1. Measurement of Cost Behaviour3
Measurement of Cost Behaviour

2. Measurement of Cost Behavior
Cost Driver
an activity which influences a cost
Relevant Range
limit over which we can assume that the cost behavior is linear
Variable Costs
vary in proportion to changes in their cost driver
Fixed Costs
are not affected by changes in the cost driver $
Volume $
Volume $
Volume

3. Variations in Cost Behaviour
Step Costs
change abruptly at intervals of activity because the resources and their costs come in indivisible chunks
supervisory salaries
Mixed Costs
contain both variable and fixed cost elements
maintenance costs $
Volume $
Volume

4. Management’s Influence on Cost Functions
Capacity Costs
fixed costs related to being able to achieve a desired level of production or service
setting capacity is very important if long-run demand fluctuates
Committed Fixed Costs
arise from the possession of facilities, equipment, and a basic organization
large, indivisible chunks of cost that the organization is obligated to incur and usually would not consider avoiding
mortgage, lease payments, property taxes, insurance, salaries of key personnel
committed fixed costs can only be changed by changing the basic philosophy, scale or scope of the organization's operations

5. Management’s Influence on Costs Functions II
Discretionary Fixed Costs
each planning period, management will determine how much to spend
advertising, promotion, research and development, employee training
the amount of spending may vary, but only because management has decided to spend more or less
management can influence spending on these costs in the short run

6. Measuring Cost Behaviour
Cost Function
algebraic equation of the cost and its cost driver
linear cost function is as follows: Y = F + VX
where
F is the intercept of the vertical axis or the fixed cost
V is the slope or the variable cost per unit of activity
Total Maintenance Costs per month
= fixed cost per month + variable cost per unit
= $10,000 + $5.00 per unit
Criteria for Choosing A Cost Function
Use activity analysis to determine which cost driver best explains how the cost behaves
Economic plausibility (it must make sense that X causes Y)
Reliability (the estimates derived by the cost equation must conform with actually observed costs)

7. Methods of Measuring Cost Functions
Engineering Analysis
systematic review of costs based on past experience
Account Analysis
review of accounting records and the subjective determination of cost behavior patterns
High-Low Analysis
use of simple linear algebra to determine variable and fixed costs
may yield unreliable results
Visual Fit Analysis
fit a representative line to the data as shown in a scatter diagram
Regression Analysis
using mathematical formula, determine the cost equation which best fits the data
may be simple least squares regression with one X variable or multiple least squares regression with more than one X variable
enables user to measure the "quality" of the predictive equation

8. High-Low Approach to Cost Analysis
Equation: Y = F + VX
Step 1: Plot/examine data to find lowest and
highest point
Step 2: Calculate variable unit cost
= largest y value – smallest y value
largest x value – smallest x value
Step 3: Calculate fixed cost
(use above # and one point (x,y) in equation to solve for F)
Step 4: Write equation

9. Visual Fit Method Equation: Y = F + VX Step 1: Plot data
Step 2: Draw “line of best fit” (trend line)
Step 3: Read fixed cost from graph (y-intercept)
Step 4: Calculate unit variable cost
Use two points ON the trend line and calculate:
= largest y value – smallest y value
largest x value – smallest x value
Step 5: Write equation

10. Regression Analysis Check for Economic Plausibility
Does it make sense that X and Y are related?
Plot the data
to see if basic relationship is linear and identify "outliers"
Generate Regression Output
Constant $9,329
Std Error of Y Estimate $2,145 Observations 12
R-Squared Degrees of Freedom 10
X Coefficient(s) $6.95 Std Error of Coefficient 0.479
Interpret Regression Output
R-squared (R2) varies between 0 and 1
The closer to R2 is to 1 the more X explains the changes in Y
Standard error of Y estimate and standard error of X coefficient(s) can be used to set confidence intervals for the cost function estimates and the predicted value of the variable cost per unit

11. Example P3-17 (page 122)
On November 15, 2001, Sandra Cook, a newly hired cost analyst at Demgren Company, was asked to predict overhead costs for the company’s operations in 2002, when 500 units are expected to be produced. She collected the following quarterly results.
Use the high-low method, visual fit method and regression to predict overhead costs in 2002.
(Excel sheet will be available after class)

12. Example P3-15 (page 121)
Violet Blossom Technology develops and markets computer software for the agriculture industry. Since support costs comprise a large portion of the cost of software development, the director of cost operations of Violet Blossom, Shirley Temple, is especially concerned with understanding the effects of support cost behavior. Temple has completed a preliminary activity analysis of one of its primary software products: Ferti Mix. This is a “template” software that is customized for specific customers, who are charged for the basic product plus customizing cots.

13. Example P3-15 (page 121) Cont’d …
The activity analysis is based on the number of customized lines of Ferti Mix code. Currently, support cost estimates are based on a fixed rate of 50 percent of the basic cost. Data are shown below for two recent customers:
Customer
West Acres Plant
Beautiful Bloom
Basic Cost of Ferti Mix
$ ,000
$ ,000
Lines of Customized Code
490
180
Estimated cost per line of customized code $ $

14. Example P3-15 (page 121) Cont’d …
1. Compute the support cost of customizing Ferti Mix for each customer using each cost estimating approach.
2. If the activity analysis is reliable, what are the pros and cons of adopting it for all of Violet Blossom’s software products?

15. Suggested Problems Summary Problems 1,2 (page 107)
Questions (all even) (page 114)
Problems 2,4,6,8,10,12 (page 116)

16. Assignment Questions 13 (page 114 ) Problems 1,3,9,21 (page 115 )
Case 1, 3 (page 125)