Cost Behaviour : Part 2 of 2

1. Ch. 6 Assignment due Feb 4(Mon), 11.59pm • Sections 1 and 2 • Feb 1, 2013 • Professor: Khim Kelly • Office: HH386B • Office Hours: Mon/Wed 11:30am – 12:30pm and Appointment • Email: kokelly@uwaterloo.ca • TA: Kun Huo • Email: khuo@uwaterloo.ca Cost Behaviour: Part 2 of 2

2. 1 Feb 2013 Overview • Last lecture … • Fixed costs, variable costs, step variable costs, mixed costs • How to use costs behaviour to predict costs • Analyze mixed costs (High-Low Method) • Major topics for today… • Analyse mixed costs (Regression) • Another example of High-Low method • The contribution margin approach

3. Regression • High-Low method uses only two data points • Improve accuracy of results by considering more data points • Regression analysis • Uses all the available data points • “Fits” a line to the data points while attempting to minimize errors. • Develops a similar looking equation to High-Low method • Both assume linearity • Need to be aware of potential differences in cost behaviour outside of the relevant range • When predicting costs, you might want to limit analysis to a range around expected activity The next slides plot data (from last lecture Clicker Question #3) with activity on the X axis and the mixed cost on the Y axis.

4. Last Lecture: Clicker Question #4: Answer $34,500 - $18,750 = 5,000 - 1,800 $15,750 = 3,200 = $4.92 per Patient-Day Then: = $34,500 a + ($4.92 * 5,000) = a $9,891 Answer: D. Y = $9,891 +$4.92X

5. Scattergram Plot Mixed Cost Patient days

6. High-Low Method Mixed Cost HL method: y= $4.92x + $9,891 Patient days

7. Least Squares Regression Method Mixed Cost HL method: y= $4.92x + $9,891 LSR method: y = 4.10x + $12,346 Patient days

8. Least Squares Regression Method Outlier? Nonlinear? Mixed Cost LSR method: y = 4.10x + $12,346 (with outlier) Patient days

9. Least Squares Regression Method Outlier? Nonlinear? Mixed Cost LSR method: y = 4.10x + $12,346 (with outlier) LSR method: y = 3.51x + $13,890 (without outlier) Patient days

10. Example: High-Low Method and Predicting Cost (P6-15) Prince Company’s total OH costs at various levels of activity are presented below:

11. Example: High-Low and Predicting Cost (P6-15) Assume OH costs consists of utilities, supervisory salary, depreciation, and maintenance. The breakdown for October at 80,000 DL hour level of activity is: The company wants the breakdown of costs into variable and fixed cost elements. Answer the following required:

12. Example: High-Low and Predicting Cost (P6-15) 1. Estimate how much of the $483,200 of OH cost in December was maintenance cost

13. Example: High-Low and Predicting Cost (P6-15) The company wants the breakdown of costs into variable and fixed cost elements. Answer the following required: Variable Cost = $104,000/80,000 * 140,000

14. It is Clicker Time!! Feel Free to Work Together on Clicker Questions

15. Clicker Question #1 (P6-15) Q: Use the high-low method to develop the cost formula for maintenance cost (select option that is closest to your answer). LOW (October): 80,000 DL hours @ $116,400 HIGH (December): 140,000 DL hours @ $181,200 • A. Y = $15,000 + $23.80X • B. Eggs + Plants = Eggplant • C. Y = $30,000 + $3.12X • D. Y = $30,000 + $1.08X • E. Y = $15,000 + $2.38X

16. Clicker Question #1 LOW (October): 80,000 DL hours @ $116,400 HIGH (December): 140,000 DL hours @ $181,200 $181,200 - $116,400 = 140,000 – 80,000 $64,800 = 60,000 = $1.08 per DL hour Then: Answer: D. Y = $30,000+$1.08X = $116,400 a + ($1.08 * 80,000) = a $30,000

17. Example: High-Low and Predicting Cost (P6-15) 3. Express the company’s total OH cost in the formula Y = a+ bX: Variable Costs: Utilities ($104,000/80,000 DL) $1.30/DL hour Maintenance $1.08/DL hour Total Variable $2.38/DL hour Fixed Costs: Salaries and depreciation $120,000 Maintenance $30,000 Total Fixed $150,000

18. Example: High-Low and Predicting Cost (P6-15) 3. Express the company’s total OH cost in the formula Y = a+ bX: Total Variable $2.38/DL hour Total Fixed $150,000 Y = $150,000 + $2.38X

19. The Contribution Format • Utilizes our ability to analyze cost behavior • An income statement format that separates expenses into fixed costs and variable costs • Differs from traditional presentation of COGS and operating expenses • Total cost is the same under both methods but only subtotals vary • Contribution margin • The amount remaining from sales after all variable costs have been deducted

20. Contribution Income Statement To Do: Analyze expense behaviour of the following and develop a contribution income statement:

21. Contribution Income Statement

22. Contribution Income Statement

23. It is Clicker Time! Feel Free to Work Together on Clicker Questions

24. Clicker Question #2 Q: Contribution margin equals revenues minus _______? • Product costs • Period costs • Variable costs • Fixed costs • 9 little monkeys jumping on the bed

25. Clicker Question #2: Answer Q: Contribution margin equals revenues minus _______? Answer: C. Variable costs

26. Clicker Question #3 Q: What is the contribution margin?

27. Clicker Question #3 Q: What is the contribution margin? • $37,250 • $100,000,000.23 • $ 87,000 • $176,000 • $262,750

28. Clicker Question #3 - Solution

29. Clicker Question #3: Answer Q: What is the contribution margin? Answer: • $37,250

30. UW … • UW is one of Canada’s leading research institution • The School of Accounting and Finance has one of the country’s premier PhD programs • Every year, I train PhD students in teaching. • So, the next 3 classes (Cost-Volume-Profit Relationships) will be taught by Kun Huo, one of our PhD students. • I will sit in the class as an observer.

31. Summary • Major topics for today… • Another example of High-Low Method • Contribution margin approach • Next class … • Chapter 7 (Cost-Volume-Profit Relationships)