1. 2-1 HANSEN & MOWEN Cost Management ACCOUNTING AND CONTROL

2. 2-2 Cost Behavior 3

3. 2-3 Fixed Costs Fixed costs are costs that in total are constant within the relevant range as the level of the activity driver varies. Basics of Cost Behavior 1 Two production lines can process 10,000 computers per year each. The workers on each line are supervised by a production-line manager who is paid $24,000 per year. For production up to 10,000 units, only one supervisor is needed. When production is between 10,001 and 20,000 computers being produced, two supervisors are required.

4. 2-4 Basics of Cost Behavior 1

5. 2-5 Basics of Cost Behavior 1

6. 2-6 Basics of Cost Behavior 1

7. 2-7 Basics of Cost Behavior 1 4,000 8,000 12,000 16,000 20,000 $48,000 24,000 Supervision Cost F = $48,000 Fixed Cost Behavior Number of Computers Processed

8. 2-8 Variable Costs Variable costs are costs that in total vary in direct proportion to changes in an activity driver. Basics of Cost Behavior 1 A 3½-inch disk drive is added to each computer at a cost of $30 per computer. The total cost of disk drives for each level of production varies.

9. 2-9 Basics of Cost Behavior 1

10. 2-10 Basics of Cost Behavior 1

11. 2-11 Basics of Cost Behavior 1 4,000 8,000 12,000 16,000 20,000 $600 120 Cost VY V = $30X Variable Cost Behavior (in thousands) 480 360 240 Number of Computers Processed

12. 2-12 Basics of Cost Behavior 1 Cost Nonlinearity of Variable Costs ($) Units of Activity Driver

13. 2-13 Basics of Cost Behavior 1 Cost Nonlinearity of Variable Costs ($) X* Units of Activity Driver Large Error Region Error Relevant Range 0

14. 2-14 Mixed costs are costs that has both a fixed and a variable component. Mixed Costs Basics of Cost Behavior 1

15. 2-15 Mixed Costs Basics of Cost Behavior 1 Y = Fixed cost + Total variable cost Y = F + VX where Y = Total cost For Days Computer, the selling cost is represented by the following equation: Y = $300,000 + $50X

16. 2-16 Selling Cost Per Unit Mixed Costs Days Computers, Inc. Fixed Cost of Selling Variable Cost of Selling Total CostComputers Sold $300,000$ 200,000$ 500,0004,000$125.00 300,000400,000700,0008,00087.50 300,000600,000900,00012,00075.00 300,000800,0001,100,00016,00068.75 300,0001,000,0001,300,00020,00065.00 Basics of Cost Behavior 1

17. 2-17 Mixed Cost Behavior Cost (in thousands) $1,500 Number of Computers Sold Variable Costs Fixed Cost 500 300 700 900 1,100 1,300 4,000 8,000 12,000 16,000 20,000 Basics of Cost Behavior 1

18. 2-18 Resources, Activities, and Cost Behavior 2 Resources Flexible resources are acquired as used and needed. They are usually considered variable costs. Example: Materials, energy Committed resources are acquired in advance of usage. They are usually considered fixed costs. Example: Buying or leasing a building or equipment

19. 2-19 Resources, Activities, and Cost Behavior 2 A step cost function displays a constant level of cost for a range of output and then jumps to a higher level of cost at some point.

20. 2-20 Resources, Activities, and Cost Behavior 2 Step-Cost Function

21. 2-21 Resources, Activities, and Cost Behavior 2 Step-Fixed Costs Cost $150,000 100,000 50,000 2,500 5,000 7,500 Activity Output (Number of Engineering Change Orders) Normal Operating Range (Relevant Range)

22. 2-22 The High-Low Method The Scatterplot Method The Method of Least Squares Variable Component Fixed Component Methods for Separating Mixed Costs into Fixed and Variable Components 3

23. 2-23 Y = F + VX Total activity cost Fixed cost component Variable cost per unit of activity Measure of activity output Methods for Separating Mixed Costs into Fixed and Variable Components 3

