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11 th  Edition Chapter 5
Chapter Five Cost Behavior: Analysis and Use
Types of Cost Behavior Patterns Recall the summary of our cost behavior discussion from an earlier chapter.
The Activity Base A measure of what causes the incurrence of a variable cost Units produced Miles driven Labor hours Machi...
True Variable Cost Example <ul><li>A variable cost is a cost whose total dollar amount varies in direct proportion to chan...
Types of Cost Behavior Patterns Recall the summary of our cost behavior discussion from an earlier chapter.
Variable Cost Per Unit Example <ul><li>A variable cost remains constant if expressed on a per unit basis. The cost per min...
Extent of Variable Costs The proportion of variable costs  differs  across organizations. For example . . .  A public util...
Examples of Variable Costs <ul><li>Merchandising companies  – cost of goods sold. </li></ul><ul><li>Manufacturing companie...
True Variable Cost <ul><li>Direct materials is a true or proportionately variable cost because the amount used during a pe...
Step-Variable Costs A resource that is obtainable only in large chunks (such as maintenance workers) and whose costs incre...
Step-Variable Costs Small changes in the level of production are not likely to have any effect on the number of maintenanc...
Step-Variable Costs Only fairly wide changes in the activity level will cause a change in the number of maintenance worker...
The Linearity Assumption and the Relevant Range Activity Total Cost Economist’s Curvilinear Cost Function Relevant Range A...
Types of Cost Behavior Patterns Let’s look at fixed cost behavior on the next screens.
Total Fixed Cost Example <ul><li>A fixed cost is a cost whose total dollar amount remains constant as the activity level c...
Types of Cost Behavior Patterns Recall the summary of our cost behavior discussion from an earlier chapter.
Fixed Cost Per Unit Example <ul><li>Average fixed costs per unit decrease as the activity level increases. The fixed cost ...
Types of Fixed Costs Examples Advertising and Research and Development Examples Depreciation on Equipment and Real Estate ...
The Trend Toward Fixed Costs The trend in many industries is toward  greater fixed costs  relative to variable costs. As m...
Is Labor a Variable or a Fixed Cost? The behavior of wage and salary costs can  differ across countries , depending on lab...
Fixed Costs and Relevant Range Rent Cost in Thousands of Dollars  0  1,000  2,000  3,000    Rented Area (Square Feet) 0 30...
Fixed Costs and Relevant Range <ul><li>Example:  Office space is available at a rental rate of $30,000 per year in increme...
Fixed Costs and Relevant Range How does this type of fixed cost differ from a step-variable cost? <ul><ul><li>Step-variabl...
Quick Check   <ul><li>Which of the following statements about cost behavior are true? </li></ul><ul><ul><li>Fixed costs p...
Quick Check   <ul><li>Which of the following statements about cost behavior are true? </li></ul><ul><ul><li>Fixed costs p...
Mixed Costs  Fixed Monthly Utility Charge Variable  Cost per KW Activity (Kilowatt Hours)  Total Utility Cost A mixed cost...
Mixed Costs  Fixed Monthly Utility Charge Variable  Cost per KW Activity (Kilowatt Hours)  Total Utility Cost Total mixed ...
Mixed Costs Example If your fixed monthly utility charge is $40, your variable cost is $0.03 per kilowatt hour, and your m...
Analysis of Mixed Costs Each account is classified as either variable or fixed based on the analyst’s  knowledge of how th...
The Scattergraph Method Plot the data points on a graph (total cost vs. activity). 0  1  2  3  4 * Maintenance Cost 1,000’...
The Scattergraph Method Draw a line through the data points with about an equal numbers of points above and below the line...
The Scattergraph Method Use one data point to estimate the total level of activity and the total cost.  Intercept = Fixed ...
The Scattergraph Method Make a quick estimate of variable cost per unit and determine the cost equation.  Y = $10,000 + $1...
The High-Low Method <ul><li>Assume the following hours of maintenance work and the total maintenance costs for six months....
