Total costs = Fixed costs + Variable costs

y = a + bx

y = Total cost (dependent variable)

a = Total fixed costs

b = Variable cost per unit

x = # of units (independent variable)

Various methods are used to determine the variable cost per unit and total fixed costs

Units represent volume of cost driver

- Cost driver can be any variable that has greatest influence on cost
- Examples include volume of production, hours worked, miles driven, or machine hours

Four steps in estimating variable cost per unit and total fixed costs

1.

Highest volume | Total cost | # of units |

Lowest volume | Total cost | # of units |

Difference | Cost | # of units |

2. Variable cost per unit = Difference in cost ÷ Difference in # of units

3. Total variable costs (at either level) = Variable cost per unit × # of units

4. Fixed costs (at either level) = Total costs – Total variable costs

Coefficient of correlation (R) indicates relationship between dependent and independent variable:

• R = 1 | Strong direct relationship |

• 1 > R > 0 | Direct relationship, not as strong |

• R = 0 | No relationship |

• 0 > R > −1 | Indirect relationship, not as strong |

• R = −1 | Strong indirect relationship |

Company will use cost driver with strongest direct or indirect relationship

Product | Period |

Direct materials ... |

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