Costs separation copy.ppt

Copyright © 2008 Prentice Hall All rights reserved
6-1
Cost Behavior
Costs separation

6-2
Cost Behavior
There are three common cost behaviors:
1. Variable costs
2. Fixed costs
3. Mixed costs

6-3
Key Characteristics of Variable
Costs
• Total variable costs change in direct proportion to
changes in volume
• The variable cost per unit of activity (v) remains constant
and is the slope of the variable cost line
• Total variable cost graphs always begin at the origin (if
volume is zero, total variable costs are zero)
• Total variable costs can be expressed as:
 y = vx
Where:
Y = total variable cost
V = variable cost per unit of activity
X = volume of activity

6-4
Total Variable Costs
$0
$500
$1,000
$1,500
$2,000
$2,500
$0 $10,000 $20,000 $30,000 $40,000
Total Sales
Total
Sales
Commissions

6-5
Key Characteristics of Fixed Costs
• Total fixed costs stay constant over a wide range of
volume
• Total fixed cost graphs are always flat lines with no slope
• The flat (horizontal) line intersects the y-axis at the level
equal to the fixed cost
• Total fixed cost can be expressed as y = f where
 Y = total fixed cost
 F = fixed cost over a given period of time
• Fixed costs per unit of activity vary inversely with
changes in volume
 Fixed cost per unit of activity increases when volume decreases
 Fixed cost per unit of activity decreases when volume increases

6-6
Total Fixed Costs
$0
$500
$1,000
$1,500
$2,000
$2,500
$0 $10,000 $20,000 $30,000 $40,000
Total Sales
Total
Sales
Salaries

6-7
Key Characteristics of Mixed Costs
• Total mixed costs increase as volume increases because of the
variable cost component
• Total mixed cost graphs slope upwards but do not begin at the
origin; they intersect at the y-axis at the level of the fixed costs
• Total mixed costs can be expressed as a combination of the variable
and fixed cost equations:
 Total mixed costs = variable cost component + fixed cost
• Y = vx + f
• Where
– Y = total mixed cost
– V = variable cost per unit of activity
– X = volume of activity
– F = fixed cost over a given period of time

6-8
Mixed Costs
$0
$500
$1,000
$1,500
$2,000
$2,500
$3,000
$3,500
$4,000
$4,500
$0 $10,000 $20,000 $30,000 $40,000
Total Sales
Sales
Compensation
Variable
Fixed

6-9
E6-16 a. Graph of Variable Costs
$0
$20,000
$40,000
$60,000
$80,000
0 5,000 10,000
Units

6-10
E6-16 b. Graph of Mixed Costs
$0
$20,000
$40,000
$60,000
$80,000
0 5,000 10,000
Units

6-11
E6-16 c. Graph of Fixed Costs
$0
$20,000
$40,000
$60,000
$80,000
0 5,000 10,000
Units

6-12
Relevant Range
• Band of volume where total fixed costs
remain constant at a certain level
• Variable costs per unit remain constant at
a certain level
• If there is a change in cost behavior it
means that the relevant range needs to be
adjusted

6-13
Other Cost Behaviors
Step Costs – Fixed over small range of activity;
then jump to new fixed level
$0
$15,000
$30,000
$45,000
$60,000
Number of Units
Total
Costs

6-14
$0
$15,000
$30,000
$45,000
$60,000
Number of Units
Total
Costs
Other Cost Behaviors
Curvilinear Costs – Are not linear and do not fit
into any neat pattern

6-15
Garments
2,000 3,500 5,000
Total Variable Costs
Total Fixed Costs
Total Operating Costs
Variable Cost/garment
Fixed Cost/garment
Average cost/garment
E6-18. 1.
7,000 7,000 7,000
$1,500 $2,625 $3,750
$8,500 $9,625 $10,750
Garments
2,000 3,500 5,000
Total Variable Costs $1,500 $2,625 $3,750
Total Fixed Costs 7,000 7,000 7,000
Total Operating Costs $8,500 ? $10,750
Variable Cost/garment $0.75 $0.75 $0.75
Fixed Cost/garment 3.50 2.00 1.40
Average cost/garment $4.25 $2.75 ?
What happens to
fixed cost per unit
as the volume
increases if
variable costs per
unit remain
constant? Can
you fill in the
blanks?

6-16
E6-18. 3.
Actual costs at 2,000 garments $8,500
Total predicted costs
($2.15 × 2,000 garments) (4,300 )
Underestimated costs $4,200

6-17
E6-20
a. 1,000 x $26.43 $26,430
b. Total costs $26,430
Less total fixed costs (18,000)
Total variable costs $8,430
÷ 1,000
Variable cost per mailbox $8.43

6-18
E6-20
c. y = $8.43x + $18,000
d. $26.43 x 1,200 mailboxes (=$31,716)
e. y = ? If the cost
equation is used,
what will the cost
be? Remember,
we must add the
fixed component
to the variable
component.

