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Similar to Cost Behavior Analysis (20)
Cost Behavior Analysis
- 2. Types of Cost behaviour
Patterns
Summary of Variable and Fixed Cost Behavior
Cost
In Total
Per Unit
Variable
Total variable cost is
proportional to the activity
level within the relevant range.
Variable cost per unit remains
the same over wide ranges
of activity.
Fixed
Total fixed cost remains the
same even when the activity
level changes within the
relevant range.
Fixed cost per unit goes
down as activity level goes up.
Ā©The McGraw-Hill Companies,
- 3. Total Variable Cost Example
Total Long Distance
Telephone Bill
Your total long distance telephone bill is
based on how many minutes you talk.
Minutes Talked
Ā©The McGraw-Hill Companies,
- 4. Variable Cost Per Unit
Example
Per Minute
Telephone Charge
The cost per minute talked is constant. For
example, 10 pence per minute.
Minutes Talked
Ā©The McGraw-Hill Companies,
- 5. Total Fixed Cost Example
Monthly Basic
Telephone Bill
Your monthly basic telephone bill is
probably fixed and does not change when
you make more local calls.
Number of Local Calls
Ā©The McGraw-Hill Companies,
- 6. Fixed Cost Per Unit Example
Monthly Basic Telephone
Bill per Local Call
The fixed cost per local call decreases as
more local calls are made.
Number of Local Calls
Ā©The McGraw-Hill Companies,
- 7. Cost behaviour
Examples of normally variable costs
Merchandisers
Service Organizations
Cost of Goods Sold
Supplies and travel
Manufacturers
Merchandisers and
Manufacturers
Direct Material, Direct
labour, and Variable
Manufacturing Overhead
Sales commissions and
shipping costs
Examples of normally fixed costs
Merchandisers, manufacturers, and
service organizations
Real estate taxes, Insurance, Sales salaries
Depreciation, Advertising
Ā©The McGraw-Hill Companies,
- 10. Step Costs
Cost
Total cost increases to a
new higher cost for the
next higher range of
activity.
Activity
Ā©The McGraw-Hill Companies,
- 11. The Linearity Assumption and
the Relevant Range
Total Cost
Economistās
Curvilinear Cost
Function
Activity
Ā©The McGraw-Hill Companies,
- 12. The Linearity Assumption and
the Relevant Range
Total Cost
Economistās
Curvilinear Cost
Function
Accountantās Straight-Line
Approximation (constant
unit variable cost)
Activity
Ā©The McGraw-Hill Companies,
- 13. Total Cost
The Linearity Assumption and
the Relevant Range
Relevant
Range
A straight line
A straight line
closely
closely
Economistās
approximates
Curvilinear Cost approximates
a curvilinear
a curvilinear
Function
variable cost
variable cost
line within the
line within the
relevant
relevant
range.
range.
Accountantās Straight-Line
Approximation (constant
unit variable cost)
Activity
Ā©The McGraw-Hill Companies,
- 14. Types of Fixed Costs
Fixed Costs
Committed
Discretionary
Long-term, cannot be
reduced in the short
term.
May be altered in the
short-term by current
managerial decisions
Examples
Examples
Depreciation on
Buildings and
Equipment
Advertising and
Research and
Development
Ā©The McGraw-Hill Companies,
- 15. Trend Toward Fixed Costs
Increased automation.
Increase in salaried knowledge workers
who are difficult to train and replace.
Implications
Implications
Managers are more ālocked-inā with fewer decision
Managers are more ālocked-inā with fewer decision
alternatives.
alternatives.
Planning becomes more crucial because fixed costs are
Planning becomes more crucial because fixed costs are
difficult to change with current operating decisions.
difficult to change with current operating decisions.
Ā©The McGraw-Hill Companies,
- 16. Fixed Costs and Relevant
Range
Example: Office space
is available at a rental
rate of Ā£30,000 per
year in increments of
1,000 square metres.
As the business grows
more space is rented,
increasing the total
cost.
Continue
Ā©The McGraw-Hill Companies,
- 17. Rent Cost in
Thousands of pounds
Fixed Costs and Relevant
Range
90
60
30
00
Relevant
Range
Total cost doesnāt
change for a wide
range of activity,
and then jumps to a
new higher cost for
the next higher
range of activity.
1,000
2,000
3,000
Rented Area (Square metres)
Ā©The McGraw-Hill Companies,
- 18. Semi-variable Costs
(also called mixed cost)
A semi-variable
cost
has both fixed
and variable
components.
Consider the
following electric
utility example.