24. 2-24 Month Material Handling Costs No. of Moves January $2,000100 February 3,090125 March 2,780175 April 1,990200 May 7,500500 June5,300300 July4,300250 August6,300400 September5,600475 October6,240425 Step 1: Solve for variable cost (V) V = Change in cost / Change in activity Step 1: Solve for variable cost (V) V = Change in cost / Change in activity The High-Low Method Methods for Separating Mixed Costs into Fixed and Variable Components 3

25. 2-25 Low High Month Material Handling Costs No. of Moves January $2,000100 February 3,090125 March 2,780175 April 1,990200 May 7,500500 June5,300300 July4,300250 August6,300400 September5,600475 October6,240425 The High-Low Method Methods for Separating Mixed Costs into Fixed and Variable Components 3 V = $7,500 – $2,000 500 – 100

26. 2-26 V = $7,500 – $2,000 500 – 100 V = $13.75 Step 2: Using either the high cost or low cost, solve for the total fixed cost (F). The High-Low Method Methods for Separating Mixed Costs into Fixed and Variable Components 3

27. 2-27 Y = F + V(X) $7,500 = F + $13.75(500) $625 = F High End Y = F + V(X) $2,000 = F + $13.75(100) $625 = F Low End The cost formula using the high-low method is: Total cost = $625 + ($13.75 x # of moves) The High-Low Method Methods for Separating Mixed Costs into Fixed and Variable Components 3

28. 2-28 Material Handling Cost Number of Moves Graph A--Anderson Company $9,000 – 8,000 – 7,000 – 6,000 – 5,000 – 4,000 – 3,000 – 2,000 – 1,000 – 100 200 300 400 500 | | | | | 1 2 3 6 7 8 9 10 5 4 The Scattergraph for Anderson Company Methods for Separating Mixed Costs into Fixed and Variable Components 3

29. 2-29 Number of Moves Graph B--High-Low Line $9,000 – 8,000 – 7,000 – 6,000 – 5,000 – 4,000 – 3,000 – 2,000 – 1,000 – 100 200 300 400 500 | | | | | 1 2 3 6 7 8 9 10 5 4 Methods for Separating Mixed Costs into Fixed and Variable Components 3 Material Handling Cost The Scattergraph for Anderson Company

30. 2-30 Number of Moves Graph C—One Possible Scattergraph Line $9,000 – 8,000 – 7,000 – 6,000 – 5,000 – 4,000 – 3,000 – 2,000 – 1,000 – 100 200 300 400 500 | | | | | 1 2 3 6 7 8 9 10 5 4 3 Material Handling Cost Methods for Separating Mixed Costs into Fixed and Variable Components The Scattergraph for Anderson Company

31. 2-31 Activity Cost 0 Activity Output Graph A--Nonlinear Relationship Cost Behavior Patterns Methods for Separating Mixed Costs into Fixed and Variable Components 3

32. 2-32 Graph B--Upward Shift in Cost Relationship Activity Cost 0 Activity Output Methods for Separating Mixed Costs into Fixed and Variable Components 3 Cost Behavior Patterns

33. 2-33 Graph C--Presence of Outliers Activity Cost 0 Activity Output Outlier Methods for Separating Mixed Costs into Fixed and Variable Components 3 Cost Behavior Patterns

34. 2-34 2,7802,900-12014,400 1,9903,200-1,101,464,100 7,5006,800700490,000 5,3004,400900810,000 4,3003,800500250,000 6,3005,600700490,000 5,6006,500-900810,000 6,2405,900340 115,600 Total measure of closeness5,068,200 The Method of Least Squares Annual Cost Predicted Cost Deviation Deviation Squared $2,000$2,00000 3,0902,300790624,100 $3,090 - 2,300 790 x 790 Methods for Separating Mixed Costs into Fixed and Variable Components 3

