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CHAPTER 10
DETERMINING HOW COSTS BEHAVE
101
The two assumptions are
1.
Variations in the level of a single activity (the cost driver) explain the variations in the
related total costs.
2.
Cost behavior is approximated by a linear cost function within the relevant range. A
linear cost function is a cost function where, within the relevant range, the graph of total
costs versus the level of a single activity forms a straight line.
102
Three alternative linear cost functions are
1.
Variable cost function––a cost function in which total costs change in proportion to the
changes in the level of activity in the relevant range.
2.
Fixed cost function––a cost function in which total costs do not change with changes in
the level of activity in the relevant range.
3.
Mixed cost function––a cost function that has both variable and fixed elements. Total
costs change but not in proportion to the changes in the level of activity in the relevant
range.
103
A linear cost function is a cost function where, within the relevant range, the graph of
total costs versus the level of a single activity related to that cost is a straight line. An example of
a linear cost function is a cost function for use of a telephone line where the terms are a fixed
charge of $10,000 per year plus a $2 per minute charge for phone use. A nonlinear cost function
is a cost function where, within the relevant range, the graph of total costs versus the level of a
single activity related to that cost is not a straight line. Examples include economies of scale in
advertising where an agency can double the number of advertisements for less than twice the
costs, stepcost functions, and learningcurvebased costs.
104
No. High correlation merely indicates that the two variables move together in the data
examined. It is essential also to consider economic plausibility before making inferences about
cause and effect. Without any economic plausibility for a relationship, it is less likely that a high
level of correlation observed in one set of data will be similarly found in other sets of data.
105
Four approaches to estimating a cost function are
1.
Industrial engineering method.
2.
Conference method.
3.
Account analysis method.
4.
Quantitative analysis of current or past cost relationships.
106
The conference method estimates cost functions on the basis of analysis and opinions
about costs and their drivers gathered from various departments of a company (purchasing,
process engineering, manufacturing, employee relations, etc.). Advantages of the conference
method include
1.
The speed with which cost estimates can be developed.
2.
The pooling of knowledge from experts across functional areas.
3.
The improved credibility of the cost function to all personnel.
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107
No. The account analysis method estimates cost functions by classifying cost accounts in
the subsidiary ledger as variable, fixed, or mixed with respect to the identified level of activity.
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 Summer '08
 Dr.Ada
 Variable Manufacturing, cost analyst

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