Day 3

I. REVIEW PREVIOUS TOPICS

II. TRADING/MERCHANDISING VS. MANUFACTURING

1. INCOME STATEMENT

2. BALANCE SHEET

COST BEHAVIOR (LINEAR & CURVILINEAR)

A curvilinear cost, also called a nonlinear cost, is an expense that increases at an

inconsistent rate as production volume increases. In other words, this is an irregular
cost that increases at different rates as total output increases.
Unlike variable costs that increase at a constant rate as production increases, curvilinear
costs have not set parameters. They tend to increase drastically at lower levels of
production, flatten out at mid-levels, and increase again at higher levels of output. These
irregular cost increases make the curvilinear cost curve look like an "s" when charted on
a graph with the x axis representing volume in units and the y axis representing total
costs. Compare this to a variable cost curve that simply consists of a straight line from
zero to infinity.
Example: Generally, nonlinear costs are made up of groups of expenses. For example,
total direct labor for hourly workers is an irregular expense. At lower levels of production,
few hourly workers are needed, so the costs are low. When production levels get into the
mid-level, more workers are needed. The costs increase, but more efficiencies are also
added which allows the same number of workers to increase output. Once the production
reaches the highest levels of output, more workers are needed increasing the total labor
costs.
Management can also use these curves to judge whether current levels of production are
sustainable over the long term and make an estimated decisions about hiring a new
workforce or expanding capacity.
COST BEHAVIOR ASSUMPTIONS:
1. RELEVANT RANGE ASSUMPTION
Refers to the band of activity within which the identified cost behaviour patterns
are VALID. Any level outside the range may have a different cost behaviour
pattern.
The relevant range refers to a specific activity level that is bounded by a minimum
and maximum amount. Within the designated boundaries, certain revenue or cost
levels can be expected to occur. Outside of that relevant range, revenues and
expenses will likely differ from the expected amount.
NOTE: TOTAL FIXED COST remain constant @ certain level
UNIT COST/UNIT remain constant @ certain level
The concept of the relevant range is particularly useful in two forms of analysis, which
are:
Cost accounting. The assumed cost of a product, service, or activity is likely to be valid
within a relevant range, and less valid outside of that range. in particular, a "fixed" cost
is likely to remain fixed only within a relevant range of activity. Also, volume
discounts from suppliers are only valid for certain purchasing volume quantities.

Example: banana cue, ang kaya ra lutuon ni manang isa 500 per day so if mulapas pa
ana kinhanglan na niya ug additional investment as to equipment and additional labor
and may kinahanglan na mag expand. So kana sya na mga cost is considered as outside
relevant range.
Example: SUV for hire which can only accommodate up to 10 persons for 2500. So
minimum amount niya is 1 person for 2500 and then 10 persons still for 2500 but if mu
exceed na siya ug 10 persons or 11 na ka person so kinaanglan na ug 2 SUVs for 11
persons and ang ma bayran is 5000. So that 5000 for 11 persons is considered outside
the relevant range.
Example: if the factory is operating at capacity, increasing production requires additional
investment in fixed costs to expand the facility or to lease or build another factory. Alternatively,
production might be reduced below a threshold at which point one of the companys factories is
no longer needed, and the fixed costs associated with that factory can be avoided. With respect
to variable costs, the company might qualify for a volume discount on fabric purchases above
some production level. The relevant range for characterizing fabric as a variable cost ends at
that production level, because the fabric cost per unit of output is different when the factory
produces above that threshold than when the factory produces below that threshold.

Two important assumptions must be considered when estimating costs using

the methods described in this chapter.!!!
1. When costs are estimated for a specific level of activity, the assumption is that the
activity level is within the relevant range.
2. Costs are estimated assuming that they are linear.
Both assumptions are reasonable as long as the relevant range is clearly identified, and
the linearity assumption does not significantly distort the resulting cost estimate.
Question: Another important assumption being made by Bikes Unlimited is that all costs
behave in a linear manner. Variable, fixed, and mixed costs are all described and shown
as a straight line. However, many costs are not linear and often take on a nonlinear
pattern. Why do some costs behave in a nonlinear way?
Answer: Assume the pattern shown in Figure 5.9 "Nonlinear Variable Costs" is for total
variable production costs. Consider this: Have you ever worked a job where you were
very slow at first but improved rapidly with experience? If a company produces just a few
units each month, workers (direct labor) do not gain the experience needed to work
efficiently and may waste time and materials. This has the effect of driving up the per
unit variable cost. Recall that the slope of the line represents the unit cost; thus, when
the unit cost increases, so does the slope. If the company produces more units each
month, workers gain experience resulting in improved efficiency, and the per unit cost
decreases (both in materials and labor). This causes the total cost line to flatten out a bit
as the slope decreases. This is fine until the company starts to reach its limit in how
much it can produce (called capacity). Now the company must hire additional
inexperienced employees or pay its current employees overtime, which once again
drives up the cost per unit. Thus the slope begins to increase.

3. TIME PERIOD
The cost behaviour patterns are identified within are true only over a specified
period of time beyond this, the cost may show a different behavior

1. Variable Cost

2. Fixed Cost

3. Mixed Cost

4. Step Cost

Previous example mao nato dayon ang matawag na step cost.

NOTE: it does not grow as gradual like VC & does not

completely stay the same like FC but the cost goes up in steps
based on range.
Exercise: classify whether variable (V), fixed (F) or mixed (M)
1.
2.
3.
4.
5.
6.
7.

Cost item
Direct labor
Indirect labor
Property taxes
Maintenance
Depreciation
Utilities
Direct materials

2,000 units
12,000
4,000
20,000
7,000
24,000
8,000
16,000

5,000 units
30,000
15,000
20,000
16,000
24,000
19,000
40,000

Answer
V
M
F
M
F
M
V

III. SEGREGATION OF FIXED AND VARIABLE ELEMENTS OF MIXED

COSTS:
Cost formula: Y= a + bx

y= total cost
A= estimated FC
B=estimated VC/unit

1. HIGH-LOW METHOD

Example: Company wants to determine the cost-volume relation between its factory overhead cost and number of
units produced. Use the high-low method to split its factory overhead (FOH) costs into fixed and variable components
and create a cost volume formula. The volume and the corresponding total cost information of the factory for past
eight months are given below:

Month
1
2

Units

FOH
1,520
1,250

$36,375
38,000

Month
3
4
5
6
7
8

Units

FOH
1,750
1,600
2,350
2,100
3,000
2,750

41,750
42,360
55,080
48,100
59,000
56,800

2. STATISTICAL SCATTERGRAPH METHOD

3. LEAST SQUARES (REGRESSION ANALYSIS)

IV. PROFIT COST CENTERS & COST CENTERS

V. GROUP ACTIVITY

CASE STUDY
Make a scenario that would probably be happening in costing products that you will be
faced as a cost accountant and decide on what will be your response on the situation.
(20pts)