Presentation on theme: "Cost Behavior: Analysis and Use"— Presentation transcript:
1 Cost Behavior: Analysis and Use Chapter 5Cost Behavior: Analysis and Use
2 Types of Cost Behavior Patterns Recall the summary of our cost behavior discussion from Chapter 2.
3 The Activity Base Units produced Miles driven Labor hours Machine hoursA measure of the event that causes the incurrence of a variable cost – a cost driver
4 True Variable Cost Example Your total long distance telephone bill is based on how many minutes you talk.Total Long Distance Telephone BillMinutes Talked
5 Variable Cost Per Unit Example The cost per minute talked is constant. For example, 10 cents per minute.Per Minute Telephone ChargeMinutes Talked
6 Total cost remains constant within a narrow range of activity. Step-Variable CostsTotal cost remains constant within a narrow range of activity.CostActivity
7 Step-Variable CostsTotal cost increases to a new higher cost for the next higher range of activity.CostActivity
8 The Linearity Assumption and the Relevant Range Exh.5-4The Linearity Assumption and the Relevant RangeRelevant RangeA straight line closely approximates a curvilinear variable cost line within the relevant range.Economist’s Curvilinear Cost FunctionTotal CostAccountant’s Straight-Line Approximation (constant unit variable cost)Activity
9 Total Fixed Cost Example Exh.5-5Total Fixed Cost ExampleYour monthly basic telephone bill is probably fixed and does not change when you make more local calls.Monthly Basic Telephone BillNumber of Local Calls
10 Fixed Cost Per Unit Example Exh.5-5Fixed Cost Per Unit ExampleThe fixed cost per local call decreases as more local calls are made.Monthly Basic Telephone Bill per Local CallNumber of Local Calls
11 Cost Behavior Examples of normally variable costs MerchandisersCost of Goods SoldService OrganizationsSupplies and travelManufacturersDirect Material, Direct Labor, and Variable Manufacturing OverheadMerchandisers and ManufacturersSales commissions and shipping costsExamples of normally fixed costsMerchandisers, manufacturers, and service organizationsReal estate taxes, Insurance, Sales salaries Depreciation, Advertising
12 Types of Fixed Costs Committed Discretionary Examples Examples Long-term, cannot be reduced in the short term.DiscretionaryMay be altered in the short-term by current managerial decisionsExamplesDepreciation on Buildings and EquipmentExamplesAdvertising and Research and Development
13 Fixed Costs and Relevant Range 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.Continue
14 Fixed Costs and Relevant Range Exh.5-6Fixed Costs and Relevant Range90Total 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.Relevant Range60Rent Cost in Thousands of Dollars30, , , Rented Area (Square Feet)
15 Fixed Costs and Relevant Range Step-variable costs can be adjusted more quickly and . . .The width of the activity steps is much wider for the fixed cost.How does this type of fixed cost differ from a step-variable cost?
16 Which of the following statements about cost behavior are true? 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.
17 Fixed Monthly Utility Charge Mixed CostsA mixed cost has both fixed and variable components. Consider the example of utility cost.XYTotal mixed costTotal Utility CostVariable Cost per KWFixed Monthly Utility ChargeActivity (Kilowatt Hours)
18 Fixed Monthly Utility Charge Mixed CostsXYTotal mixed cost Y = a + bXTotal Utility CostVariable Cost per KWFixed Monthly Utility ChargeActivity (Kilowatt Hours)
19 The Analysis of Mixed Costs Account AnalysisEngineering ApproachScattergraph PlotHigh-Low MethodLeast-Square Regression Method
20 Account Analysis & Engineering Estimates 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.
21 The High-Low MethodWiseCo recorded the following production activity and maintenance costs for two months:Using these two levels of activity, compute:the variable cost per unit;the fixed cost; and thenexpress the costs in equation form Y = a + bX.
22 Changein cost Change in units The High-Low MethodVariable cost per unit = Change in cost ÷ change in unitsChangein cost Change in units
23 The High-Low Method Variable cost per unit = $2,400 ÷ 3,000 units
24 The High-Low MethodVariable cost = $2,400 ÷ 3,000 units = $0.80 per unitFixed cost = Total cost – Total variable costFixed cost = $9,800 – ($0.80 per unit × 8,000 units)Fixed cost = $9,800 – $6,400 = $3,400
25 The High-Low MethodVariable cost = $2,400 ÷ 3,000 units = $0.80 per unitFixed cost = Total cost – Total variable costFixed cost = $9,800 – ($0.80 per unit × 8,000 units)Fixed cost = $9,800 – $6,400 = $3,400Total cost = Fixed cost + Variable cost (Y = a + bX) Y = $3,400 + $0.80X
26 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 variable portion of sales salaries and commission?a. $0.08 per unitb. $0.10 per unitc. $0.12 per unitd. $0.125 per unit$4,000 ÷ 40,000 units = $0.10 per unit
27 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. $ 2,000b. $ 4,000c. $10,000d. $12,000
28 Let’s put our knowledge of cost behavior to work by preparing a contribution format income statement.
29 The Contribution Format The contribution margin format emphasizes cost behavior. Contribution margin covers fixed costs and provides for income.
30 The Contribution Format Used primarily for external reporting.Used primarily by management.