MAC3761 — Learning Unit 1
Cost Classification and Cost Estimation
Focused Textbook Study Summary
Scope: This shorter guide covers only the prescribed textbook coursework for Learning
Unit 1: Principles of Management Accounting: A South African Perspective, 3rd edition (2020),
Chapter 2 sections 2.1–2.6 and Chapter 3 sections 3.1–3.7. It excludes ancillary activities,
podcasts, tests, self-review exercises and non-prescribed textbook material. It also
excludes standard error, normal distribution, confidence level, range, adjusted R
square, ANOVA, t-statistic and p-value, as directed in the Learning Unit guide.
1. Big Picture
This learning unit explains how management accountants classify costs for decision-making,
control and financial reporting, and how they estimate future cost when a cost contains fixed
and variable elements. The central theme is that cost information must be classified according
to the purpose for which it is needed, then linked to an appropriate cost driver to predict cost
reliably within a relevant range.
2. Prescribed Scope and Learning Outcomes
2.1 Textbook sections covered
Chapter Prescribed sections
Chapter 2: Cost
2.1 Introduction; 2.2 Cost behaviour; 2.3 Assignment; 2.4 Relevance; 2.5 Function; 2.6 Timing
Classification
Chapter 3: Cost 3.1 Introduction; 3.2 Cost drivers; 3.3 Scatter graph; 3.4 High-low method; 3.5 Least-squares regression;
Estimation 3.6 Factors affecting accuracy; 3.7 Other means of estimating costs and predicting cost behaviour
2.2 Learning outcomes
You must be able to:
Describe the main costing terms and classifications.
Identify and explain variable, fixed, step and mixed costs.
Explain why costs are classified by different attributes.
Split mixed costs using high-low and least-squares regression.
Identify dependent and independent variables.
, Form a cost equation and predict cost at different activity levels.
Calculate and interpret correlation coefficient and coefficient of determination .
3. Dual-Column Study Summary
Question / clue Key study fact
Why classify cost Each classification answers a different management question: how a cost changes, whether it can be
differently? traced, whether it matters to a decision, what function it performs and when it is expensed.
Five cost attributes Behaviour, assignment, relevance, function and timing.
Relevant range The range of activity over which the assumed cost behaviour and cost equation are valid.
Total cost changes in proportion to activity; variable cost per unit stays constant within the relevant
Variable cost
range.
Total cost stays constant within the relevant range and period; fixed cost per unit changes inversely with
Fixed cost
activity.
Step cost Cost changes in fixed blocks once activity passes specified thresholds.
Mixed cost Contains a fixed component plus a variable component.
The item for which cost is measured, such as a product, service, customer, project, job, department or
Cost object
activity.
Direct cost Can be traced to the cost object economically.
Indirect cost Cannot be traced economically; may be allocated on a reasonable basis. Also called overhead.
Relevant
A future, differential cash flow.
cost/revenue
Opportunity cost The best benefit forgone by selecting an alternative.
Differential cost A cost that differs between alternatives.
Sunk cost Already incurred; cannot be changed by the decision; irrelevant.
Direct materials Physical inputs economically traceable to the manufactured product.
Direct labour Labour physically expended on a product and economically traceable to it.
Manufacturing Manufacturing costs indirect to the product, including indirect materials, indirect labour and relevant
overhead factory costs.
Product cost Included in inventory and expensed when inventory is sold under absorption costing.
Period cost Expensed immediately in the period incurred.
Cost driver Activity that causes or best explains changes in cost.
Cost equation : total cost = variable rate × activity + fixed cost.
High-low method Uses highest and lowest activity observations to estimate variable and fixed cost.
Least-squares
Uses all observations to produce the best-fit line.
regression
Measures direction and strength of linear relationship.
, Question / clue Key study fact
Measures percentage/proportion of variation in total cost explained by the selected driver.
4. Chapter 2 — Cost Classification
4.1 Purpose of cost classification
Management’s objective in a profit-seeking organisation is to create and enhance shareholder
value. Management therefore needs information that shows how decisions and control actions
affect future cash flows. Ordinary financial-accounting labels—assets, liabilities, equity, income
and expenses—do not provide enough information for this purpose.
