WEEK 2.docx - WEEK 2 Cost behaviour: The relationship...

WEEK 2
Cost behaviour: The relationship between a cost and the level of activity that causes this cost (i.e the
cost driver)
Cost estimation: The process of determining the cost behaviour of a particular cost item
Cost prediction: Using knowledge of cost behaviour to forecast the level of cost at a particular level
of activity
We analyse costs
To aid the control of costs manage resources ‐
To estimate how costs will behave in the future planning To do this we want to understand what ‐
causes different costs to vary what are the drivers of costs ‐ the cost drivers? ‐
An activity or factor that causes costs to be incurred The number of chairs manufactured drives the
cost of direct material used. The level of production or volume drives the direct material costs
Each style of chair to be made may require modification to the machinery to cut the timber
differently. The number of times we adjust the machinery to cater for each style of chair will drive
the machine set up costs.
• Volume based cost driver: assumes that costs are driven, or caused, by the volume of production
(or sales)
Non volume based cost driver: a cost driver that is not directly related to production volume
Unit level costs
Relate to activities performed for each unit produced Eg Direct material costs – cost driver is number
of units produced
Batch level costs
Relate to activities performed for a group of product units, eg. a batch or load Eg Delivery truck costs
– cost driver could be the number of deliveries made
Product (or product sustaining) level ‐
Relates to activities performed for specific products or product groups Eg Design of a new product –
the cost driver could be number of products available
Facility level

Costs incurred to support the business as a whole, not caused by any particular product Eg Rent of
factory no specific driver ‐
Cost behaviour is the relationship between a cost and the level of activity
• Variable costs
• Fixed costs
• Step fixed costs ‐
• Semi variable costs ‐
• Curvilinear costs
Y = a + bX
Where Y = total cost
a = fixed cost component (the intercept on the vertical axis)
b = variable cost per unit of activity (the slope of the line)
X = the level of activity
Variable costs
As activity increases or decreases total variable costs change in direct proportion. The variable cost
per unit remains constant
The variable cost per unit is the slope (b) of the cost line in the following cost function:
Y = a + bX
Fixed costs
• As activity increases or decreases total fixed costs do not change but fixed cost per unit changes
• The fixed cost is the vertical axis intercept (a) of the cost line in the following cost function:
Y = a + bX
Note: Fixed cost per unit is often calculated to use in product costing but is of limited use in
management decision making fixed costs do not vary with activity within the relevant range ‐
Step fixed costs ‐
Remain fixed over a wide range of activity levels but jump to a different amount for levels outside
that range
Semi variable (or mixed) costs ‐
Have both fixed and variable components