Ā©The McGraw-Hill Companies,
- 19. Mixed Costs
Total Utility Cost
Y
tal
To
ixe
m
os
dc
t
Variable
Utility Charge
Fixed Monthly
Activity (Kilowatt Hours)
X
Utility Charge
Ā©The McGraw-Hill Companies,
- 20. Mixed Costs
The total mixed cost line can be expressed
as an equation: Y = a + bX
Total Utility Cost
Y
Where:
tal
To
ixe
m
os
dc
t
Y = the total mixed cost
bX
+
=aa
Y
= the total fixed cost (the
vertical intercept of the line)
b = the variable Variable
cost per unit of
activity (the slope of the line)
Utility Charge
X = the level of activity
Fixed Monthly
Activity (Kilowatt Hours)
X
Utility Charge
Ā©The McGraw-Hill Companies,
- 21. Mixed Costs
Total Utility Cost
Y
tal
To
ixe
m
os
dc
t
=a
Y
bX
+
Variable
bX
Utility Charge
Fixed Monthly
a
Activity (Kilowatt Hours)
X
Utility Charge
Ā©The McGraw-Hill Companies,
- 22. The Analysis of Mixed Costs
Account Analysis
Engineering Approach
High-Low Method
Scattergraph Method
Least-Square Regression Method
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- 23. Account Analysis
Each account is classified as either
variable or fixed based on the analystās
knowledge of how the account behaves.
Ā©The McGraw-Hill Companies,
- 25. The High-Low Method
WiseCo recorded the following production activity
and maintenance costs for two months:
High activity level
Low activity level
Change
Units
9,000
5,000
4,000
Cost
Ā£ 9,700
6,100
Ā£ 3,600
Using these two levels of activity, compute:
ļµ the variable cost per unit;
ļ¶ the fixed cost; and then
ļ· express the costs in equation form Y = a + bX.
Ā©The McGraw-Hill Companies,
- 26. The High-Low Method
High activity level
Low activity level
Change
ļµ Unit variable cost =
Units
9,000
5,000
4,000
Cost
Ā£ 9,700
6,100
Ā£ 3,600
Change in cost
Change in units
Ā©The McGraw-Hill Companies,
- 27. The High-Low Method
High activity level
Low activity level
Change
Units
9,000
5,000
4,000
Cost
Ā£ 9,700
6,100
Ā£ 3,600
ļµ Unit variable cost = Ā£3,600 Ć· 4,000 units = Ā£0.90 per unit
Ā©The McGraw-Hill Companies,
- 28. The High-Low Method
High activity level
Low activity level
Change
Units
9,000
5,000
4,000
Cost
Ā£ 9,700
6,100
Ā£ 3,600
ļµ Unit variable cost = Ā£3,600 Ć· 4,000 units = Ā£0.90 per unit
ļ¶ Fixed cost = Total cost ā Total variable cost
Fixed cost = Ā£9,700 ā (Ā£0.90 per unit Ć 9,000 units)
Fixed cost = Ā£9,700 ā Ā£8,100 = Ā£1,600
Ā©The McGraw-Hill Companies,
- 29. The High-Low Method
High activity level
Low activity level
Change
Units
9,000
5,000
4,000
Cost
Ā£ 9,700
6,100
Ā£ 3,600
ļµ Unit variable cost = Ā£3,600 Ć· 4,000 units = Ā£0.90 per unit
ļ¶ Fixed cost = Total cost ā Total variable cost
Fixed cost = Ā£9,700 ā (Ā£0.90 per unit Ć 9,000 units)
Fixed cost = Ā£9,700 ā Ā£8,100 = Ā£1,600
ļ· Total cost = Fixed cost + Variable cost (Y = a + bX)
Y = Ā£1,600 + Ā£0.90X
Ā©The McGraw-Hill Companies,
- 30. The High-Low Method
If sales salaries and commissions are Ā£10,000
If sales salaries and commissions are Ā£10,000
when 80,000 units are sold and Ā£14,000 when
when 80,000 units are sold and Ā£14,000 when
120,000 units are sold, what is the variable
120,000 units are sold, what is the variable
portion of sales salaries and commission?
portion of sales salaries and commission?
a. Ā£0.08 per unit
a. Ā£0.08 per unit
b. Ā£0.10 per unit
b. Ā£0.10 per unit
c. Ā£0.12 per unit
c. Ā£0.12 per unit
d. Ā£0.125 per unit
d. Ā£0.125 per unit
Ā©The McGraw-Hill Companies,
- 31. The High-Low Method
If sales salaries and commissions are Ā£10,000
If sales salaries and commissions are Ā£10,000
when 80,000 units are sold and Ā£14,000 when
when 80,000 units are sold and Ā£14,000 when
120,000 units are sold, what is the variable
120,000 units are sold, what is the variable
portion of sales salaries and commission?
portion of sales salaries and commission?
a. Ā£0.08 per unit
a. Ā£0.08 per unit
Units
Cost
b. Ā£0.10 per unit
High level
120,000
Ā£ 14,000
b. Ā£0.10 per unit
Low level
80,000
10,000
c. Ā£0.12 per unit
c. Ā£0.12 per unit
Change
40,000
Ā£ 4,000
d. Ā£0.125 per unit
d. Ā£0.125 per unit
Ā£4,000 Ć· 40,000 units
= Ā£0.10 per unit
Ā©The McGraw-Hill Companies,
- 32. The High-Low Method
If sales salaries and commissions are Ā£10,000
If sales salaries and commissions are Ā£10,000
when 80,000 units are sold and Ā£14,000 when
when 80,000 units are sold and Ā£14,000 when
120,000 units are sold, what is the fixed portion
120,000 units are sold, what is the fixed portion
of sales salaries and commissions?
