Methods of Determining cost behavior
Judgment based methods
Industrial engineering method
Account analysis method
Quantitative methods
High-Low method
Scatter plot method
Least square method
Judgment based method
1. Industrial Engineering Method
Physical observation and analysis
Time and motion study
Very expensive to implement
Seldom updated once they are done
Mostly used in manufacturing process where there is a direct link between materials and labour inputs with the outputs.
Can be applied to new processes and designs
Less useful in case of costing services
Account analysis method
Costs are classified into fixed, variable and mixed costs
Accountant uses judgment and experience to separate the accounts into two categories – Fixed and variable
Once the fixed categories are known, the monthly cost can be computed and this is the fixed amount.
The variable categories need to be further separated into categories according to the driver the accountant wishes to associate with the account
Quantitative methods
1. High-Low method:
The high-low method preselects the two points that are used to compute the parameters F ( Fixed cost) and V ( variable cost).
High point is the point with the highest output or driver level.
Low point is the point with the lowest output or driver level.
High and low point determined by the independent variable
1.Determine high and low point
The high number of moves is in May and the low number of moves is in January.
2. Calculate the variable rate for materials handling based on the number of moves.
Variable rate = ( High cost – Low cost)/ ( High moves- Low moves)
= ($7,500- $2,000)/ (500-100)
= $13.75 per move
3. Calculate the fixed monthly cost of material handling
Fixed cost= Total cost – ( Variable rate * moves)
= $7500 –($13.75*500)
=$625
4. Write the cost formula for the material handling activity showing the fixed cost and the variable rate.
Total cost = Fixed cost + Variable cost (X)
X= No of moves
Total cost = $625+$13.75(x)
5. If company estimates that Nov. will have 350 moves, what is the total estimated materials handling cost for that month?
Material handling cost = $625 +$13.75(350)
= $ 5,437.50
6. If the company wants to estimate the materials handling cost for the coming year and expects 3,940 moves, what will be the material handling cost?
12($625)+$13.75(3940)
= $61,675
2. Scatter plot method
Plot the data points so that the relationship between materials handling costs and activity output can be seen.
Scatter point can provide insight concerning the relationship between cost and output by allowing one to visually fit a line to the points on the scatter graph.
3. Method of Least Square
Method of least square identifies the best-fitting line.
With the help of this line cost can be estimated.
Method of least square is also statistically called as regression model.
Learning curve and Nonlinear cost behaviour
Learning curve is an important type of nonlinear cost curve
3. Judgment based method
1. Industrial Engineering Method
Physical observation and analysis
Time and motion study
Very expensive to implement
Seldom updated once they are done
Mostly used in manufacturing process where there is a
direct link between materials and labour inputs with
the outputs.
Can be applied to new processes and designs
Less useful in case of costing services
4. 2. Account analysis method
Costs are classified into fixed, variable and mixed
costs
Accountant uses judgment and experience to separate
the accounts into two categories – Fixed and variable
Once the fixed categories are known, the monthly cost
can be computed and this is the fixed amount.
The variable categories need to be further separated
into categories according to the driver the accountant
wishes to associate with the account
5. Eg. Accounts that are variable with respect of direct
labour can be separated, their average cost
determined, and then that total divided by the average
amount of direct labour hours to obtain the variable
rate per direct labour hour.
Accounts driven by machine hours, purchase orders
etc can be separated
6. Quantitative methods
1. High-Low method:
The high-low method preselects the two points that
are used to compute the parameters F ( Fixed cost) and
V ( variable cost).
High point is the point with the highest output or
driver level.
Low point is the point with the lowest output or driver
level.
High and low point determined by the independent
variable.
7. Company data for material handling cost
and number of moves
Month Material Handling cost Number of Moves
Jan $2,000 100
Feb $3090 125
Mar $2780 175
Apr $1990 200
May $7500 500
June $5300 300
July $4300 250
Aug $6300 400
Sept $5600 475
Oct $6240 425
8. 1.Determine high and low point
The high number of moves is in May and the low
number of moves is in January.
2. Calculate the variable rate for materials handling
based on the number of moves.
Variable rate = ( High cost – Low cost)/ ( High moves-
Low moves)
= ($7,500- $2,000)/ (500-100)
= $13.75 per move
9. 3. Calculate the fixed monthly cost of material handling
Fixed cost= Total cost – ( Variable rate * moves)
= $7500 –($13.75*500)
=$625
4. Write the cost formula for the material handling
activity showing the fixed cost and the variable rate.
Total cost = Fixed cost + Variable cost (X)
X= No of moves
Total cost = $625+$13.75(x)
10. 5. If company estimates that Nov. will have 350 moves,
what is the total estimated materials handling cost for
that month?
Material handling cost = $625 +$13.75(350)
= $ 5,437.50
6. If the company wants to estimate the materials
handling cost for the coming year and expects 3,940
moves, what will be the material handling cost?
12($625)+$13.75(3940)
= $61,675
11. 2. Scatter plot method
Plot the data points so that the relationship between
materials handling costs and activity output can be
seen.
Scatter point can provide insight concerning the
relationship between cost and output by allowing one
to visually fit a line to the points on the scatter graph.
13. 3. Method of Least Square
Method of least square identifies the best-fitting line.
With the help of this line cost can be estimated.
Method of least square is also statistically called as
regression model.
14. Learning curve and Nonlinear cost
behaviour
Learning curve is an important type of nonlinear cost
curve.
The basis of the learning curve is almost intuitive –as
we perform an action over and over, we improve, and
each additional performance takes less time than the
preceding ones.
This effect was first documented in aircraft industry.
One common form of the learning curve model is the
cumulative average-time learning curve model.
15. Cumulative Average-Time Learning
Curve
The cumulative average-time learning curve model states
that the cumulative average time per unit decreases by a
constant percentage, each time cumulative quantity of
units produced doubles.
Expression for cumulative average time learning model:
Y=pXq
Y= cumulative average time per unit
X= cumulative number of units produced
P= Time in labour hours required to produce the first unit
q = Rate of learning
16. Cumulative average-time learning
Cumulative No.
Of units
(1)
Cumulative
average time per
unit in
Hours
(2)
Cumulative total
time : Labour
hours
(3) = (1) x (2)
Individual Unit
time for nth
Unit: Labour
Hours
(4)
1 100 100 100
2 80 160 60
3 70.21 210.63 50.63
4 64 256 45.37
5 59.57 297.85 41.85
6 56.17 337.02 39.17
7 53.45 374.15 37.13
8 51.20 409.60 35.45
16 40.96 655.36 28.06
32 32.77 1048.64
17. References:
Liming Guan, Don R. Hansen, and Maryanne M.
Mowen (2014). Corner Stones of Cost Management,
2/e; New Delhi: Cengage Learning
Leslie G. Eldenburg and Susan K. Wolcott (2011). Cost
management: Measuring, Monitoring and Motivating
Performance, 2/e: Wiley.