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Finance 2B – FINM6212
LU2: Cost- classification, Estimation and Behavior
Introduction:
Cost behavior Involves separating mixed costs into their variable and fixed components and
analysis analyzing how costs and revenues react to varying levels of activity
Cost estimation Involves measuring past costs to predict future costs for decision-making
purposes
Cost classification Involves grouping costs according to their common characteristics. Costs can be
classified on the basis of:
Identity (materials, labor or expenses)
Function (manufacturing, administration or selling and distribution costs)
Variability (fixed, variable or semi-variable cost)
Controllability (controllable or uncontrollable cost)
Normality (normal or abnormal cost)
Time (historical or pre-determined cost)
Variable, fixed or mixed costs:
Costs are either fixed, variable or mixed, and can be defined as follows:
Let us look at page 47 for a graphical example of each of these costs
High- Low method:
The high-low method is a cost accounting method that uses the highest and lowest costs as a basis for
estimating the fixed and variable elements of a mixed cost. It is applied using the following cost-volume
formula:
y=a+bx or a= y−bx
1
, where:
o y=total cost
o x=volume ( output )
o a=¿ cost [ total cost −( variable costs x volume ) ]
difference ∈costs
o b=variable cost ( )
difference∈ production
Using the cost equation, we can solve for a as follows:
(i) a= y−bx (ii) a= y−bx
a=38 400−(12 000 x 2) a=26 400−( 6 000 x 2)
2
Finance 2B – FINM6212
LU2: Cost- classification, Estimation and Behavior
Introduction:
Cost behavior Involves separating mixed costs into their variable and fixed components and
analysis analyzing how costs and revenues react to varying levels of activity
Cost estimation Involves measuring past costs to predict future costs for decision-making
purposes
Cost classification Involves grouping costs according to their common characteristics. Costs can be
classified on the basis of:
Identity (materials, labor or expenses)
Function (manufacturing, administration or selling and distribution costs)
Variability (fixed, variable or semi-variable cost)
Controllability (controllable or uncontrollable cost)
Normality (normal or abnormal cost)
Time (historical or pre-determined cost)
Variable, fixed or mixed costs:
Costs are either fixed, variable or mixed, and can be defined as follows:
Let us look at page 47 for a graphical example of each of these costs
High- Low method:
The high-low method is a cost accounting method that uses the highest and lowest costs as a basis for
estimating the fixed and variable elements of a mixed cost. It is applied using the following cost-volume
formula:
y=a+bx or a= y−bx
1
, where:
o y=total cost
o x=volume ( output )
o a=¿ cost [ total cost −( variable costs x volume ) ]
difference ∈costs
o b=variable cost ( )
difference∈ production
Using the cost equation, we can solve for a as follows:
(i) a= y−bx (ii) a= y−bx
a=38 400−(12 000 x 2) a=26 400−( 6 000 x 2)
2