The High-Low Method The  variable cost per hour  of maintenance is equal to the change in cost divided by the change in ho...
The High-Low Method Total Fixed Cost = Total Cost – Total Variable Cost Total Fixed Cost = $9,800 – ($8/hour  × 800 hours)...
The High-Low Method Y  =  $3,400 + $8.00 X The Cost Equation for Maintenance
Quick Check   <ul><li>Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 uni...
Quick Check   <ul><li>Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 uni...
Quick Check   <ul><li>Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 uni...
Quick Check   <ul><li>Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 uni...
Least-Squares Regression Method A method used to analyze mixed costs if a scattergraph plot reveals an approximately linea...
Least-Squares Regression Method <ul><li>Software can be used to fit a regression line through the data points. </li></ul><...
Least-Squares Regression Method 0  1  2  3  4 Total Cost 10 20 0 Activity * * * * * * * * * * R 2   is the percentage of t...
Comparing Results From the Three Methods The three methods just discussed provide slightly different estimates of the fixe...
Let’s put our knowledge of cost behavior to work by preparing a contribution format income statement.
The Contribution Format The contribution margin format emphasizes cost behavior.  Contribution margin covers fixed costs a...
Uses of the Contribution Format <ul><li>The contribution income statement format is used as an internal planning and decis...
The Contribution Format Used primarily for external reporting. Used primarily by management.
Appendix 5A Least-Squares Regression Using Microsoft Excel.
Simple Regression Analysis Example Matrix, Inc. wants to know its average fixed cost and variable cost per unit.  Using th...
Simple Regression Using Excel <ul><li>You will need three pieces of information from your regression analysis: </li></ul><...
Simple Regression Using Excel Place your cursor in cell F4 and press the = key. Click on the pull down menu and scroll dow...
Simple Regression Using Excel Scroll down to the “ Statistical ”, functions. Now scroll down the statistical functions unt...
Simple Regression Using Excel 1. In the Known_y’s box enter C4:C19 for the range. 2. In the Known_x’s box enter D4:D19 for...
Simple Regression Using Excel 1. In the Known_y’s box enter C4:C19 for the range. 2. In the Known_x’s box enter D4:D19 for...
Simple Regression Using Excel With you cursor in cell F5, press the = key and go to the pull down menu for special functio...
Simple Regression Using Excel 1. In the Known_y’s box enter C4:C19 for the range. 2. In the Known_x’s box enter D4:D19 for...
Simple Regression Using Excel Finally, we will determine the “ goodness of fit ”, or  R 2 , by using the  RSQ  function.
Simple Regression Using Excel 1. In the Known_y’s box enter C4:C19 for the range. 2. In the Known_x’s box enter D4:D19 for...
End of Chapter 5
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Managerial Accounting by G. Norren Chap005

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Managerial Accounting by G. Norren Chap005

  1. 1. 11 th Edition Chapter 5
  2. 2. Chapter Five Cost Behavior: Analysis and Use
  3. 3. Types of Cost Behavior Patterns Recall the summary of our cost behavior discussion from an earlier chapter.
  4. 4. The Activity Base A measure of what causes the incurrence of a variable cost Units produced Miles driven Labor hours Machine hours
  5. 5. True Variable Cost Example <ul><li>A variable cost is a cost whose total dollar amount varies in direct proportion to changes in the activity level. Your total long distance telephone bill is based on how many minutes you talk. </li></ul>Minutes Talked Total Long Distance Telephone Bill
  6. 6. Types of Cost Behavior Patterns Recall the summary of our cost behavior discussion from an earlier chapter.
  7. 7. Variable Cost Per Unit Example <ul><li>A variable cost remains constant if expressed on a per unit basis. The cost per minute talked is constant. For example, 10 cents per minute. </li></ul>Minutes Talked Per Minute Telephone Charge
  8. 8. Extent of Variable Costs The proportion of variable costs differs across organizations. For example . . . A public utility with large investments in equipment will tend to have fewer variable costs. A manufacturing company will often have many variable costs. A merchandising company usually will have a high proportion of variable costs like cost of sales. A service company will normally have a high proportion of variable costs.