Costs are therefore analysed from five perspectives:
Attribute Management question answered
Cost behaviour How will total cost respond if activity changes?
Assignment Can the cost be traced to the selected cost object?
Relevance Will the cost or revenue change if a particular decision is made?
Function What purpose does the cost serve in the entity?
Timing When is the cost recognised as an expense?
A single cost can have several classifications at the same time. For example, a factory
supervisor’s salary may be fixed in behaviour, indirect to a product, manufacturing overhead
by function and a product cost under absorption costing.
4.2 Cost behaviour
Variable costs
A variable cost changes in total in proportion to changes in the activity level. The variable cost
per unit of activity stays constant within the relevant range.
Examples can include material used per unit, sales commission per sale, and assessment fees
per student.
Key distinction: Total variable cost changes; variable cost per unit does not change within the
relevant range.
, Fixed costs
A fixed cost is constant in total regardless of activity changes, but only within a specified
relevant range and time period.
As activity rises, the same total fixed cost is spread over more units, so fixed cost per unit falls.
A fixed cost is not fixed forever. It may change when a new period starts, a contract changes or
capacity is exceeded. In the long run, all costs are variable.
Step costs
A step cost is incurred in blocks. It stays constant over a range of activity and then jumps when
another block of capacity is needed.
Example: one marker is required for every 25 scripts or part thereof. If each marker costs R4
500, 62 scripts require three markers:
Mixed costs
A mixed cost has both fixed and variable components.
Example: a monthly service fee of R4 000 plus R18 per transaction.
At 1 250 transactions:
Relevant range
Cost patterns are reliable only over the relevant range. A variable cost per unit can change at
very low or high volume because of economies or diseconomies of scale. A fixed cost may step
up when capacity is exceeded.
4.3 Assignment: direct and indirect costs
A cost object is any item for which cost is measured: a product, service, customer, flight,
project, job, department or activity.
Cost Classification and Cost Estimation
Focused Textbook Study Summary
Scope: This shorter guide covers only the prescribed textbook coursework for Learning
Unit 1: Principles of Management Accounting: A South African Perspective, 3rd edition (2020),
Chapter 2 sections 2.1–2.6 and Chapter 3 sections 3.1–3.7. It excludes ancillary activities,
podcasts, tests, self-review exercises and non-prescribed textbook material. It also
excludes standard error, normal distribution, confidence level, range, adjusted R
square, ANOVA, t-statistic and p-value, as directed in the Learning Unit guide.
1. Big Picture
This learning unit explains how management accountants classify costs for decision-making,
control and financial reporting, and how they estimate future cost when a cost contains fixed
and variable elements. The central theme is that cost information must be classified according
to the purpose for which it is needed, then linked to an appropriate cost driver to predict cost
reliably within a relevant range.
2. Prescribed Scope and Learning Outcomes
2.1 Textbook sections covered
Chapter Prescribed sections
Chapter 2: Cost
2.1 Introduction; 2.2 Cost behaviour; 2.3 Assignment; 2.4 Relevance; 2.5 Function; 2.6 Timing
Classification
Chapter 3: Cost 3.1 Introduction; 3.2 Cost drivers; 3.3 Scatter graph; 3.4 High-low method; 3.5 Least-squares regression;
Estimation 3.6 Factors affecting accuracy; 3.7 Other means of estimating costs and predicting cost behaviour
2.2 Learning outcomes
You must be able to:
Describe the main costing terms and classifications.
Identify and explain variable, fixed, step and mixed costs.
Explain why costs are classified by different attributes.
Split mixed costs using high-low and least-squares regression.
Identify dependent and independent variables.
, Form a cost equation and predict cost at different activity levels.
Calculate and interpret correlation coefficient and coefficient of determination .
3. Dual-Column Study Summary
Question / clue Key study fact
Why classify cost Each classification answers a different management question: how a cost changes, whether it can be
differently? traced, whether it matters to a decision, what function it performs and when it is expensed.
