Introduction to Management Accounting

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Introduction to Management Accounting
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Chapter 3
Introduction to Management Accounting
Measurement of Cost Behavior
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Linear-cost Behavior
Costs are assumed to be fixed or variable
within the relevant range of activity
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Step Cost Behavior Patterns
Learning Objective 1
Step costs change abruptly at intervals of
activity because the resources and their costs
come in indivisible chunks.
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Step Cost Behavior Patterns
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Mixed-Cost Behavior Patterns
Mixed costs contain elements of both fixed- and
variable-cost behavior.
The fixed-cost element is unchanged over a range
of cost-driver activity.
The variable-cost element varies proportionately
with cost-driver activity.
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Mixed-Cost Behavior Patterns
Parkview Medical Center
Predicted costs
fixed variable costs (patient-days)
Predicted costs 10,000 5(4,000)

Predicted costs 30,000
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Managements Influence on Cost Behavior
Learning Objective 2
Choice of process and product design
Quality levels
Product features
Distribution channels
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Capacity Decisions
What are capacity costs?
They are the fixed costs of being able to achieve
a desired level of production or to provide a
desired level of service while maintaining
product or service attributes.
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Committed Fixed Costs
Committed fixed costs arise from the possession
of facilities, equipment, and a basic
organization.
Lease payments
Property taxes
Salaries of key personnel
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Discretionary Fixed Costs
Discretionary fixed costs are costs fixed at
certain levels only because management decided
that these levels of cost should be incurred to
meet the organizations goals.
These discretionary fixed costs have no obvious
relationship to levels of output activity but
are determined as part of the periodic planning
process.
Each planning period, management will determine
how much to spend on discretionary items. These
costs then become fixed until the next planning
period.
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Examples of DiscretionaryFixed Costs
Research and development
Employee training
Advertising and promotion
Management salaries
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Technology Decisions
Choice of technology (e-commerce versus in-store
or mail-order sales) positions the organization
to meet its current goals and to respond to
changes in the environment.
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Cost-Control Incentives
Managers use their knowledge of cost behavior to
set cost expectations.
Employees may Receive rewards that are tied to
meeting these expectations.
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Cost Functions
Learning Objective 3
Planning and controlling the activities of an
organization require accurate and useful
estimates of future fixed and variable costs.
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Cost Functions
Understanding relationships between costs and
their cost drivers allows managers to...
Make better operating, marketing, And production
decisions
Plan and evaluate actions
Determine appropriate costs for short-run and
long-run decisions.
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Cost Functions
The first step in estimating or predicting costs
is measuring cost behavior as a function of
appropriate cost drivers.
The second step is to use these cost measures to
estimate future costs at expected levels of
cost-driver activity.
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Cost Function Equation
Let Y Total cost F Fixed cost V Variable
cost per unit X Cost-driver activity in number
of units
The mixed-cost function is called a linear-cost
function.
Mixed-cost function Y F VX Y 10,000
5.00X
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Developing Cost Functions
Plausibility
The cost function must be believable.
Reliability
A cost functions estimates of costs at actual
levels of activity must reliably conform with
actually observed costs.
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Choice of Cost Drivers Activity Analysis
Learning Objective 4
Choosing a cost function starts with choosing
cost drivers.
Managers use activity analysis to identify
appropriate cost drivers.
Activity analysis directs management accountants
to the appropriate cost drivers for each cost.
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Choice of Cost Drivers Activity Analysis
Northwestern Computers makes two products
Mozart-Plus and Powerdrive
In the past, most of the support costs were twice
as much as labor costs.
Northwest has upgraded the production function,
which has increased support costs and reduced
labor cost.
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Choice of Cost Drivers Activity Analysis
Using the old cost driver, labor cost,
the prediction of support costs would be
Mozart-Plus Powerdrive Labor cost
8.50 130.00 Support cost 2 Direct
labor cost 17.00 260.00
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Choice of Cost Drivers Activity Analysis
Using the more appropriate cost driver, the
number of components added to products, the
predicted support costs are
Mozart-Plus
Powerdrive Support cost at 20/component 20
5 components 100.00 20 9
components 180.00 Difference in
predicted support cost 83.00
80.00 higher lower
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Methods of Measuring Cost Functions
Learning Objective 5

• 1. Engineering analysis
• 2. Account analysis
• 3. High-low analysis
• 4. Visual-fit analysis
• 5. Least-squares regression analysis

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Engineering Analysis
Engineering analysis measures cost behavior
according to what costs should be, not by what
costs have been.
Engineering analysis entails a systematic review
of materials, supplies, labor, support services,
and facilities needed for products and services.
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Account Analysis
The simplest method of account analysis selects a
plausible cost driver and classifies each account
as a variable or fixed cost.
Parkview Medical Center
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Account Analysis Example
3,700 patient-days
Fixed cost per month 9,673
Variable cost per patient-day 27,750 3,700
7.50 per patient-day
Y 9,673 (7.50 patient-days)
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High-Low Method
Plot historical data points on a graph.
Focus on the highest- and lowest-activity points.
High month April Maintenance cost
47,000 Number of patient-days 4,900
Low month September Maintenance cost
17,000 Number of patient-days 1,200
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High-Low Method Example
The point at which the line intersects the Y axis
is the intercept, F, or estimate of Fixed Costs,
and the slope of the line measures the variable
cost.
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High-Low Method Example
What is the variable cost (V)? Using algebra to
solve for variable and fixed costs.
Variable costs Change in costs change
in activity V (47,000 17,000) (4,900
1,200) 30,000 3,700 8.1081
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High-Low Method Example
What is the fixed cost (F)?

• F Total mixed cost total variable cost
• At X (high) F 47,000 - (8.1081 4,900 patient
  days)
• 47,000 39,730
• 7,270 a month

• At X (low) F 17,000 (8.1081 1,200 patient
  days)
• 17,000 9,730
• 7,270 a month

Cost function measured by high-low method
Y 7,270 per month
(8.1081 patient-days)
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Visual-Fit Method
In the visual-fit method, the cost
analyst visually fits a straight line through a
plot of all of the available data, not
just between the high point and the low point,
making it more reliable than the high-low method.
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Least-Squares Regression Method
Regression analysis measures a cost function more
objectively by using statistics to fit a
cost function to all the data.
Regression analysis measures cost behavior more
reliably than other cost measurement methods.
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Coefficient of Determination
One measure of reliability, or goodness of fit,
is the coefficient of determination, R² (or
R-squared).
The coefficient of determination measures how
much of the fluctuation of a cost is explained by
changes in the cost driver.
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The End
End of Chapter 3