  9. 9. Examples of Variable Costs <ul><li>Merchandising companies – cost of goods sold. </li></ul><ul><li>Manufacturing companies – direct materials, direct labor, and variable overhead. </li></ul><ul><li>Merchandising and manufacturing companies – commissions, shipping costs, and clerical costs such as invoicing. </li></ul><ul><li>Service companies – supplies, travel, and clerical. </li></ul>
  10. 10. True Variable Cost <ul><li>Direct materials is a true or proportionately variable cost because the amount used during a period will vary in direct proportion to the level of production activity. </li></ul>Volume Cost
  11. 11. Step-Variable Costs A resource that is obtainable only in large chunks (such as maintenance workers) and whose costs increase or decrease only in response to fairly wide changes in activity is known as a step-variable cost . Volume Cost
  12. 12. Step-Variable Costs Small changes in the level of production are not likely to have any effect on the number of maintenance workers employed. Volume Cost
  13. 13. Step-Variable Costs Only fairly wide changes in the activity level will cause a change in the number of maintenance workers employed Volume Cost
  14. 14. The Linearity Assumption and the Relevant Range Activity Total Cost Economist’s Curvilinear Cost Function Relevant Range A straight line closely approximates a curvilinear variable cost line within the relevant range. Accountant’s Straight-Line Approximation (constant unit variable cost)
  15. 15. Types of Cost Behavior Patterns Let’s look at fixed cost behavior on the next screens.
  16. 16. Total Fixed Cost Example <ul><li>A fixed cost is a cost whose total dollar amount remains constant as the activity level changes. Your monthly basic telephone bill is probably fixed and does not change when you make more local calls. </li></ul>Number of Local Calls Monthly Basic Telephone Bill
  17. 17. Types of Cost Behavior Patterns Recall the summary of our cost behavior discussion from an earlier chapter.
  18. 18. Fixed Cost Per Unit Example <ul><li>Average fixed costs per unit decrease as the activity level increases. The fixed cost per local call decreases as more local calls are made. </li></ul>Number of Local Calls Monthly Basic Telephone Bill per Local Call
  19. 19. Types of Fixed Costs Examples Advertising and Research and Development Examples Depreciation on Equipment and Real Estate Taxes Discretionary May be altered in the short-term by current managerial decisions Committed Long-term, cannot be significantly reduced in the short term.
  20. 20. The Trend Toward Fixed Costs The trend in many industries is toward greater fixed costs relative to variable costs. As machines take over many mundane tasks previously performed by humans, “ knowledge workers ” are demanded for their minds rather than their muscles Knowledge workers tend to be salaried, highly-trained and difficult to replace. The cost to compensate these valued employees is relatively fixed rather than variable.
  21. 21. Is Labor a Variable or a Fixed Cost? The behavior of wage and salary costs can differ across countries , depending on labor regulations, labor contracts, and custom. In France , Germany , China , and Japan management has little flexibility in adjusting the size of the labor force. Labor costs are more fixed in nature. In the United States and the United Kingdom management has greater latitude. Labor costs are more variable in nature.
  22. 22. Fixed Costs and Relevant Range Rent Cost in Thousands of Dollars 0 1,000 2,000 3,000 Rented Area (Square Feet) 0 30 60 90 Relevant Range Total cost doesn’t change for a wide range of activity, and then jumps to a new higher cost for the next higher range of activity.
  23. 23. Fixed Costs and Relevant Range <ul><li>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. </li></ul>The relevant range of activity for a fixed cost is the range of activity over which the graph of the cost is flat.