6-19
E6-20
f. Using average at 1,000 $31,716
Using cost equation 28,116
$3,600

6-20
Account Analysis
• Account Analysis as it applies to cost
behavior determination is the use of
judgment to classify each general ledger
account as variable, fixed or mixed cost
• Three common methods used to perform
the analysis:
• Scatter Plots
• High-Low Method
• Regression Analysis

6-21
Scatter Plots
• Use historical data to determine a cost’s
behavior
• A scatter plot is the graph of historical cost
data on the y-axis and volume data on the
x-axis
• Helps managers visually determine how
strong the relationship is between the cost
and the volume of the chosen activity base

6-22
Scatter Plot Example
$0
$1,000
$2,000
$3,000
$4,000
$5,000
$6,000
$7,000
0 5000 10000 15000 20000

6-23
High-Low Method
• Method to separate mixed costs into
variable and fixed components
• Select the highest level and the lowest
level of activity over a period of time
• Uses the selected activity levels to create
a total cost equation that defines the cost
behavior

Dependent variable
Independent variable

6-25
High-Low Method: E6-23
Step 1: Find slope of the mixed cost line
(variable cost/unit) =
Δ in cost (y) / Δ in volume (x)
The slope represents the variable cost per
unit of activity
($5,830-$4,935) ÷ (17,300-14,500)
$895 ÷ 2,800 = $0.32

6-26
Step 2: Find the vertical intercept (fixed
costs) =
Total mixed cost – Total variable cost
$5,830 – ($0.32 • 17,300) = $295
or
$4,935 – ($0.32 • 14,500) = $295

6-27
Step 3: Create and use an equation to show
the behavior of a mixed cost
Y = $0.32 per mile + $1,250
Predicted operating costs at 15,000 miles:
($0.32 • 15,000) + $1,250 = $6,050

6-28
Regression Analysis
• Statistical procedure to find the line that
best fits data
• Uses all data points
• Results in equation of line and an R-
square value

6-29
Three Pieces of Information Needed
for Regression Analysis
1. The Intercept Coefficient – the vertical
intercept; it is the fixed cost component of
the mixed cost
2. The X Variable 1 coefficient is the line’s
slope, or the variable cost per unit.
3. The R-square value – the goodness-of-fit
statistic

6-30
R-Square Value
• “Goodness of fit”
• How well does the line fit the data points?
• Ranges from 0 to 1
 “0” – no relationship between costs and
volume; activity is not a cost driver
 “1” – perfect relationship; activity is a cost
driver

6-31
Data Concerns
• Seasonal variations
• Inflation
• Outliers – abnormal data points

6-32
Traditional Income Statement
Sales
- Cost of Goods Sold
Gross Margin
- Selling,general & administrative costs
Operating Income

6-33
Contribution Margin Income
Statement
Sales
- Variable Costs
Contribution Margin
- Fixed Costs
Operating Income

6-34
Contribution Margin Income
Statement
• Predicts how changes in volume will
affect operating income

6-35
Rachel’s Rock Shop
Income Statement
For the year ending 20XX
Revenue:
Sales Revenue (27,000 + 7,000) $34,000
Rental Revenue 22,000
Lesson Revenue 40,000
Total Revenue $96,000
Less: Cost of Goods Sold (7,500 + 2,000) (9,500)
Gross Margin $86,500
Less Operating Costs:
Depreciation $ 4,000
Employee Salary expenses 30,000
Musician wages 25,000
Lease 12,000
Total operating costs 71,000
Operating Income $15,500
P6-40b

6-36
E6-25
Rachel’s Rock Shop
Contribution Margin Income Statement
For the year ending 20XX
Revenue:
Sales Revenue (27,000 + 7,000) $34,000
Rental Revenue 22,000
Lesson Revenue 40,000
Total Revenue $96,000
Less: Variable Costs
Cost of Goods Sold (7,500 + 2,000) $ 9,500
Musician wages 25,000
Total Variable costs (34,500)
Contribution Margin $61,500
Less Fixed Costs:
Depreciation $ 4,000
Employee Salary expenses 30,000
Lease 12,000
Total fixed costs (46,000)
Operating Income $15,500

6-37
Variable Costing
• Assigns only variable manufacturing costs
to products
 Direct materials
 Direct labor
 Variable manufacturing overhead
• Fixed manufacturing overhead = period
cost
• Contribution margin income statements
 For internal management decisions

6-38
Absorption Costing
• Required by GAAP for external reporting
• Assign all manufacturing costs to product
 Direct materials
 Direct labor
 Variable manufacturing overhead
 Fixed manufacturing overhead
• Traditional income statement

6-39
Rays
Conventional (Absorption Costing) Income Statement
Year Ended December 31, 2008
Sales revenue (185,000  $35) $6,475,000
Less: Cost of Goods Sold:
Beginning finished goods inventory $ 0
Cost of goods manufactured 5,000,000
Cost of goods available for sale 5,000,000
Ending finished goods inventory (375,000)
Cost of goods sold 4,625,000
Gross profit 1,850,000
Operating expenses 1,175,000
Operating income $ ?
E6-32
How do we
derive
operating
income?

6-40
E6-32
Rays
Contribution Margin (Variable Costing) Income Statement
Year Ended December 31, 2008
Sales revenue $6,475,000
Variable expenses:
Variable cost of goods sold $2,775,000*
Sales commission expense 925,000 3,700,000
Contribution margin $2,775,000
Fixed expenses:
Manufacturing overhead $2,000,000
Operating expenses 250,000 2,250,000
Operating income $ ?
* computation of variable
cost of goods sold
What is
difference in
operating
income? How
does it compare
to the operating
income on the
previous slide?

6-42
E6-32
Incremental analysis:
Increase in contribution margin
(($35-20) x 15,000 goggles) $225,000
Increase in fixed costs (150,000)
Increase in operating income $75,000

Costs separation copy.ppt

Recommended

Recommended

More Related Content

What's hot

What's hot (20)

Similar to Costs separation copy.ppt

Similar to Costs separation copy.ppt (20)

Recently uploaded

Recently uploaded (20)

Costs separation copy.ppt