CPAR

CPA Review School of the Philippines

MANAGEMENT ADVISORY SERVICES
COSTS AND CONCEPTS
Cost- a measurement, in monetary terms, of the amount of resources used for some purpose. When notified
by a term that defines the purpose, cost becomes operational, e.g., selling cost, acquisition cost, variable
cost,etc.
Cost pool an account which a variety of similar costs are accumulated prior to allocation to cost objects. It is
a group of costs associated with an activity. Example: overhead account.
Cost object the intermediate and final disposition of cost pools.
Example: product, job, process
Cost driver a factor that causes a change in the cost pool for a particular activity. It is used as a basis for
cost allocation; any factor or activity that has a direct cause-effect relationship.
Activity any event, action, transaction, or work sequence that incurs costs when producing a product or
providing a service.
COST BEHAVIOR
COST BEHAVIOR describes how a cost behaves or changes as the amount of cost driver changes.
TYPES OF COSTS AS TO BEHAVIOR
1. FIXED COST in total: constant within the relevant range as activity output changes; per unit: changes
as activity level changes.
2. VARIABLE COST in total: varies in direct proportion to changes in activity output; per unit: remains
constant.
3. MIXED COST has both fixed and variable components.
COST BEHAVIOR ASSUMPTIONS:
1. Relevant Range Assumption
Relevant range refers to the band of activity within which the identified cost behavior patterns
are valid. Any level of activity outside this range may have a different cost behavior pattern.
2. Time Period Assumption
The cost behavior patterns identified are true only over a specified period of time. Beyond this,
the cost may show a different behavior.
SEGREGATION OF FIXED AND VARIABLE ELEMENTS OF MIXED COSTS:
1. High-Low Points Method the fixed and Variable elements of the mixed costs are computed from two
data points (period)-the high and low periods as to activity level or cost driver.
2. Statistical Scattergraph Method various costs (the dependent variable) are plotted on a vertical line
(y-axis) and measurement figures (x-axis). A straight line is drawn through the points and, using this
line, the rate of variability and the fixed cost are computed.
3. Method of Least Squares (Regression Analysis) mathematically determines a line of best fit or a
linear regression line through a set of plotted points so that the sum of the squared deviations of each
actual plotted point from the point directly above or below it on the regression line is at minimum.

This method uses the following equations in computing for the values of unit variable cost and fixed
cost:

Equation 1:

Y = na + b x

Equation 2:

xy = a x + b x2

COST FORMULA: y = a + bx
Where: y denotes total cost. It is called the dependent variable because it is dependent on the value of
another variable, the activity level x.
a is an estimate of the fixed cost
b is an estimate of the variable cost per unit of activity.
EXERCISES:
1. Malabon Industries has developed two new products but has only enough plant capacity to introduce
one product during the coming year. The following data will assist management in deciding which
product should be selected.
Malabons fixed overhead includes rent and utilities, equipment depreciation, and supervisory salaries.
Selling and administrative expenses are not allocated to products.
Raw materials

Machining @ P12 per hour

Assembly @ P10 per hour
Variable overhead @ P8 per hour
Fixed overhead @ P4 per hour
Total cost
Suggested selling price
Actual R & D costs
Propoed advertising and promotion costs

Product A

Product B

44.00
18.00
30.00
36.00
18.00
P 146.00
P 169.95
P 240,000
P 500,000

36.00
15.00
10.00
18.00
9.00
P 88.00
P 99.98
P175,000
P350,000

A. For Malabons Product A, the unit costs for raw materials, machining, and assembly represent
a. Conversion costs
c. Prime costs
b. Separable costs
d. Common costs
B. The difference between the P99.98 suggested selling price for Product B and its total unit cost of
P88.00 represents the units
a. Contribution margin
c. Prime costs
b. Gross profit
d. Common costs
C. The total overhead cost of P27.00 for Product b is a
a. Carrying cost
c. Mixed cost
b. Sunk cost
d. Committed cost
D. Research and development costs for two new products are
a. Conversion cost
c. Relevant cost
b. Sunk cost
d. Avoidable costs
E. The advertising and promotion costs for the product selected by Malabon will be
a. Discretionary costs
c. Prime costs
b. Opportunity costs
d. Incremental costs
F. The costs included in the fixed overhead are

a. Joint costs
b. Committed costs

c. Opportunity costs
d. Prime costs

2. The following data have been collected for four different cost items.
Cost item
cost at 100 units
cost at 140 units
W
P8,000
P10,560
X
P5,000
P5,000
Y
P6,500
P9,100
Z
P6,700
P8,580
Which of the following classifications of these cost items by cost behavior is correct?
a.
b.
c.
d.

