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Introduction

  • We started our discussion on fixed and variable costs and how they influence cost.
  • Let's explore further into the behavior of costs.

Cost Items in a Cost Sheet

Material Cost (Variable Cost)

  • Varies based on volume.
  • No production → no material cost.
  • If material cost = ₹100/unit:
    • 1000 units → ₹1,00,000
    • 2000 units → ₹2,00,000
  • Employee wages based on units produced also considered variable.

Rent (Fixed Cost)

  • Constant regardless of production.
  • Examples: Depreciation, insurance, management salaries.

Repairs & Maintenance (Mixed Cost)

  • Even with no production, basic maintenance required.
  • More production → more maintenance cost.

Cost Classification Approaches

1. Accounting Analysis

  • Manager manually classifies each item.
  • Subjective, based on experience.
  • Example: 30% of repairs = fixed, 70% = variable.
  • Pros: Manager insight.
  • Cons: Needs frequent review, may miss cost structure changes.

2. High-Low Method

  • Based on highest and lowest activity level data.
  • Assume linear relationship between cost and volume.

Example:

-- Lowest: 100 units → ₹50,000
-- Highest: 300 units → ₹1,20,000
-- ΔCost = ₹70,000; ΔVolume = 200
-- Variable Cost/Unit = ₹350 (₹70,000 / 200) -- Fixed Cost = Total Cost - (Variable Cost × Units)

  • For 100 units → ₹50,000 - ₹35,000 = ₹15,000

-- Pros: Simple, objective. -- Cons: Ignores other monthly data.

3. Scatter Graph Method

  • Plot cost vs volume on XY chart (Excel).
  • Y-axis: Total Cost
  • X-axis: Volume
  • Draw line through data points:
    • Slope = Variable cost/unit
    • Y-intercept = Fixed cost

4. Regression Analysis

  • Uses all data points (e.g., 10 years of data).
  • Equation: Cost = a + b × Volume
    • a = Fixed Cost
    • b = Variable Cost (% of sales)

Real Company Example (10-Year Data)

Kansai Nerolac:

  • High-Low Method:

    • Sales: ₹2731 lakh → Cost: ₹429 lakh
    • Variable Cost: 14.28% of revenue
    • Fixed Cost: ₹39.36 crore

  • Regression:

    • Variable Cost: 14.76%
    • Fixed Cost: ₹44.64 crore

ACC:

  • Variable Cost: 23.57%
  • Fixed Cost: ₹47 crore

Hindalco, Sterlite:

  • Applied same methods.

Ultratech:

  • Used 2004 data (2003 not available)
  • Variable Cost: 22.46%
  • Fixed Cost: ₹125 lakh

Asian Paints (Special Case):

  • Revenue: ₹1650 → ₹8335 crore (5x increase)
  • Cost: ₹280 → ₹1636 crore (>5x increase)
  • Branding increased significantly → high variable component
  • Negative fixed cost appears → indicates assumption flaw

Revised Regression (Intercept = 0):

  • Equation: S&D Cost = 0 + b × Sales
  • Variable Cost: 19.86%
  • Fixed Cost: 0
  • R² ~ 0.99: High reliability
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