of sales salaries and commissions?
a. Ā£ 2,000
a. Ā£ 2,000
b. Ā£ 4,000
b. Ā£ 4,000
c. Ā£10,000
c. Ā£10,000
d. Ā£12,000
d. Ā£12,000
Ā©The McGraw-Hill Companies,
- 33. The High-Low Method
If sales salaries and commissions are Ā£10,000
If sales salaries and commissions are Ā£10,000
when 80,000 units are sold and Ā£14,000 when
when 80,000 units are sold and Ā£14,000 when
120,000 units are sold, what is the fixed portion
120,000 units are sold, what is the fixed portion
of sales salaries and commissions? fixed cost +
Total cost = Total
of sales salaries and commissions?
Total variable cost
a. Ā£ 2,000
a. Ā£ 2,000
Ā£
14,000 = Total fixed cost +
b. Ā£ 4,000
b. Ā£ 4,000
(Ā£0.10 Ć 120,000 units)
c. Ā£10,000
c. Ā£10,000
Total fixed cost = Ā£14,000 - Ā£12,000
d. Ā£12,000
d. Ā£12,000
Total fixed cost = Ā£ 2,000
Ā©The McGraw-Hill Companies,
- 34. The Scattergraph Method
Plot the data points on a
graph (total cost vs. activity).
Total Cost in
1,000ās of pounds
Y
20
10
0
* *
* *
* ** *
**
X
0
1
2
3
4
Activity, 1,000ās of Units Produced
Ā©The McGraw-Hill Companies,
- 35. The Scattergraph Method
Draw a line through the data points with about an
equal numbers of points above and below the line.
Total Cost in
1,000ās of pounds
Y
20
10
0
* *
* *
* ** *
**
X
0
1
2
3
4
Activity, 1,000ās of Units Produced
Ā©The McGraw-Hill Companies,
- 36. The Scattergraph Method
Total Cost in
1,000ās of pounds
Y
The slope of this line is the variable unit
cost. (Slope is the change in total cost
for a one unit change in activity).
20
10
* *
* *
* ** *
**
Estimated fixed cost = Ā£10,000
0
X
0
1
2
3
4
Activity, 1,000ās of Units Produced
Ā©The McGraw-Hill Companies,
- 37. The Scattergraph Method
Slope =
Total Cost in
1,000ās of pounds
Y
20
10
* *
* *
Change in cost
Change in units
* ** *
**
Vertical
distance
is the
change
in cost.
Horizontal distance is
the change in activity.
0
X
0
1
2
3
4
Activity, 1,000ās of Units Produced
Ā©The McGraw-Hill Companies,
- 38. Least-Squares Regression
Method
ā¢ Accountants and managers
may use computer software
to fit a regression line
through the data points.
ā¢ The cost analysis objective
is the same: Y = a + bx
Least-squares regression also provides a statistic, called
Least-squares regression also provides a statistic, called
the adjusted R22,that is a measure of the goodness
the adjusted R , that is a measure of the goodness
of fit of the regression line to the data points.
of fit of the regression line to the data points.
Ā©The McGraw-Hill Companies,
- 39. Least-Squares Regression
Method
R2 is the percentage of the variation
in total cost explained by the activity.
Total Cost
Y
20
* *
* *
10
0
0
* ** *
**
R2 for this relationship is near
100% since the data points are
very close to the regression line.
X
1
2
3
4
Ā©The McGraw-Hill Companies,
Activity
- 40. The Contribution Format
Letās put our
knowledge of cost
behaviour to work
by preparing a
contribution format
profit statement.
Ā©The McGraw-Hill Companies,
- 41. The Contribution Format
Sales Revenue
Less: Variable costs
Contribution margin
Less: Fixed costs
Net profit
Total
Ā£ 100,000
60,000
Ā£ 40,000
30,000
Ā£ 10,000
Unit
Ā£ 50
30
Ā£ 20
The contribution margin format emphasizes cost
behaviour. Contribution margin covers fixed costs
and provides for profit.
Ā©The McGraw-Hill Companies,
- 42. The Contribution Format
Comparison of the Contribution Profit Statement
with the Traditional Profit Statement
Traditional Approach
(costs organized by function)
Contribution Approach
(costs organized by behavior)
Sales
Ā£ 100,000
Less cost of goods sold
70,000
Gross margin
Ā£ 30,000
Less operating expenses
20,000
Net profit
Ā£ 10,000
Sales
Ā£ 100,000
Less variable expenses
60,000
Contribution margin
Ā£ 40,000
Less fixed expenses
30,000
Net profit
Ā£ 10,000
Used primarily for
external reporting.
Used primarily by
management.
Ā©The McGraw-Hill Companies,