CHAPTER 2

COSTS- CONCEPTS AND CLASSIFICATION

LEARNING OBJECTIVES
Upon Completion of this chapter, you should be able to
• Distinguish between costs, expenses and losses
• Distinguish between direct and indirect costs
• Define the three integral components of a product
• Define prime costs and conversion costs
• Define variable, fixed and mixed costs and discuss the effects of changes in volume on these costs
• Distinguish between common costs and joint costs
• Distinguish between capital expenditures and revenue expenditures
• Identify the costs for planning, control and analytical processes.

Costs are associated with all types of organizations – business, non-business, service, retail, and manufacturing. Generally,
the kind of costs that are incurred and the way in which these costs are classified will depend on the type of organization involved.

Our initial focus will be on manufacturing, but in our discussion we should be aware that, in a conceptual sense,
manufacturing encompasses much more than just firms in the industrial sector of our economy. It also encompasses many
organizations that are typically viewed as being service in nature, such as movie studios and fast food outlets. Organizations such as
these are involved in manufacturing in the sense that they create a distinct product for customers or patrons. As we proceed with our
discussion, therefore, we should keep in mind that manufacturing is a broad term, and that the costs included under the manufacturing
involved in service type activities. As understanding the cost structure of a manufacturing company therefore provides a broad,
general understanding of costing that can be very helpful in understanding the cost structures of other types of organizations.

Before cost terminology can be discussed the term cost itself must be defined. Cost is the cash or cash equivalent value
sacrificed for goods and services that are expected to bring a current or future benefit to the organization. We say cash equivalent
because non-cash assets can be exchanged for the desired goods or services. For example, it may be possible to exchange land for
some needed equipment.

Costs are incurred to produce future benefits in a profit making firm, future benefits usually mean revenue. As costs are used
up in the production of revenues, they are said to expire. Expired costs are called expenses. In each period, expenses are deducted
from revenues in the income statement to determine the period’s profit. A loss is a cost that expires without producing any revenue
benefit. The focus of cost accounting is on costs, not expenses.

CLASSIFICATION OF COSTS
I. Costs classified as to relation to a product
A. Manufacturing costs/ product costs
1. Direct materials
2. Direct labor
3. Factory overhead
B. Non-manufacturing costs/period costs
1. Marketing or selling expense
2. General or administrative expense
II. Costs classified as to variability
A. Variable costs
B. Fixed costs
C. Mixed costs
III. Cost classified as to relation to manufacturing departments
A. Direct departmental charges
B. Indirect departmental charges
IV. Costs classified to their nature as common or joint
A. Common costs
B. Joint costs
V. Costs classified as to relation to an accounting period
A. Capital expenditures
B. Revenue expenditures
VI. Costs for planning, control and analytical process
A. Standard costs
B. Opportunity costs
C. Differential costs
D. Relevant costs
E. Out-of-pocket cots
F. Sunk cost
G. Controllable cost

MANUFACTURING COSTS/ PRODUCT COSTS/ INVENTORIABLE COSTS

Direct Materials
All manufactured products are made from basic direct materials. The basic materials may be iron ore for steel, sheet steel for
automobiles, or flour for bread. These examples show the link between a basic raw material and a final product.

The way a company buys, stores and uses materials is important. Timely purchasing is important because if the company
runs out of materials, the manufacturing process will be forced to shut down. (Shutting down production results in no products,
unhappy customers and loss of sales and profits) Buying too many direct materials, on the other hand, can lead to high storage costs.

Proper storage of materials will avoid waste and spoilage. Large enough storage space and orderly storage procedures are
essential. Materials must be handled and stored properly to guarantee their satisfactory use in production. Proper records, the materials
stock cards, make it possible to find goods easily. Such records reduce problems caused by lost or misplaced items.

Direct materials are materials that become part of a finished product and can be conveniently and economically traced to
specific product units. The costs of these materials are direct costs. In some cases, however, even though a material becomes part of a
finished product, the expense of actually tracing the cost of a specific material is too great. Some examples of this include nails in
furnitures, bolts in automobiles, and rivets in airplanes. These minor materials and other production supplies that cannot be
conveniently or economically traced to specific products are accounted for as indirect materials. Indirect materials costs are part of
factory overhead costs.

Direct labor
Labor services are, in essence, purchased from employees working in the factory. In addition, other types of labor are
purchased from people and organizations outside the company. The labor costs usually associated with manufacturing include
machine operators; maintenance workers; managers and supervisors; support personnel; and people who handle, inspect, and store
materials. Because these people are all connected in some way with production process, their wages and salaries must be accounted
for as production costs and finally, as costs of products. However, tracing many of these costs directly to individual products is
difficult.