Cost W
Variable
Mixed
Variable
Mixed

Cost X
fixed
fixed
fixed
fixed

Cost Y
mixed
variable
variable
mixed

Cost Z
variable
mixed
variable
mixed

3. The administrator of Buntis Maternity Hospital would like a cost formula linking the costs involved in
admitting patients to the number of patients admitted during a month. The admitting department cost
and the number of patients admitted during the immediately preceding ten months are given in the
following table:
Month
May
June
July
August
September
October
November
December
January
February

Number of patients Admitted

201
276
122
386
274
436
321
328
24
161

Admitting Department Costs

P13,845
20,624
12,941
18,452
14,843
21,890
16,831
21,924
1,826
16,832

The administrator realizes that many more months of data should be gathered before jumping to
conclusions about how costs behave. He also wishes that more detailed classifications were available
(for example, age of patient, sex, height, weight etc. ). But he has decided to use the foregoing data as
a start.
REQUIRED:
1. Segregation the fixed and variable components of the admitting costs using the high-low method.
2. Express the fixed and variable components of admitting costs as a cost formula in the linear
equation form Y = a + bX.
4. The controller of Leon Furniture, a retail store, wants to determine the variable and fixed cost
components of the companys costs and expenses. He has prepared income statements for recent
months, which he plans to use in conducting cost analysis.
Sales
P80,000
P90,000
Cost of goods sold
48,000
54,000
Gross profit
P32,000
P36,000
Operating expenses:
Selling
P 8,500
P 8,800
Administrative
9,200
9,400

Total

P17,700
P14,300

Profit

P18,200
P17,800

Required:
a. Determine the fixed and variable components of cost of goods sold, selling expenses, and
administrative expenses.
b. Compute income if sales amount to P100,000.
5. Below is an examination of last years financial statements of Mickey Company. Units produced and
production costs for the first four (4) months of the year, which are representative for the year, were as
follows:
Month
January
February
March
April

Labor Hours
25
35
45
35

Total Production Costs

P200
250
300
250

REQUIRED:
1. Using the least-square method, calculate the monthly fixed and variable components of the total
production costs.
2. Using the estimates made in number 1, compute the total cost for 300 units.
6. An analysis of past janitorial costs indicates that the average janitorial cost is P1.50 per machine hour
at an activity level of 40,000 machine hours and P1.20 per machine hour at an activity level of 50,000
machine hours. Assuming that this activity is within the relevant range, what is the total expected
janitorial cost if the activity level is 45,000 machine hours?
7. The Mix? Company uses the high-low method to estimate the cost function. The information for 2012 is
provided below:
Machine-hours
Labor cost
Highest observation of cost driver
500
P15,000
Lowest observation of cost driver
220
6,600
What is the total cost for 400 hours?
8. Black Forest Clinic contains 600 beds. The average occupancy rate is 90% per month. In other words,
an average of 90% of the clinics beds are occupied by patients. At this level of occupancy, the clinics
operating costs are P25 per occupied bed per day, assuming a 30-day month. This P25 contains both
variable and fixed costs elements.
During April, the clinics occupancy rate was only 80%. A total P390,600 in operating costs was incurred
during the month.
REQUIRED:
1. Using the high-low method, estimate the (a) variable cost per occupied bed on a daily basis and (b)
the total fixed operating costs per month.
2. Assume an occupancy rate of 85% per month. What amount of total operating costs would you
expect the clinic to incur?
9. Makina Companys total overhead costs at various levels of activity are presented below:
Month
Machine Hours
Total Overhead Costs
April
140,000
P198,000
May
120,000
174,000
June
160,000
222,000