  24. 24. Fixed Costs and Relevant Range How does this type of fixed cost differ from a step-variable cost? <ul><ul><li>Step-variable costs can be adjusted more quickly and . . . </li></ul></ul><ul><ul><li>The width of the activity steps is much wider for the fixed cost. </li></ul></ul>
  25. 25. Quick Check  <ul><li>Which of the following statements about cost behavior are true? </li></ul><ul><ul><li>Fixed costs per unit vary with the level of activity. </li></ul></ul><ul><ul><li>Variable costs per unit are constant within the relevant range. </li></ul></ul><ul><ul><li>Total fixed costs are constant within the relevant range. </li></ul></ul><ul><ul><li>Total variable costs are constant within the relevant range. </li></ul></ul>
  26. 26. Quick Check  <ul><li>Which of the following statements about cost behavior are true? </li></ul><ul><ul><li>Fixed costs per unit vary with the level of activity. </li></ul></ul><ul><ul><li>Variable costs per unit are constant within the relevant range. </li></ul></ul><ul><ul><li>Total fixed costs are constant within the relevant range. </li></ul></ul><ul><ul><li>Total variable costs are constant within the relevant range. </li></ul></ul>
  27. 27. Mixed Costs Fixed Monthly Utility Charge Variable Cost per KW Activity (Kilowatt Hours) Total Utility Cost A mixed cost has both fixed and variable components. Consider the example of utility cost. Total mixed cost X Y
  28. 28. Mixed Costs Fixed Monthly Utility Charge Variable Cost per KW Activity (Kilowatt Hours) Total Utility Cost Total mixed cost X Y
  29. 29. Mixed Costs 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? Y = a + bX Y = $40 + ($0.03 × 2,000) Y = $100
  30. 30. Analysis of Mixed Costs Each account is classified as either variable or fixed based on the analyst’s knowledge of how the account behaves. Cost estimates are based on an evaluation of production methods, and material, labor and overhead requirements. Account Analysis and the Engineering Approach
  31. 31. The Scattergraph Method Plot the data points on a graph (total cost vs. activity). 0 1 2 3 4 * Maintenance Cost 1,000’s of Dollars 10 20 0 * * * * * * * * * Patient-days in 1,000’s X Y
  32. 32. The Scattergraph Method Draw a line through the data points with about an equal numbers of points above and below the line. 0 1 2 3 4 * Maintenance Cost 1,000’s of Dollars 10 20 0 * * * * * * * * * Patient-days in 1,000’s X Y
  33. 33. The Scattergraph Method Use one data point to estimate the total level of activity and the total cost. Intercept = Fixed cost: $10,000 0 1 2 3 4 * Maintenance Cost 1,000’s of Dollars 10 20 0 * * * * * * * * * Patient-days in 1,000’s X Y Patient days = 800 Total maintenance cost = $11,000
  34. 34. The Scattergraph Method Make a quick estimate of variable cost per unit and determine the cost equation. Y = $10,000 + $1.25X Variable cost per unit = $1,000 800 = $1.25/patient-day Total maintenance cost Number of patient days
  35. 35. The High-Low Method <ul><li>Assume the following hours of maintenance work and the total maintenance costs for six months. </li></ul>
  36. 36. The High-Low Method The variable cost per hour of maintenance is equal to the change in cost divided by the change in hours. = $8.00/hour $2,400 300
  37. 37. The High-Low Method Total Fixed Cost = Total Cost – Total Variable Cost Total Fixed Cost = $9,800 – ($8/hour × 800 hours) Total Fixed Cost = $9,800 – $6,400 Total Fixed Cost = $3,400
  38. 38. The High-Low Method Y = $3,400 + $8.00 X The Cost Equation for Maintenance
  39. 39. Quick Check  <ul><li>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 variable portion of sales salaries and commission? </li></ul><ul><li>a. $0.08 per unit </li></ul><ul><li>b. $0.10 per unit </li></ul><ul><li>c. $0.12 per unit </li></ul><ul><li>d. $0.125 per unit </li></ul>
  40. 40. Quick Check  <ul><li>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 variable portion of sales salaries and commission? </li></ul><ul><li>a. $0.08 per unit </li></ul><ul><li>b. $0.10 per unit </li></ul><ul><li>c. $0.12 per unit </li></ul><ul><li>d. $0.125 per unit </li></ul>$4,000 ÷ 40,000 units = $0.10 per unit
  41. 41. Quick Check  <ul><li>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? </li></ul><ul><li>a. $ 2,000 </li></ul><ul><li>b. $ 4,000 </li></ul><ul><li>c. $10,000 </li></ul><ul><li>d. $12,000 </li></ul>
  42. 42. Quick Check  <ul><li>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? </li></ul><ul><li>a. $ 2,000 </li></ul><ul><li>b. $ 4,000 </li></ul><ul><li>c. $10,000 </li></ul><ul><li>d. $12,000 </li></ul>
  43. 43. Least-Squares Regression Method A method used to analyze mixed costs if a scattergraph plot reveals an approximately linear relationship between the X and Y variables. This method uses all of the data points to estimate the fixed and variable cost components of a mixed cost. The goal of this method is to fit a straight line to the data that minimizes the sum of the squared errors .