To help overcome this problem, the wages of machine operatos and other workers involved in actually shaping the product
are classified as direct labor costs. Direct labor costs include all labor costs for specific work performed on products that can be
conveniently and economically traced to end products. Labor costs for production related activities that cannot be conveniently and
economically traced to end products are called indirect labor costs. These costs include the wages and salaries of such workers as
machine helpers, supervisors, and other support personnel. Like indirect material costs, indirect labor costs are accounted for as
factory overhead costs. Payroll related costs, such as payroll taxes, group insurance, sick pay, vacation and holiday pay, and other
fringe benefits can be considered as part of direct labor costs, but are usually included as factory overhead.

Direct labor plus direct materials = prime costs, while direct labor plus factory overhead = conversion costs. Prime costs and
conversion costs may be diagrammed as shown below.
Factory Overhead
The third manufacturing cost element is a catchall for manufacturing costs that cannot be classified as direct materials or
direct labor costs. Factory overhead costs are a varied collection of production-related costs that cannot be practically or conveniently
traced directly to end products. This collection of costs is also called manufacturing overhead, factory burden, and indirect
manufacturing costs.

Examples of major classifications of factory overhead costs are:

Indirect materials and supplies; nail, rivets, lubricants, and small tools.

Indirect labor costs: lift-truck driver’s wages, maintenance and inspection labor, engineering labor, machine helpers, and
supervisors.
Other indirect factory costs: building maintenance, machinery and tool maintenance, property taxes, property insurance,
pension costs, depreciation on plant and equipment, rent expense and utility expense.

NON-MANUFACTURING COSTS/ PERIOD COSTS

Marketing or selling expenses

Marketing or selling expenses include all costs necessary to secure customer orders and get finished product or service to
secure customer orders and get finished product or service into the hands of the customer. Since marketing expenses relate to
contacting customers and providing for their needs, these expenses are often referred to as order-getting and order-filling costs.
Examples of marketing expenses include advertising, shipping, sales travel; sales commissions, sales salaries, and expenses associated
with finished goods warehouses. All organizations have marketing costs, regardless of whether the organizations are manufacturing,
merchandising, or service in nature.

Administrative or general expenses

Administrative expenses include all executive, organizational and clerical expenses that cannot logically be included under
either production or marketing. Examples of such expenses include executive compensation, general accounting, secretarial, public
relations, and similar expense having to do with the overall general administration of the organization as a whole. As with marketing
expenses, all organizations have administrative expenses.

COST CLASSIFIED AS TO VARIABILITY

Fixed, Variable and Mixed

One of the most important cost classifications involves the way of a cost changes in relation to changes in the activity of the
organization. Activity refers to a measure of the organization’s output of products or services. In specifying cost behaviour, the
managerial accountant often limits the description to a specific range of activity. This is called the relevant range.

. Fixed costs
Items of costs which remain constant in total, irrespective of the volume in production. Fixed costs are not related to
activity within the relevant range. If activity increases or decreases by 20 percent, total fixed costs remains the same. Cost per unit
decreases as volume increases, and increases as volume decreases. Fixed costs are assignable to departments based on difference
allocation methods. Examples are salaries of production executives, depreciation of equipment computed on a straight-line basis,
periodic rent payments, and insurance.
Fixed costs may be classified into two categories, depending on the ability of management to influence the levels of these
costs in the short-term.

1. Committed fixed costs – costs that represent relatively long term commitments on the part of management as a result of
past decision. Example – depreciation on equipment.

2. Managed fixed costs (also known as discretionary, programmed or planned fixed costs) – costs that are incurred on a
short-term basis and can be more easily modified in response to changes in management objectives. Examples – advertising,
research and development and costs of employee training programs.
 Shown is the graph of fixed costs. It is clearly shown that the total fixed costs remains unchanged as activity changes.
When activity triples, from 10 to 30 units, total fixed costs remain constant at P1,500. If activity level is only 1 unit, then the fixed cost
per unit is P1,500. If the activity level is 10 units, then the fixed cost per unit declines to P150 per unit. So we can conclude that fixed
cost per unit will decrease as we increase the volume or units of production and fixed cost per unit will increase as we decrease the
volume of production.
Total fixed cost