35. 2-35 Material Handling Cost 0 Number of Moves Line Deviations $9,000 – 8,000 – 7,000 – 6,000 – 5,000 – 4,000 – 3,000 – 2,000 – 1,000 – 100 200 300 400 500 | | | | | 1 2 3 6 7 8 9 10 5 4 The Method of Least Squares Methods for Separating Mixed Costs into Fixed and Variable Components 3

36. 2-36 Spreadsheet Data for Anderson Company The Method of Least Squares Methods for Separating Mixed Costs into Fixed and Variable Components 3

37. 2-37 Regression Output for Anderson Company The Method of Least Squares Methods for Separating Mixed Costs into Fixed and Variable Components 3

38. 2-38 The results give rise to the following equation: Material handling cost = $854.50 + ($12.39 x number of items) The Method of Least Squares Methods for Separating Mixed Costs into Fixed and Variable Components 3

39. 2-39 Coefficient of Correlation Positive Correlation Machine Hours Utilities Costs r approaches +1 Machine Hours Utilities Costs Reliability of Cost Formulas 4

40. 2-40 Negative Correlation Hours of Safety Training Industrial Accidents r approaches –1 Hours of Safety Training Industrial Accidents Coefficient of Correlation Reliability of Cost Formulas 4

41. 2-41 No Correlation Hair Length Accounting Grade r ~ 0 Hair Length Accounting Grade Coefficient of Correlation Reliability of Cost Formulas 4

42. 2-42 Y = F + V 1 X 1 + V 2 X 2 X 1 = Number of moves X 2 = The total distance Multiple Regression 5

43. 2-43 Material Handling Number Pounds Month Cost of Moves Moved January$2,0001006,000 February3,09012515,000 March2,7801757,800 April1,990200600 May7,50050029,000 June5,30030023,000 July4,30025017,000 August6,30040025,000 September5,60047512,000 October6,24042522,400 Multiple Regression 5

44. 2-44 Y = $507 + $7.84X + $0.11X 12 = $507 + $7.84(350) + $0.11(17,000) = $507 + $2.744 + $1,870 = $5,121 Multiple Regression 5

45. 2-45 The Learning Curve and Nonlinear Cost Behavior 6

46. 2-46 1100100100 280 (0.8 x 100)16060 370.21210.6350.63 464 (0.8 x 80)25645.37 559.57297.8541.85 656.17337.0239.17 753.45374.1537.13 851.20 (0.8 x 64)409.6035.45 1640.96655.3628.06 3232.771,048.64 Cumulative Cumulative Cumulative Individual Units Number Average Time Total Time: Time for nth of Units per Unit in Hours Labor Hours Unit-Labor Hours (1) (2) (3) = (1) x (2) (4) Data for Cumulative Average Time Learning Curve with 80 Percent Learning Rate The Learning Curve and Nonlinear Cost Behavior 6

47. 2-47 1,200 – 1,000 – 800 – 600 – 400 – 200 – 0 – 1 5 10 15 20 25 30 35 36 Graph of Cumulative Total Hours Required and the Cumulative Average time per Unit Total Hours Units Cumulative total hours required Cumulative average time per unit The Learning Curve and Nonlinear Cost Behavior 6

48. 2-48 1100100100 280 (0.8 x 100) 18090 370.21259.2183.40 464 (0.8 x 80)314.2178.55 559.57373.7874.76 656.17429.9571.66 753.45483.4069.06 851.20 (0.8 x 64)534.6066.83 1640.96892.0055.75 Cumulative Individual Unit Cumulative Cumulative Number Time for nth Unit Total Time: Average Time per of Units in Labor Hours Labor Hours Unit-Labor Hours (1) (2) (3) (4) = (3)/(1) Data for an Incremental Unit-Time Learning Curve with an 80 Percent Learning Rate The Learning Curve and Nonlinear Cost Behavior 6

49. 2-49 Managerial Judgment 7 Managerial judgment is critically important in determining cost behavior and is by far the most widely used method in practice.

50. 2-50 End of Chapter 3