Cost Behavior: Analysis and Use

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Cost BehaviorAnalysis and Use
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Types of Cost Behavior Patterns
Recall the summary of our cost behavior
discussion from Chapter 1.
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Total Variable Cost Example

• Your total long distance telephone bill is
  based on how many minutes you talk.

4
Variable Cost Per Unit Example

• The cost per minute talked is constant. For
  example, 10 cents per minute.

5
Total Fixed Cost Example

• Your monthly basic telephone bill is probably
  fixed and does not change when you make more
  local calls.

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Fixed Cost Per Unit Example

• The fixed cost per local call decreases as more
  local calls are made.

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Cost Behavior
Examples of normally variable costs
Service Organizations Supplies and travel
Merchandisers Cost of Goods Sold
Merchandisers and Manufacturers Sales commissions
and shipping costs
Manufacturers Direct Material, Direct Labor, and
Variable Manufacturing Overhead
Examples of normally fixed costs
Merchandisers, manufacturers, and service
organizations Real estate taxes, Insurance, Sales
salariesDepreciation, Advertising
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The Activity Base
A measure of the event causing the incurrence
of a variable cost a cost driver
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Step-Variable Costs
Cost
Activity
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Step-Variable Costs
Cost
Activity
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The Linearity Assumption and the Relevant Range
EconomistsCurvilinear Cost Function
Total Cost
Activity
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The Linearity Assumption and the Relevant Range
A straight line closely approximates a
curvilinear variable cost line within the
relevant range.
EconomistsCurvilinear Cost Function
Total Cost
Accountants Straight-Line Approximation
(constant unit variable cost)
Activity
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Types of Fixed Costs
Fixed Costs
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Trend Toward Fixed Costs

• Increased automation.
• Increase in salaried knowledge workers who are
  difficult to train and replace.

Implications Managers are more locked-in with
fewer decision alternatives. Planning becomes
more crucial because fixed costs are difficult to
change with current operating decisions.
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Fixed Costs and Relevant Range

• Example Office space is available at a
  rental rate of 30,000 per year in increments of
  1,000 square feet. As the business grows more
  space is rented, increasing the total cost.

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Fixed Costs and Relevant Range
90
Total cost doesnt change for a wide range of
activity, and then jumps to a new higher cost for
the next higher range of activity.
Relevant Range
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Rent Cost in Thousands of Dollars
30
0
0 1,000 2,000
3,000 Rented Area (Square Feet)
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Quick Check ?

• Which of the following statements about cost
  behavior are true?
• a. Fixed costs per unit vary with the level of
  activity.
• b. Variable costs per unit are constant within
  the relevant range.
• c. Total fixed costs are constant within the
  relevant range.
• d. Total variable costs are constant within the
  relevant range.

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Quick Check ?

• Which of the following statements about cost
  behavior are true?
• a. Fixed costs per unit vary with the level of
  activity.
• b. Variable costs per unit are constant within
  the relevant range.
• c. Total fixed costs are constant within the
  relevant range.
• d. Total variable costs are constant within the
  relevant range.

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Fixed Costs and Relevant Range
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Mixed Costs

• A mixed costhas both fixed and
  variablecomponents.

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Mixed Costs
Total mixed cost
Total Utility Cost
Activity (Kilowatt Hours)
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Mixed Costs
Total mixed cost Y a bX
Variable Utility Charge
Total Utility Cost
Fixed MonthlyUtility Charge
Activity (Kilowatt Hours)
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Mixed Costs
Total mixed cost Y a bX
Variable Utility Charge
Total Utility Cost
bX
Fixed MonthlyUtility Charge
a
Activity (Kilowatt Hours)
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The Analysis of Mixed Costs
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Account Analysis
Each account is classified as eithervariable or
fixed based on the analysts knowledge of how
the account behaves.
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Engineering Estimates
Cost estimates are based on an evaluation of
production methods, and material, laborand
overhead requirements.
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The High-Low Method

• WiseCo recorded the following production activity
  and maintenance costs for two months
• Using these two levels of activity, compute
• the variable cost per unit
• the fixed cost and then
• express the costs in equation form Y a bX.