1500

10 20 30 Activity
Graph of total fixed cost

Activity Fixed cost per unit Total Fixed Cost

1 1,500 1,500
2 750 1,500
5 300 1,500
10 150 1,500
20 75 1,500
30 50 1,500

Variable costs
Items of cost which may vary directly, in total, in relation to volume of production. If activity increases by 20 percent, total
variable cost increases by 20 percent also. Cost per unit remains constant as volume changes within a relevant range. Examples are:
direct materials, direct labor, royalties and commission of salesmen. Show below is graph of total variable costs. As this graph shows
total variable cost increases proportionately with activity. When activity doubles from 10 to 20 units, total variable cost doubles, from
P1,000 to P2,000. However, the variable cost per unit remains the same as activity changes. The variable cost associated with each
unit of activity is P100, whether it is the first unit, the fourth or the tenth.

To summarize as activity changes, total variable cost increases or decreases proportionately with the activity change, but
unit variable cost remains the same.
Total variable cost

3000

2000

1000

10 20 30 Activity

Graph of total variable cost

TABULATION OF VARIABLE COST
Activity Variable cost per unit Total Variable Cost
1 100 100
10 100 1,000
20 100 2,000
30 100 3,000

Mixed cost
Items of cost with fixed and variable components. Mixed costs vary with the level of production, though not in direct
relation to it, probably because part of the cost is fixed while the rest is variable. Two types of mixed costs exist – semi variable costs
and step costs.
Semi-variable cost The fixed portion of a semi-variable cost usually represents a minimum fee for making a particular
item or service available. The variable portion is the cost charged for actually using the service. The cost of electricity where there is a
basic minimum charge plus a specified cost per kilowatt hour above the minimum is an example of such as semi-variable cost. The
cost charged for using a cell phone under a plan is also an example of semi-variable cost. The cost of the plan is fixed and it is for a
specified time used. However if the user exceeds the time allowed, then charges will be made on a per minute basis.

Semi-variable cost
35,000
30,000 Variable
25,000
(P15,000)
20,000
15,000
Fixed
10,000
(P20,000)
5,000
-
5,000 1,000

Kilometer

Assume that a company rents a delivery truck at a flat rate of P20,000 per month plus P1.50/km driven. The fixed portion is the
P20,000 monthly rental fee; the variable portion is the P1.50/km driven. If 10,000 km are driven during the month, the total monthly
cost of the delivery truck is P35,000, computed as follows:
Flat fee (fixed portion) P20,000
Variable portion – 10,000 km x P1.50 15,000
Total cost P35,000

Step costs – the fixed part of step costs changes abruptly at various activity levels because these costs are acquired in
indivisible portions. A step cost is similar to a fixed cost within a very small relevant range.

180,000
150,000
120,000
90,000
60,000
30,000
-
10 20 30 40 50 60
Number of workers
The supervisor’s salary is an example of step cost. Assume that one supervisor with a salary of P30,000 is needed for every 10
workers, then if 15 workers are used, 2 supervisors (with salaries of P60,000) will be needed. If 18 workers are used, still 2
supervisors would be needed. If the number of workers increases to 22, three supervisors would be needed.
Ideally, for both planning purposes and making certain type of decisions, all costs would be classified as either fixed or
variable, with semi-variable costs being separated into their fixed and variable components. One of the most important steps in
estimating the variable and fixed components of a mixed cost is to examine the cause and effect relationship between activities that
affect costs. There are different methods of separating mixed costs into fixed and variable components. (1) scatter graph (2) high-low
point, (3) and method of least square. We will illustrate the use of high-low point method and method of least square.

(1) HIGH-LOW POINT METHOD

Summary of electricity costs and direct labor hours

Month Direct labor hrs. Cost of electricity
January 28 625
February 24 565
March 30 630
April 33 640
May 38 685
June 34 640
July 35 655
August 40 700
September 42 715
October 47 726
November 43 700
December 32 630

Direct labor hrs. Cost

Highest month (Oct.) 47 726
Lowest month (Feb.) 24 565
Difference 23 161

Variable rate per direct labor hour = P161/23 hours

= P7/ direct labor hour

Fixed cost can be computed from either the high or low data
High Low
Total cost of electricity 726 565
Less: variable proportion
(P 7 x 47) 329
(P7 x 24) 168
Monthly fixed cost 397 397

The formula for projecting the total monthly cost of electricity based on these data would be P397 plus P7 multiplied by the direct
labor hours expected to be worked during the period (Y = FC + VC or Y= FC + VX) where

