Cost Behavior and Analysis

Certain costs, such as direct materials and direct labor, vary in proportion with the level of activity. These are known as variable costs. As the level of activity increases, the total variable costs increases directly with the change in the level of activity.

Fixed costs, on the other hand, do not change. They remain constant regardless of the level of activity.

For cost data to be more useful in analysis, costs are classified into variable costs and fixed costs. A problem arises when a cost contain features of both fixed and variable costs. Some costs do not have a clear pattern of behavior in relation to the cost driver.

Several cost segregation methods are employed to separate fixed costs and variable costs. The commonly used segregation methods include the high-low method, the scatter graph method, and the least squares method.

The high-low method considers the highest and lowest points of activity only. The scatter graph considers all data, hence provides more reliable results. The scatter graph method is done graphically and visually. The least squares method provides the most accurate results through a series of mathematical computations.

Lesson 1

Fixed Costs and Variable Costs

Costs, when categorized according to behavior (in relation to changes in level of activity), can be classified into fixed costs and variable costs. Learn about fixed and variable costs in this detailed lesson, complete with explanation and examples. Read more..
Lesson 2

High Low Method: Cost Segregation

Before costs can be effectively used in analysis, they should be segregated into purely fixed and purely variable costs. The easiest method used in segregating mixed costs is the high-low method. Read more..
Lesson 3

Scatter Graph Method: Cost Segregation

The scatter graph method estimates fixed and variable costs graphically. Compared to the high-low method which considers the highest level and lowest level of activity only, the scatter graph method is more reliable since it considers all data. Read more..
Lesson 4

Least Squares Method (Regression): Cost Segregation

The use of linear regression, or least squares method, is the most accurate method in segregating total costs into fixed and variable components. The values of a (total fixed cost) and b (variable cost per unit) can be computed through a series of mathematical computations. Read more..
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