Five cost attributes Behaviour, assignment, relevance, function and timing.
Relevant range The range of activity over which the assumed cost behaviour and cost equation are valid.
Total cost changes in proportion to activity; variable cost per unit stays constant within the relevant
Variable cost
range.
Total cost stays constant within the relevant range and period; fixed cost per unit changes inversely with
Fixed cost
activity.
Step cost Cost changes in fixed blocks once activity passes specified thresholds.
Mixed cost Contains a fixed component plus a variable component.
The item for which cost is measured, such as a product, service, customer, project, job, department or
Cost object
activity.
Direct cost Can be traced to the cost object economically.
Indirect cost Cannot be traced economically; may be allocated on a reasonable basis. Also called overhead.
Relevant
A future, differential cash flow.
cost/revenue
Opportunity cost The best benefit forgone by selecting an alternative.
Differential cost A cost that differs between alternatives.
Sunk cost Already incurred; cannot be changed by the decision; irrelevant.
Direct materials Physical inputs economically traceable to the manufactured product.
Direct labour Labour physically expended on a product and economically traceable to it.
Manufacturing Manufacturing costs indirect to the product, including indirect materials, indirect labour and relevant
overhead factory costs.
Product cost Included in inventory and expensed when inventory is sold under absorption costing.
Period cost Expensed immediately in the period incurred.
Cost driver Activity that causes or best explains changes in cost.
Cost equation : total cost = variable rate × activity + fixed cost.
High-low method Uses highest and lowest activity observations to estimate variable and fixed cost.
Least-squares
Uses all observations to produce the best-fit line.
regression
Measures direction and strength of linear relationship.
, Question / clue Key study fact
Measures percentage/proportion of variation in total cost explained by the selected driver.
4. Chapter 2 — Cost Classification
4.1 Purpose of cost classification
Management’s objective in a profit-seeking organisation is to create and enhance shareholder
value. Management therefore needs information that shows how decisions and control actions
affect future cash flows. Ordinary financial-accounting labels—assets, liabilities, equity, income
and expenses—do not provide enough information for this purpose.
Costs are therefore analysed from five perspectives:
Attribute Management question answered
Cost behaviour How will total cost respond if activity changes?
Assignment Can the cost be traced to the selected cost object?
Relevance Will the cost or revenue change if a particular decision is made?
Function What purpose does the cost serve in the entity?
Timing When is the cost recognised as an expense?
A single cost can have several classifications at the same time. For example, a factory
supervisor’s salary may be fixed in behaviour, indirect to a product, manufacturing overhead
by function and a product cost under absorption costing.
4.2 Cost behaviour
Variable costs
A variable cost changes in total in proportion to changes in the activity level. The variable cost
per unit of activity stays constant within the relevant range.
Examples can include material used per unit, sales commission per sale, and assessment fees
per student.
Key distinction: Total variable cost changes; variable cost per unit does not change within the
relevant range.
, Fixed costs
A fixed cost is constant in total regardless of activity changes, but only within a specified
relevant range and time period.
As activity rises, the same total fixed cost is spread over more units, so fixed cost per unit falls.
A fixed cost is not fixed forever. It may change when a new period starts, a contract changes or
capacity is exceeded. In the long run, all costs are variable.
Step costs
A step cost is incurred in blocks. It stays constant over a range of activity and then jumps when
another block of capacity is needed.
Example: one marker is required for every 25 scripts or part thereof. If each marker costs R4
500, 62 scripts require three markers:
Mixed costs
A mixed cost has both fixed and variable components.
Example: a monthly service fee of R4 000 plus R18 per transaction.
At 1 250 transactions:
Relevant range
Cost patterns are reliable only over the relevant range. A variable cost per unit can change at
very low or high volume because of economies or diseconomies of scale. A fixed cost may step
up when capacity is exceeded.
4.3 Assignment: direct and indirect costs
A cost object is any item for which cost is measured: a product, service, customer, flight,
project, job, department or activity.
