
then jumps
jumps to
to aa
new
new higher
higher cost
cost for
for
the
the next
next higher
higher
range
range of
of activity.
activity.

1,000
2,000

3,000
Rented Area (Square Feet)
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Fixed Costs and Relevant Range
The relevant range of activity for a fixed cost
is the range of activity over which the graph
of the cost is flat.
Example: Office space is
available at a rental rate of
$30,000 per year in
increments of 1,000 square
feet. As the business grows
more space is rented,
increasing the total cost.
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Fixed Costs and Relevant Range

How does this
type of fixed cost
differ from a stepvariable cost?
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Step-variable costs
can be adjusted

more quickly and . . .
The width of the
activity steps is
much wider for the
fixed cost.
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Quick Check 
Which
Which of
of the
the following
following statements
statements about
about cost
cost
behavior
behavior are
are true?
true?
1.
1. Fixed
Fixed costs
costs per
per unit
unit vary
vary with
with the
the level

level of
of
activity.
activity.
2.
2. Variable
Variable costs
costs per
per unit
unit are
are constant
constant within
within the
the
relevant
relevant range.
range.
3.
3. Total
Total fixed
fixed costs
costs are
are constant
constant within
within the
the
relevant
relevant range.
range.
4.

4. Total
Total variable
variable costs
costs are
are constant
constant within
within the
the
relevant
relevant range.
range.
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