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The High-Low Method
Change?in costChange in units

• Unit variable cost

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The High-Low Method

• Unit variable cost 3,600 4,000 units
  0.90 per unit

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The High-Low Method

• Unit variable cost 3,600 4,000 units
  0.90 per unit
• Fixed cost Total cost Total variable cost
• Fixed cost 9,700 (0.90 per unit
  9,000 units)
• Fixed cost 9,700 8,100 1,600

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The High-Low Method

• Unit variable cost 3,600 4,000 units
  0.90 per unit
• Fixed cost Total cost Total variable cost
• Fixed cost 9,700 (0.90 per unit
  9,000 units)
• Fixed cost 9,700 8,100 1,600
• Total cost Fixed cost Variable cost (Y a
  bX) Y 1,600 0.90X

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Quick Check ?

• If sales salaries and commissions are 10,000
  when 80,000 units are sold and 14,000 when
  120,000 units are sold, what is the variable
  portion of sales salaries and commission?
• a. 0.08 per unit
• b. 0.10 per unit
• c. 0.12 per unit
• d. 0.125 per unit

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Quick Check ?

• If sales salaries and commissions are 10,000
  when 80,000 units are sold and 14,000 when
  120,000 units are sold, what is the variable
  portion of sales salaries and commission?
• a. 0.08 per unit
• b. 0.10 per unit
• c. 0.12 per unit
• d. 0.125 per unit

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Quick Check ?

• If sales salaries and commissions are 10,000
  when 80,000 units are sold and 14,000 when
  120,000 units are sold, what is the fixed portion
  of sales salaries and commissions?
• a. 2,000
• b. 4,000
• c. 10,000
• d. 12,000

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Quick Check ?

• If sales salaries and commissions are 10,000
  when 80,000 units are sold and 14,000 when
  120,000 units are sold, what is the fixed portion
  of sales salaries and commissions?
• a. 2,000
• b. 4,000
• c. 10,000
• d. 12,000

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Note

• How does the high-low method work when you have
  data for more than two periods?
• Select the two periods with the lowest and
  highest level of activity.

Low
High
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Quick Check ?

• Using the high-low method, estimate the cost
  formula Y a bX for the patient admitting costs
  on the previous page.
• a. Y 9,720 2.00X
• b. Y 7,050 3.00X
• c. Y 8,385 2.50X
• d. Y 8,480 2.50X

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Quick Check ?

• Using the high-low method, estimate the cost
  formula Y a bX for the patient admitting costs
  on the previous page.
• a. Y 9,720 2.00X
• b. Y 7,050 3.00X
• c. Y 8,385 2.50X
• d. Y 8,480 2.50X

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The Scattergraph Method
Plot the data points on a graph (total cost vs.
activity).
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The Scattergraph Method
Draw a line through the data points with about
anequal numbers of points above and below the
line.
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The Scattergraph Method
The slope of this line is the variable unit cost.
(Slope is the change in total cost for a one unit
change in activity).
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The Scattergraph Method
Vertical distance is the change in cost.
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Least-Squares Regression Method

• Software can be used to fit a regression line
  through the data points.
• The cost analysis objective is the same Y a
  bx

Least-squares regression also provides a
statistic, calledthe adjusted R2, that is a
measure of the goodnessof fit of the regression
line to the data points.
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Least-Squares Regression Method

Y
20










Total Cost
10
0
X
0 1 2 3 4
Activity
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Note

• Lets plot the data for patient admitting costs.

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Note

• Problems with the high-low method
• Throws away information contained in all of the
  data other than the low and the high points.
• The low and high levels of activity tend to be
  unusual.
• You should always plot the data if you have more
  than two points to make sure it even makes sense
  to be using the high-low method.

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The Contribution Format
Lets put our knowledge of cost behavior to work
by preparing a contribution format income
statement.
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The Contribution Format
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The Contribution Format
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End of Chapter 5