July

180,000

246,000

Assume that the total overhead costs above consist of utilities, supervisory salaries and maintenance.
The breakdown of these costs at the 120,000 machine-hour level of activity is:
Utilities (V)
P 48,000
Supervisory salaries (F)
21,000
Maintenance (M)
105,000
Total overhead costs
P174,000
V = variable; F = fixed; M = mixed
Makina Companys management wants to break down the maintenance cost into its basic variable and fixed
cost elements.
REQUIRED: 1. As shown above, overhead costs in July amounted to P246,000. Determined how much of
this consisted of maintenance cost.
2. By means of the high-low method, estimate a cost formula for maintenance.
3. Express the companys total overhead costs in the linear equation from Y=a + bX
4. What total overhead costs would you expect to be incurred at an operating activity level of
150,000 machine hours?
10. The chief statistician of Aloha Company has developed the following cost formula:
Y= P49,272 + P1.78L + P2.68M
Where: Y= total monthly manufacturing overhead cost
L= labor hours
M = machine hours
The measure of goodness of fit is good and no evidence of multicolinearity exists. The company will
use 12,000 labor hours and 2,000 machine hours next month.
REQUIRED:
1. Determine the total manufacturing overhead costs that Aloha should incur next month.
2. Aloha makes a product that has P6.00 in material cost. it requires two hours of labor time and 30
minutes of machine time. Laborers earn P10 per hour. What is the products per unit variable
manufacturing cost?
3. Suppose that Aloha could reduce the labor time for the product described in requirement 2 by 30
minutes, to 1.50 hours. Machine time will remain the same. By how much would the per unit
variable manufacturing cost fall?
11. M. Munda Company produces and sells rattan baskets. The number of units produced and the
corresponding total production costs for six months, which are representatives for the year are as
follows:
Month
April
May
June
July
August
September

Unit produced
500
700
900
600
800
550

Production Costs
P4,000
8,000
6,000
7,500
8,500
7,250

[Link] cost function derived by the simple least squares method

a. Is linear.
b. Is curvilinear
c. Is parabolic
d. Must be tested for minimum and maximum points.

11b. Using the least squares method, the variable production cost per unit is approximately
a. P 5
c. P 0.27
b. P 10
d. P 3.74
[Link] the least squares method, the monthly fixed production cost is approximately
a. P 1,500.
c. P 4,350
b. P 18,000
d. P 52,200
11d. If the high-low points method is used, the results when compared with those under the
method of least squares, are
Variable Cost Per Unit
Total Fixed Costs
a. Equal
Equal
b. Higher by P1.26
Lower by P2,850
c. Lower by P1.26
Higher by P2,850
d.
Higher by P5
Lower by P1,500
12. Meemon Company manufactures and sells a single product. A partially completed schedule of the
companys total and per unit costs over the relevant range of 30,000 to 50,000 units produced and sold
annually is given below:
Units produced and sold
30,000
40,000
50,000
Total Costs:
Variable costs
P180,000
?
?
Fixed costs
300,000
?
?
Total
P480,000
?
?
Cost per unit:
Variable cost
?
?
?
Fixed cost
?
?
?
Total
?
?
?
Required:
a. Complete the schedule of the companys total and unit costs above.
b. Compute income, assuming that the company produces and sells 45,000 units during a year at a
sell price of P16 per unit.
13. A company makes prestige high-end watches in small lots. The company has been in operation since
1990. One of the companys productions, a platinum diving watch, goes through an etching process.
The company has observed etching costs as follows over the last six weeks:
Week
Units
Total Etching Costs
1
4
P 18
2
3
17
3
8
25
4
6
20
5
7
24
6
2
16
30
P120
For planning purposes management would like to know the amount of variable etching cost per unit and
the total fixed etching cost per week.
Required:
1. Using the least squares regression method, estimate the variable and fixed elements of etching
costs.
2. Express the cost data in (1) above in the form of Y = a + bX.
3. If the company processes five (5) units next week, what would be the expected total etching
cost?