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212 Review

212 Review. Basic Cost Behavior. Independent Variable. Dependent Variable. Parameters (coefficients). Basic Model of Total Cost. In A&MIS 212, we use the basic model of total cost, TC = F + v Q. Model Characteristics. Total cost depends exclusively on the volume of activity

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212 Review

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  1. 212 Review Basic Cost Behavior Prof. Bentz

  2. Independent Variable Dependent Variable Parameters (coefficients) Basic Model of Total Cost • In A&MIS 212, we use the basic model of total cost, TC = F + vQ Prof. Bentz

  3. Model Characteristics • Total cost depends exclusively on the volume of activity • Total cost is a linearfunction of activity volume Prof. Bentz

  4. Illustration • Consider an illustration of five ways information might be presented to you on a quiz, exam, or practical situation. All five are based on the same fact situation, so the answers will be the same. What differs is the manner in which the information is presented. Prof. Bentz

  5. Basic Data • Fact situation: • Sales volume measured in units or dollars • Fixed cost, F = $20,000 • Variable cost v = $1.50 per unit Prof. Bentz

  6. Case A • Given the two cost estimation parameters, estimate total cost for a specified volume level (like GN exercise 5 - 1) Prof. Bentz

  7. Case A • Variable cost, v = $1.50 • Fixed cost, F = $20,000 • Compute total cost (TC) of 13, 000 units Prof. Bentz

  8. Case A • TC = $20,000 + $1.50(13,000) = $20,000 + $19,500 = $39,500 Prof. Bentz

  9. Case B • Given the total cost for a specified level of volume, and the proportion of total cost represented by either the fixed or the variable component of total cost, estimate total cost for a different volume level Prof. Bentz

  10. Case B • Given: • TC = $50,000 for 20,000 units • Fixed cost is 40% of total cost at this volume • Compute total cost (TC) of 13, 000 units Prof. Bentz

  11. Case B • TC = F + vQ • vQ = TC – F • vQ = $50,000 – 40%($50,000) = $50,000 - $20,000 v(20,000) = $30,000 v = $30,000 / 20,000 units = $1.50 per unit Prof. Bentz

  12. Case B • TC = $20,000 + $1.50(13,000) = $20,000 + $19,500 = $39,500 Prof. Bentz

  13. Case C • Given per-unit fixed and variable costs for a specified level of volume, estimate total cost for a different level of volume Prof. Bentz

  14. Case C • Given the cost per unit by component for 12,000 units: • Variable $ 1.50000 • Fixed 1.66667 • Total $ 3.16667 • Compute total cost (TC) of 13, 000 units Prof. Bentz

  15. Case C • F = 12,000 units @ $1.66667 F= $20,000 v = $1.50 per unit (given) Therefore, the cost estimation equation is: TC = $20,000 + $1.50 Q Prof. Bentz

  16. Case C • Compute total cost of 13,000 units TC = $20,000 + $1.50(13,000) = $20,000 + $19,500 = $39,500 Prof. Bentz

  17. Case D • Given two volume levels, and the total costs at each of those two levels of volume, develop the information required to estimate total cost for a different level of volume and prepare that estimate. Prof. Bentz

  18. Case D • Given volume in units and total cost at each of the volume levels: Sales 1Sales 2 • Sales (units) 12,000 14,000 • Total cost $38,000 $41,000 Prof. Bentz

  19. Case D • v = Change in cost/change in volume v = ($41,000 - $38,000) (14,000 – 12,000) v = $3,000 / 2,000 units = $1.50 per unit Prof. Bentz

  20. Case D • F = TC – vQ = $41,000 - $1.50(14,000) F = $41,000 - $21,000 = $20,000 Prof. Bentz

  21. Case D • Compute total cost of 13,000 units TC = $20,000 + $1.50(13,000) = $20,000 + $19,500 = $39,500 Prof. Bentz

  22. Case E • Given two sales levels (in dollars), and the total costs at each of these two levels of sales, develop the information required to estimate total cost for a different level of sales volume and prepare that estimate. Prof. Bentz