Y = total cost VC = Total variable cost

V = variable cost per unit FC = Fixed cost
X= Activity level
 (2) METHOD OF LEAST SQUARE
The three formulas to be used in least-square method are:
Equation 1 Y = a+bx
Equation 2 ∑Y = na+b∑x
Equation 3 ∑XY= ∑xa + b∑x2

Using the same data as in the high-low method the following have been computed
Month Direct labor hrs. Cost of Electricity
X Y XY x2
January 28 625 17,500 784
February 24 565 13,560 576
March 30 630 18,900 900
April 33 640 21,120 1,089
May 38 685 26,030 1,444
June 34 640 21,760 1,156
July 35 655 22,925 1,225
August 40 700 28,000 1,600
September 42 715 30,030 1,764
October 47 726 34,122 2,209
November 43 700 30,100 1,849
December 32 630 20,160 1,024
426 7,911 284,207 15,620
∑= a
By substitution:
Equation 2 ∑y = na+b∑x
(7,911 = 12a + b426) 35.5(426/12)

Equation 3 ∑xy = ∑xa + b∑x2

284,207 = 426a + b15,620
Equation 1 x 35.5 280,840.5=426a + b15,123
3,366.5 = 0 + b497
b = 3,366.5/497
b = 6.77

Substituting the value for Equation 2, we can compute for as follows

7,911 = 12a + (6.77) (426)
7,911 = 12a + 2,884
12a = 7,911 – 2,884
a = 5,027/12
= 418.92
Formula using high-low method
Y = a+bx
= 397 + 7x
Formula using least square method
Y = a +bx
= 419 + 6.77x

Common cost vs. Joint cost

Common cost
Costs of facilities and services employed in two or more accounting periods, operations, commodities, or services. Just like
indirect costs, these costs are subject to allocation.
Joint cost
 Costs of materials, labor and overhead incurred in the manufacture of two or more products at the same time. A major
difficulty inherent to joint costs is that they are indivisible and they are not specifically identifiable with any of the products being
simultaneously produced. These costs are also subject to allocation.

Capital Expenditure vs. Revenue expenditure

Capital Expenditure
Expenditure intended to benefit more than one accounting periods and is recorded as an asset. The allocation of the cost to
the different periods is – depreciation for fixed tangible assets, amortization for intangible assets and depletion for wasting assets.

Revenue expenditure
Expenditure that will benefit current period only and is recorded as an expense.

Direct vs. Indirect departmental charges

Direct departmental charges
Costs that are immediately charged to the particular manufacturing department(s) that incurred the costs since the cost can
be conveniently identified or associated with the department(s) that benefited from said costs.

Indirect departmental charges

Costs that are originally charged to some other manufacturing department(s) or account(s) but are later allocated or
transferred to another department(s) that indirectly benefited from said costs.

Costs for Planning, control and analytical processes

Standard costs
Predetermined costs for direct materials, direct labor, and factory overhead. They are established by using information
accumulated from past experience and data secured from research studies. In essence, a standard cost is a budget for the production of
one unit of product or service. It is, the cost chosen by the managerial accountant to serve as the benchmark in the budgetary control
system.

Opportunity cost
The benefit given up when one alternative is chosen over another. Opportunity costs are not usually recorded in the accounting
system. However, opportunity costs should be considered when evaluating alternatives for decision making. If an asset can be used to
perform only one function and cannot be sold or used in other ways, the opportunity cost of that asset is zero.

Example 1
Michelle has part-time job that pays her P1,000 per week. She would like to spend a week in Bracey during summer
vacation from school, but she has no vacation time available. If she takes the trip anyway, the P1,000 in lost wages will be an
opportunity cost of doing so.

Example 2
Marco is employed with a company that pays him a salary of P20,000 a month. He is thinking about leaving the company and
returning to school. Since returning to school would require that he give up his P240,000 salaries, the forgone salary would
be an opportunity cost of seeking further education.

Differential cost
Costs that is present under one alternative but is absent in whole or in part under another alternative. An increase in cost from one
alternative to another is known as incremental cost, while a decrease in cost is known as decremental cost. Differential cost is a
broader term, encompassing both cost increases (incremental cost) and cost decreases (decremental costs) between alternatives.

