Activity Analysis, Cost Behavior, and Cost Estimation

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7
Chapter Seven

• Activity Analysis, Cost Behavior, and
  CostEstimation

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Introduction
Costestimation
Process ofdeterminingcost behavior,often
focusingon historicaldata.
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Cost Behavior Patterns
Recall the summary of our cost behavior
discussion from Chapter 2.
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Total Variable Cost Example

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

Total Long DistanceTelephone Bill
Minutes Talked
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Variable Cost Per Unit Example

• The cost per long distance minute talked is
  constant. For example, 5 cents per minute.

Per MinuteTelephone Charge
Minutes Talked
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Total Fixed Cost Example

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

Monthly Basic Telephone Bill
Number of Local Calls
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Fixed Cost Per Unit Example

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

Monthly Basic Telephone Bill per Local Call
Number of Local Calls
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Step-Variable Costs
Total cost remainsconstant within anarrow range
ofactivity.
Cost
Activity
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Step-Variable Costs
Total cost increases to a new higher cost for
the next higher range of activity.
Cost
Activity
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Step-Fixed Costs

• 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.

Continue
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Step-Fixed Costs
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.
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Rent Cost in Thousands of Dollars
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0
0 1,000 2,000
3,000 Rented Area (Square Feet)
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Step-Fixed Costs
How does this type of fixed cost differ from a
step-variable cost?
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Semivariable Cost

• A semivariable cost is partly fixed and partly
  variable.

Consider thefollowing electric utility example.
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Semivariable Cost
Total semivariable cost
Variable Utility Charge
Total Utility Cost
Fixed MonthlyUtility Charge
Activity (Kilowatt Hours)
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Curvilinear Cost
CurvilinearCost Function
Activity
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Engineered, Committed and Discretionary Costs
Discretionary May be altered in the short term by
current managerial decisions.
Committed Long-term, cannot be reduced in the
short term.
Engineered Physical relationship with activity
measure.
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Shifting Cost Structure in the New Manufacturing
Environment

• A trend toward more fixed costs because of
• Increased automation.
• Stable workforce.

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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Cost Behavior in Other Industries
Examples of variable costs
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Cost Behavior in Other Industries
Examples of fixed costs
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Cost Estimation
Account-Classification Method
Visual-Fit Method
High-Low Method
Least-Squares Regression Method
Engineering Method of Cost Estimation
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Account Classification Method
Cost estimates are based on areview of each
account making up the total cost being analyzed.
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Account Classification MethodExample
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Visual-Fit Method

• A scatter diagram of past cost behavior
  may be helpful in analyzing mixed costs.

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Visual-Fit Method
Plot the data points on a graph (total cost vs.
activity).
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Visual-Fit Method
Draw a line through the plotted data points so
that about equal numbers of points fall above and
below the line.
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Visual-Fit Method
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Visual-Fit Method
Total variable cost Total cost Total
fixed costTotal variable cost 16,000
10,000 6,000
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Visual-Fit Method
Total variable cost Total cost Total
fixed costTotal variable cost 16,000
10,000 6,000Unit variable cost 6,000
3,000 units 2
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The High-Low Method

• OwlCo recorded the following production activity
  and maintenance costs for two months
• Using these two levels of activity, compute
• the variable cost per unit.
• the total fixed cost.

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The High-Low Method
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The High-Low Method
??in cost??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

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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)

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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)

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The High-Low Method

• Unit variable cost 3,600 4,000 units
  .90 per unit
• Fixed cost Total cost Total variable cost
• Fixed cost 9,700 (.90 per unit 9,000
  units)
• Fixed cost 9,700 8,100 1,600

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The High-Low Method Question 1

• If sales 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
  commission per unit sold?
• a. .08 per unit
• b. .10 per unit
• c. .12 per unit
• d. .125 per unit

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The High-Low Method Question 1

• If sales 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
  commission per unit sold?
• a. .08 per unit
• b. .10 per unit
• c. .12 per unit
• d. .125 per unit

4,000 40,000 units .10 per unit
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The High-Low Method Question 2

• If sales 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 the sales
  commission?
• a. 2,000
• b. 4,000
• c. 10,000
• d. 12,000

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The High-Low Method Question 2

• If sales 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 the sales
  commission?
• a. 2,000
• b. 4,000
• c. 10,000
• d. 12,000

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Least-Squares Regression Method

• Regression is a statistical procedure usedto
  determine the relationship between variables such
  as activity and cost.

The objective ofthe regressionmethod is
thegeneral cost equation Y a bX in cost
terms TC F VX
Total Cost
Activity
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Equation Form of Least-Squares Regression Line
TC F VX
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Least-Squares Regression Method

• Statistics courses and computer courses deal with
  detailed regression computations using computer
  spreadsheet software.
• Accountants and managers must be able to
  interpret and use regression estimates.

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Goodness of Fit
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Total Cost
10
0
0 1 2 3 4
Activity
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Multiple Regression

• Multiple regression includes two or more
  independent variables
• Terms in the equation have the samemeaning as
  in simple regression withonly one independent
  variable.

TC FC V1X1 V2X2
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Data Collection Problems

• Missing data.
• Outlier data points.
• Mismatched time periods costs.
• Trade-offs in choosing the time period.
• Allocated and discretionary costs.
• Inflation.

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Effect of Learningon Cost Behavior
As I make more of thesethings it takes me
lesstime for each one. It mustbe the learning
curve effectthat the boss wastalking about.
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Effect of Learningon Cost Behavior
A systematic relationship betweenthe amount of
experience inperforming a task and the
timerequired to carry out the task.
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Effect of Learningon Cost Behavior
A systematic relationship betweenthe amount of
experience inperforming a task and the
timerequired to carry out the task.
The average time per task declines by a constant
percentage each time the quantity of tasks
doubles.
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Effect of Learningon Cost Behavior

• BerryCo. makes products requiring labor that
  follows an 80 percent learning rate. If the
  first unit of such a product requires 10 hours,
  what is the average time for 16 units of this
  product?

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Effect of Learningon Cost Behavior

• BerryCo. makes products requiring labor that
  follows an 80 percent learning rate. If the
  first unit of such a product requires 10 hours,
  what is the average time for 16 units of this
  product?

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Effect of Learningon Cost Behavior
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Effect of Learningon Cost Behavior
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Effect of Learningon Cost Behavior
The graphic presentation of the learning
phenomenon is called the learning curve.
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Learning Curve
Learning effectsare large initially.
Learning effectsbecome smaller, eventually
reaching steady state.
Average LaborTime per Unit
Cumulative Production Output
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End of Chapter 7