  23. Case E • Given total sales and total costs for two different volumes: Sales 1 Sales 2 • Sales $40,000 $48,000 • Total cost $35,000 $38,000 Prof. Bentz

  24. Case E • v = Change in cost / change in sales volume v = ($38,000 - $35,000) ($48,000 - $40,000) v = $3,000 / $8,000 = 3/8 or 37.5% of sales $ Prof. Bentz

  25. Case E • F = TC – vQ = $38,000 – 0.375($48,000) F = $38,000 - $18,000 = $20,000 Prof. Bentz

  26. Case E • Compute total cost for sales of $52,000: TC = $20,000 + 0.375($52,000) = $20,000 + $19,500 = $39,500 Prof. Bentz

  27. Review of Illustration • Obviously, there any number of ways one might encounter the information necessary to compute the cost estimation equation to be able to predict total costs for a given level of volume. But they are all based on the same fundamental relationship of cost to volume. Prof. Bentz

  28. Exercise 5 -1 • With exercise 5 -1 we have three ways to estimate the equation that describes the behavior of total shipping expense with respect to the number of units shipped. Prof. Bentz

  29. Exercise 5 -1 • The method shows that, in fact, we will can get three different answers using the three methods. The similarity of the three estimates is totally determined by the data presented and one cannot generalize about the differences. Prof. Bentz

  30. Exercise 5 -1 • Zerbel Company, a wholesaler of large, custom-built air conditioning units or commercial buildings, has noticed considerable fluctuation in its shipping expense from month to month, as shown on the following slide: Prof. Bentz

  31. Data for Exercise 5 -1 Prof. Bentz

  32. Ex. 5 –1, Requirement 1 • Using the high-low method, estimate the cost formula for shipping expense. Prof. Bentz

  33. Ex. 5 –1, Requirement 1 Prof. Bentz

  34. Ex. 5 –1, Requirement 1 Prof. Bentz

  35. Estimation equation TC = $ 800 + $ 350 Q Prof. Bentz

  36. Ex. 5 –1, Requirement 2 • The president has no confidence in the high-low method and would like you to “check out” your results using the scattergraph method. Do the following: • Prepare a scattergraph using the data given above. Prof. Bentz

  37. Ex. 5 –1, Requirement 2 • Using your scatter graph, estimate the approximate variable cost per unit shipped and the approximate fixed cost per month with the “quick-and-dirty method (see below). Prof. Bentz

  38. Req. 2: Scattergraph Method Prof. Bentz

  39. Req. 2: Scattergraph Method Prof. Bentz

  40. Req. 2: Estimation equation TC = $1,100 + $300 Q Prof. Bentz

  41. Regression Analysis Results Intercept (fixed cost) $ 1,010.71 Slope (variable unit cost) $ 317.86 Regression results provide the theoretically correct standard against which we can compare ad-hoc methods. Prof. Bentz

  42. Estimation equation TC = $1,100.71 + $317.86 Q Prof. Bentz

  43. Summary of results • High-Low method (unique answer) TC = $800 + $350 Q • Scatter graph method (judgment) TC = $1,100 + $300 Q • Regression analysis method (unique answer) TC = $1,010.71 + $317.86 Q Prof. Bentz

  44. High-Low Method • In summary, the High-Low method is the least accurate of the three methods assuming the regression model best captures the information contained in all the data points. Prof. Bentz

  45. Ex. 5 –1, Requirement 3 • What factors, other than the number of units shipped, are likely to affect the company’s shipping expense? • Weather • Road construction and repairs • Fuel costs • Car and truck traffic Prof. Bentz

  46. General Assumption • In the absence of evidence to the contrary, for testing and homework purposes in A&MIS 212, assume that all costs can be modeled as semi-variable (mixed) costs. This is the assumption that underlies the high-low method! Prof. Bentz

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