The accountant’s differential cost concept is basically the same as the economist’s marginal cost concept. In speaking of
changes in cost and revenue, the economist employs the terms marginal cost and marginal revenue. The revenue that can be obtained
from selling one more unit of product is called marginal revenue, and the cost involved in producing one more unit of product is
called marginal cost.
 Differential costs can be either fixed or variable. To illustrate, assume Avon corp. is thinking about changing its marketing
method from distribution through retailers to distribution by direct sale. Present costs and revenues are compared to projected costs
and revenues in the table below:
Retailer Direct Sale Differential
Distribution Distribution Cost and
(present) (proposed) Revenue
Reveues (V) 900,000 1,200,000 300,000
Cost of goods sold (V) 450,000 600,000 150,000
Advertising (F) 80,000 45,000 (35,000)
Commission (V) 40,000 40,000
Warehouse depreciation (F) 50,000 80,000 30,000
Other expenses (F) 60,000 60,000
Total 640,000 825,000 185,000
Net Income 260,000 375,000 115,000

V= Variable
F = Fixed

The differential revenue is P300,000 and the differential costs total P185,000, leaving a positive differential net income of P115,000
under the proposed marketing plan. As noted earlier, those differential costs representing cost increases could have been referred to
more specifically as incremental costs, and those representing cost decreases could have been referred to more specifically as
decremental costs.

Relevant cost
A future cost that change across alternatives. In the example above, the relevant costs are cost of goods sold, advertising,
commissions, and warehouse depreciation.

Out-of-pocket cost
Cost that requires the payment of money (or other assets) as a result of their incurrence.

Sunk cost
A cost for which an outlay has already been made and it cannot be changed by present or future decision. Since sunk costs
cannot be changed by any present or future decision, they are not differential costs, and therefore they should be used in analyzing
future courses of action.

Controllable and Non-controllable Costs

A cost is considered to be controllable cost at a particular level of management if that level has power to authorize the cost.
For example, entertainment expense would be controllable by a sales manager if he or she had power to authorize the amount and type
of entertainment for customers. On the other hand, depreciation of warehouses facilities would not be controllable by the sales
manager, since he or she would have no power to authorize warehouse construction.

In some situations, there is a time dimension to controllability. Costs that are controllable over the long run may not be
controllable over the short run. A good example is advertising. Once an advertising program has been set and a contract signed,
management has no power to change the amount of spending. But the contract expires, advertising costs can be negotiated, and thus
management can exercise control over the long run.
COST-FLOW MANUFACTURING FIRMS
Cost incurrence Expense Category

Direct materials

Direct Labor Work in Process Finished Cost of goods sold

goods
Direct overhead

Selling and Administrative Operating expenses

Work in process consists of goods that are started but not completed. Finished goods are goods that are completed and ready for sale.

COST FLOW – MERCHANDISING FIRM

Cost incurrence Expense Category
Finished goods Cost of goods sold
Selling and Administrative Operating expense

COST FLOW – SERVICE FIRM

Cost incurrence Expense Category
Direct materials

Direct labor Cost of services

Factory overhead

Selling and Administrative Operating expenses

The essential purpose of any organization is to transform inputs into outputs. The activity for merchandising,
manufacturing and service organizations are shown in the previous and current page. These organizations have many similarities, all
require labor and capital as inputs, and all transform them into a product or service for the market. These organizations also differ
from one another in many respects. The differences between these organizations are reflected in their accounting systems.

A merchandising organization starts with a finished product and markets it. Because inventory is acquired in finished form,
its cost is easily ascertained.

The accounting system for a manufacturing organization is more complex because direct materials are first acquired and
then converted to finished products. A manufacturer’s accounting system focuses on work in process, which is the account that
reflects the costs involved in transforming input materials into finished goods.

Service organizations are different from manufacturing and merchandising because they have no inventory of goods for
sale. Costs are charged to responsibility centers for performance evaluation. In a public accounting firm, for example, costs are
charged to the audit department, the tax department and so forth. Costs are also charged to jobs. The assignment of costs facilitates
performance evaluation. The manager of each department is held responsible for the costs of the department, the manager of each job
is held responsible for the cost of that job.

Of the three kinds of operations, manufacturer require the most complex and comprehensive accounting system. All three
uses cost information for decision making and performance evaluation. But in addition, manufacturers need product costing for
inventory valuation and to measure cost of goods sold reported on external financial statements. Many manufacturers also have
service and merchandising activities, costs of which must be recorded.
Problem 1
Presented below is a list of costs and expenses usually incurred by Ram Corporation, a manufacturer of furniture, in its factory.

