BASICS OF COST BEHAVIOR

Cost behavior is the general term for describing whether a cost changes when the level of
output changes. A cost that does not change in total as output changes is a xed cost. A
variable cost, on the other hand, increases in total with an increase in output and decreases in
total with a decrease in output.
Measures of Output and the Relevant Range
A cost driver is a causal factor that measures the output of the activity that leads (or causes)
costs to change. Identifying and managing drivers helps managers better predict and control
costs. The relevant range is the range of output over which the assumed cost relationship is
valid for the normal operations of a rm. The relevant range limits the cost relationship to the
range of operations that the rm normally expects to occur.
Fixed Costs
Fixed costs are costs that in total are constant within the relevant range as the level of output
increases or decreases.
Discretionary Fixed Costs and Committed Fixed Costs
Discretionary xed costs are xed costs that can be changed or avoided relatively easily at
management discretion. Committed xed costs are xed costs that cannot be easily changed.
Variable Costs
Variable costs are costs that in total vary in direct proportion to changes in output within the
relevant range.
Total Variable Costs = Variable Rate X Units of Output
The Reasonableness of Straight-Line Cost Relationships
when economies of scale are present, the true total cost function is increasing at a decreasing
rate. Some managers refer to costs that behave in this manner as semi-variable costs.
MIXED COSTS AND STEP COSTS
Mixed Costs
Mixed costs are costs that have both a xed and a variable component.
Total Cost = Total Fixed Cost X Total Variable Cost
Step Cost Behavior
A step cost displays a constant level of cost for a range of output and then jumps to a higher
level (or step) of cost at some point, where it remains for a similar range of output. The width
of the step denes the range of output for which a particular amount of the resource applies.
METHODS FOR SEPARATING MIXED COSTS INTO FIXED AND VARIABLE
COMPONENTS
Three methods of separating a mixed cost into its xed and variable components are
commonly used:.
1. the high-low method.
2. the scattergraph method
3. the method of least squares
The High-Low Method

Scattergraph Method
The scattergraph method is a way to see the cost relationship by plotting the data points on
a graph. The rst step in applying the scattergraph method is to plot the data points so that the
relationship between materials handling costs and activity output can be seen.
The Method of Least Squares
The method of least squares (regression) is a statistical way to nd the best-tting line
through a set of data points.

Managerial Judgment
Managerial judgment is critically important in determining cost behavior and is by far the
most widely used method in practice. Many managers simply use their experience and past
observation of cost relationships to determine xed and variable costs. This method,
however, may take a number of forms. Some managers simply assign some costs to the xed
category and others to the variable category. They ignore the possibility of mixed costs.