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Cost Behavior: Analysis and Use. Chapter 5. Learning Objective 1. Understand how fixed and variable costs behave and how to use them to predict costs. Types of Cost Behavior Patterns – Variable .

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learning objective 1
Learning Objective 1

Understand how fixed and variable costs behave and how to use them to predict costs.

types of cost behavior patterns variable
Types of Cost Behavior Patterns – Variable

A variable cost is a cost whose total dollar amount varies in direct proportion to changes in the activity level.

the activity base also called a cost driver
The Activity Base (also called a cost driver)

Unitsproduced

Machine hours

A measure of what causes the incurrence of a variable cost

Miles driven

Labor hours

true variable cost an example
True Variable Cost – An Example

As an example of an activity base, consider overage charges on a cell phone bill. The activity base is the number of minutes used above the allowed minutes in the calling plan.

Total Overage Charges on Cell Phone Bill

Minutes Talked

types of cost behavior patterns variable1
Types of Cost Behavior Patterns – Variable

Variable costs remain constant if expressed on a per unit basis.

variable cost per unit an example
Variable Cost Per Unit – An Example

Referring to the cell phone example, the cost per overage minute is constant, for example 45 cents per overage minute.

Per MinuteOverage Charge

Minutes Talked

examples of variable costs
Examples of Variable Costs
  • Merchandising companies – cost of goods sold.
  • Manufacturing companies – direct materials, direct labor, and variable overhead.
  • Merchandising and manufacturing companies – commissions, shipping costs, and clerical costs such as invoicing.
  • Service companies – supplies, travel, and clerical.
true variable costs
True Variable Costs

The amount of a true variable cost used during the period varies in direct proportion to the activity level. The overage charge on a cell phone bill was one example of a true variable cost.

Direct material is another example of a cost that behaves in a true variable pattern.

Cost

Volume

step variable costs

Cost

Volume

Step-Variable Costs

A step-variable cost is a resource that is obtainable only in large chunks (such as maintenance workers) and whose costs change only in response to fairly wide changes in activity.

step variable costs1

Cost

Volume

Step-Variable Costs

Small changes in the level of production are not likely to have any effect on the number of maintenance workers employed.

step variable costs2

Cost

Volume

Step-Variable Costs

Only fairly wide changes in the activity level will cause a change in the number of maintenance workers employed.

types of cost behavior patterns fixed
Types of Cost Behavior Patterns – Fixed

A fixed cost is a cost whose total dollar amount remains constant as the activity level changes.

total fixed cost an example
Total Fixed Cost – An Example

For example, your cell phone bill probably includes a fixed amount related to the total minutes allowed in your calling plan. The amount does not change when you use more or less allowed minutes.

Monthly Basic Cell Phone Bill

Number of Minutes Used within Monthly Plan

types of cost behavior patterns fixed1
Types of Cost Behavior Patterns – Fixed

Average fixed costs per unit decrease as the activity level increases.

fixed cost per unit example
Fixed Cost Per Unit Example

For example, the fixed cost per minute used decreases as more allowed minutes are used.

Cost Per Cell Phone Call

Number of Minutes Used within Monthly Plan

types of fixed costs
Types of Fixed Costs

Committed

Long-term, cannot be significantly reduced in the short term.

Discretionary

May be altered in the short-term by current managerial decisions

Examples

Depreciation on Buildings and Equipment and Real Estate Taxes

Examples

Advertising and Research and Development

the trend toward fixed costs
The Trend Toward Fixed Costs

The trend in many industries is toward greater fixed costs relative to variable costs.

As machines take overmany mundane taskspreviously performedby humans, “knowledge workers”are demanded fortheir minds ratherthan their muscles.

Knowledge workerstend to be salaried,highly-trained anddifficult to replace. Thecost of compensatingthese valued employees

is relatively fixed

rather than variable.1

fixed costs and the relevant range
Fixed Costs and the Relevant Range

90

The relevant range of activity for a fixed cost is the range of activity over which the graph of the cost is flat.

Relevant Range

60

Rent Cost in Thousands of Dollars

30

0

0 1,000 2,000 3,000 Rented Area (Square Feet)

fixed costs and the relevant range1
Fixed costs would increase in a step fashion at a rate of $30,000 for each additional 1,000 square feet. Fixed Costs and the Relevant Range

For example, assume office space is available at a rental rate of $30,000 per year in increments of 1,000 square feet.

fixed costs and the relevant range2
Fixed Costs and the Relevant Range
  • Step-variable costs can be adjusted more quickly as conditions change and . . .
  • The width of the activity steps is much wider for the fixed cost.

How does this step-function pattern differ from a step-variable cost?

quick check
Which of the following statements about cost behavior are true?

Fixed costs per unit vary with the level of activity.

Variable costs per unit are constant within the relevant range.

Total fixed costs are constant within the relevant range.

Total variable costs are constant within the relevant range.

Quick Check 
quick check1
Quick Check 

Which of the following statements about cost behavior are true?

  • Fixed costs per unit vary with the level of activity.
  • Variable costs per unit are constant within the relevant range.
  • Total fixed costs are constant within the relevant range.
  • Total variable costs are constant within the relevant range.
mixed costs also called semivariable costs

Y

X

Mixed Costs (also called semivariable costs)

A mixed cost contains both variable and fixed elements. Consider the example of utility cost.