  44. 44. Least-Squares Regression Method <ul><li>Software can be used to fit a regression line through the data points. </li></ul><ul><li>The cost analysis objective is the same: Y = a + bX </li></ul>Least-squares regression also provides a statistic, called the R 2 , that is a measure of the goodness of fit of the regression line to the data points.
  45. 45. Least-Squares Regression Method 0 1 2 3 4 Total Cost 10 20 0 Activity * * * * * * * * * * R 2 is the percentage of the variation in total cost explained by the activity. R 2 varies from 0% to 100%, and the higher the percentage the better. X Y
  46. 46. Comparing Results From the Three Methods The three methods just discussed provide slightly different estimates of the fixed and variable cost components of the mixed cost. This is to be expected because each method uses differing amounts of the data points to provide estimates. Least-squares regression provides the most accurate estimate because it uses all the data points.
  47. 47. Let’s put our knowledge of cost behavior to work by preparing a contribution format income statement.
  48. 48. The Contribution Format The contribution margin format emphasizes cost behavior. Contribution margin covers fixed costs and provides for income.
  49. 49. Uses of the Contribution Format <ul><li>The contribution income statement format is used as an internal planning and decision making tool. We will use this approach for: </li></ul><ul><li>Cost-volume-profit analysis (Chapter 6). </li></ul><ul><li>Budgeting (Chapter 9). </li></ul><ul><li>Segmented reporting of profit data (Chapter 12). </li></ul><ul><li>Special decisions such as pricing and make-or-buy analysis (Chapter 13). </li></ul>
  50. 50. The Contribution Format Used primarily for external reporting. Used primarily by management.
  51. 51. Appendix 5A Least-Squares Regression Using Microsoft Excel.
  52. 52. Simple Regression Analysis 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.
  53. 53. Simple Regression Using Excel <ul><li>You will need three pieces of information from your regression analysis: </li></ul><ul><li>Estimated Variable Cost per Unit (line slope) </li></ul><ul><li>Estimated Fixed Costs (line intercept) </li></ul><ul><li>Goodness of fit, or R 2 </li></ul>To get these three pieces information we will need to use three different Excel functions. LINEST, INTERCEPT, & RSQ
  54. 54. Simple Regression Using Excel Place your cursor in cell F4 and press the = key. Click on the pull down menu and scroll down to “More Functions . . .”
  55. 55. Simple Regression Using Excel Scroll down to the “ Statistical ”, functions. Now scroll down the statistical functions until you highlight “ LINEST ”
  56. 56. Simple Regression Using Excel 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.
  57. 57. Simple Regression Using Excel 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. Here is the estimate of the slope of the line.
  58. 58. Simple Regression Using Excel With you 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.
  59. 59. Simple Regression Using Excel 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. Here is the estimate of the fixed costs.
  60. 60. Simple Regression Using Excel Finally, we will determine the “ goodness of fit ”, or R 2 , by using the RSQ function.
  61. 61. Simple Regression Using Excel 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. Here is the estimate of R 2 .
  62. 62. End of Chapter 5

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