1. Metal used in manufacturing tables

2. Insurance on factory machines
3. Leather used in manufacturing furniture
4. Wages paid to machine operators
5. Depreciation of factory machinery
6. Salaries of factory supervisors
7. Wood used in manufacturing furniture
8. Sandpaper, bolts and nails
9. Property taxes on factory building
10. Rent of factory building
Instructions:
Classify the above items into the following categories (a) direct materials, (b) direct labor and (c) manufacturing overhead.

Problem 2
Classify the following as either manufacturing (M), selling (S), or administrative (A).
1. Metal for the manufacture of golf clubs
2. Wages of drivers delivering goods to customers
3. Rent on factory building
4. Freight-in of materials purchased
5. President’s salary
6. Cost of machine breakdown
7. Power to operate factory equipment
8. Advertising
9. Commission paid to sales personnel
10. Travel expenses of salesmen

Problem 3
Rocco Delivery services reports the following costs and expenses in June of the current year.
Direct materials P220,000
Factory rent 50,000
Direct labor 180,000
Factory utilities 8,500
Supervisor’s salary in the factory 60,000
Depreciation – factory equipment 20,000
Sales commission 57,000
Advertising 47,000
Depreciation – office equipment 10,000
Salary of the president 250,000
Required:
1. Classify each of the costs using the format given below
 Product Cost Period Cost
Direct Direct Manufacturing Selling Administrative
Cost Materials labor overhead expense expense
Direct materials 220,000
Factory rent
Direct labor
Factory utilities
Supervisor's salaries
Depreciation - FE
Sales commission
Advertising
Depreciation - OE
Salary - Pres.
Total

2. Total product cost

3. Total period cost
4. Cost per unit if the company was able to manufacture 40,000 units.

Problem 4
Mighty Muffler, Inc. operates an automobile service facility, which specializes in replacing mufflers on cars. The following table
shows the costs incurred during a month when 750 mufflers were replaced.
Number of Muffler Replacements
400 500 800
Total costs
Fixed costs a 50,000 b
Variable costs c 60,000 d
Total costs e 110,000 f
Cost per muffler replacement
Fixed costs g h i
Variable cost j k l
Total cost per replacement m n o

Required: Fill in the missing amounts

Problem 1
The financial statements of Father Goose Company included these items:
Marketing costs 160,000
Direct labor cost 245,000
Administrative costs 145,000
Direct materials used 285,000
Fixed factory overhead costs 175,000
Variable factory overhead costs 155,000
Compute:
1. Prime cost
2. Conversion cost
3. Total inventoriable/ product cost
4. Total period cost

Problem 2
Given the following facts, complete the requirements below:
Sales price P200 per unit
Fixed costs:
Marketing and administrative 24,000 per period
Manufacturing overhead 30,000 per period
Variable costs:
Marketing and administrative 6 per unit
Manufacturing overhead 9 per unit
Direct labor 30 per unit
Direct materials 60 per unit
Units produced and sold 1,200 per period

Required: compute for the following:

1. Variable manufacturing cost per unit
2. Variable cost per unit
3. Full manufacturing cost per unit
4. Full cost to make and sell per unit

Problem 3

Westinghouse Company manufactures major appliances. Because of growing interest in its product, it had just had its most successful
years. In preparing the budget for next year, its controller compiled these data.
MONTH VOLUME IN MACH. HRS. ELECTRICITY COST
JULY 6,000 60,000
AUGUST 5,000 53,000
SEPTEMBER 4,500 49,500
OCTOBER 4,000 46,000
NOVEMBER 3,500 42,500
DECEMBER 3,000 39,000
6-MONTH TOTAL 26,000 290,000
Using the high-low method compute
1. The variable cost per machine hour
2. The monthly fixed electricity costs
3. The total electricity costs if 4,800 machine hours are projected to be used next month
PROBLEM 4
Valdez Motors Co. makes motorcycles. Management wants to estimate overhead costs to plan its operations. A recent trade
publication revealed that overhead costs then to vary with machine hours. To check this, they collected the following data for the past
12 months.
Month no. Machine hours Overhead Costs
1 175 4,500
2 170 4,225
3 160 4,321
4 190 5,250
5 175 4,800
6 200 5,100
7 160 4,450
8 150 4,200
9 210 5,475
10 180 4,760
11 170 4,325
12 145 3,975

Requirement:
1. Using the high-low method to estimate the fixed and variable portion of overhead costs based on machine hours.
2. If the plant is planning to operate at a level of 300 machine hours next period, what would be the estimated overhead costs?