Total mixed cost

Total Utility Cost

Variable Cost per KW

Fixed MonthlyUtility Charge

Activity (Kilowatt Hours)

mixed costs

Y

X

Mixed Costs

Total mixed cost

Total Utility Cost

Variable Cost per KW

Fixed MonthlyUtility Charge

Activity (Kilowatt Hours)

mixed costs an example

Y = a +bX

Y = $40 + ($0.03 × 2,000)

Y =

$100

Mixed Costs – An Example

If your fixed monthly utility charge is $40, your variable cost is $0.03 per kilowatt hour, and your monthly activity level is 2,000 kilowatt hours, what is the amount of your utility bill?

analysis of mixed costs
Analysis of Mixed Costs

Account Analysis and the Engineering Approach

In account analysis, each account is

classified as either variable or fixed based

on the analyst’s knowledge of how

the account behaves.

The engineering approach classifies costs based upon an industrial engineer’s evaluation of production methods, and material, labor and overhead requirements.

learning objective 3
Learning Objective 3

Analyze a mixed cost using the high-low method.

the high low method an example1

$2,400 400

= $6.00/hour

The High-Low Method – An Example

The variable cost per hourof maintenance is equal to the change in cost divided by the change in hours.

the high low method an example2

Total Fixed Cost = $9,800 – $5,100

Total Fixed Cost = $4,700

The High-Low Method – An Example

Total Fixed Cost = Total Cost – Total Variable Cost

Total Fixed Cost = $9,800 – ($6/hour × 850 hours)

quick check2
Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is thevariable 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

Quick Check 
quick check3

$4,000 ÷ 40,000 units = $0.10 per unit

Quick Check 

Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is thevariable 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

quick check4
Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the fixed portion of sales salaries and commissions?

a. $ 2,000

b. $ 4,000

c. $10,000

d. $12,000

Quick Check 
quick check5
Quick Check 

Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the fixed portion of sales salaries and commissions?

a. $ 2,000

b. $ 4,000

c. $10,000

d. $12,000

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 Method

Least-squares regression also provides a statistic, called the R2, which is a measure of the goodnessof fit of the regression line to the data points.

least squares regression method1
Least-Squares Regression Method

R2is the percentage of the variation in the dependent variable (total cost) that is explained by variation in the independent variable (activity).

Y

20

*

*

*

*

*

*

*

*

*

*

Total Cost

10

R2varies from 0% to 100%, andthe higher the percentage the better.

0

X

0 1 2 3 4

Activity

learning objective 4
Learning Objective 4

Prepare an income statement using the contribution format.

the contribution format
The Contribution Format

Let’s put our knowledge of cost behavior to work by preparing a contribution format income statement.

the contribution format1

The contribution margin format emphasizes cost behavior. Contribution margin covers fixed costs and provides for income.

The Contribution Format
uses of the contribution format
Uses of the Contribution Format
  • The contribution income statement format is used as an internal planning and decision-making tool. We will use this approach for:
  • Cost-volume-profit analysis (Chapter 6).
  • Budgeting (Chapter 9).
  • Segmented reporting of profit data (Chapter 12).
  • Special decisions such as pricing and make-or-buy analysis (Chapter 13).
learning objective 5
Learning Objective 5

Analyze a mixed cost using the least-squares regression method.

simple regression analysis an example
Simple Regression Analysis – An Example

Matrix, Inc. wants to know its average fixed cost and variable cost per unit.

Using the data to the right, let’s see how to do a regression using Microsoft Excel.

simple regression using excel an example
Simple Regression Using Excel – An Example
  • You will need three pieces of information from your regression analysis:
  • Estimated Variable Cost Per Unit (line slope)
  • Estimated Fixed Costs (line intercept)
  • Goodness of fit, or R2

To get these three pieces information we will need to use three Excel functions.

SLOPE, INTERCEPT, and RSQ

slide49

Simple Regression Using Excel – An Example

Scroll down to the “Statistical”, functions. Now scroll down the statistical functions until you highlight “SLOPE”

slide50

Simple Regression Using Excel – An Example

1. In the Known_y’s box, enter C4:C19 for the range.

2. In the Known_x’s box, enter D4:D19 for the range.

slide51

Simple Regression Using Excel – An Example

Here is the estimate of the slope of the line.

1. In the Known_y’s box, enter C4:C19 for the range.

2. In the Known_x’s box, enter D4:D19 for the range.

slide52

Simple Regression Using Excel – An Example

With your cursor in cell F5, press the = key and go to the pull down menu for “Special Functions.” Select Statistical and scroll down to highlight the INTERCEPT function.

slide53

Simple Regression Using Excel – An Example

Here is the estimate of the fixed costs.

1. In the Known_y’s box, enter C4:C19 for the range.

2. In the Known_x’s box, enter D4:D19 for the range.

slide54

Simple Regression Using Excel – An Example

Finally, we will determine the “goodness of fit”, or R2, by using the RSQ function.

slide55

Simple Regression Using Excel – An Example

Here is the estimate of R2.

1. In the Known_y’s box, enter C4:C19 for the range.

2. In the Known_x’s box, enter D4:D19 for the range.