Introduction to Management Accounting

Chapter 3 Introduction to Management Accounting Measurement of Cost Behavior

AmericaWest was a low-cost/full-service airline (Contrast to Southwest) Decided to expand service which required additional costs Most of these new costs would be fixed but revenues in the industry fluctuate with the economy Flexibility was accomplished via leasing | Remember Me Log-in Help

Linear-cost Behavior Costs are assumed to be fixed or variable within the relevant range of activity

Step Cost Behavior Patterns Step costs change abruptly at intervals of activity because the resources and their costs come in indivisible chunks. Learning Objective 1

Step Cost Behavior Patterns

Mixed-Cost Behavior Patterns Mixed costs contain elements of both fixed- and variable-cost behavior. The fixed-cost element is unchanged over a range of cost-driver activity. The variable-cost element varies proportionately with cost-driver activity.

Mixed-Cost Behavior Patterns Parkview Medical Center Predicted costs = fixed + variable costs (patient-days) Predicted costs = $10,000 + $5(4,000) Predicted costs = $30,000

Distribution channels Choice of process and product design Quality levels Product features Learning Objective 2 Management’s Influence on Cost Behavior

Capacity Decisions They are the fixed costs of being able to achieve a desired level of production or to provide a desired level of service while maintaining product or service attributes.

Committed Fixed Costs Salaries of key personnel Committed fixed costs arise from the possession of facilities, equipment, and a basic organization. Lease payments Property taxes

Discretionary Fixed Costs Discretionary fixed costs are costs fixed at certain levels only because management decided that these levels of cost should be incurred to meet the organization’s goals. These discretionary fixed costs have no obvious relationship to levels of output activity but are determined as part of the periodic planning process. Each planning period, management will determine how much to spend on discretionary items. These costs then become fixed until the next planning period.

Examples of Discretionary Fixed Costs Advertising and promotion Research and development Managementsalaries Employee training

Technology Decisions Choice of technology (e-commerce versus in-store or mail-order sales) positions the organization to meet its current goals and to respond to changes in the environment.

Cost-Control Incentives Managers use their knowledge of cost behavior to set cost expectations. Employees may Receive rewards that are tied to meeting these expectations.

Cost Functions Planning and controlling the activities of an organization require accurate and useful estimates of future fixed and variable costs. Learning Objective 3

Cost Functions Understanding relationships between costs and their cost drivers allows managers to... Make better operating, marketing, And production decisions Plan and evaluate actions Determine appropriate costs for short-run and long-run decisions.

Cost Functions The first step in estimating or predicting costs is measuring cost behavior as a function of appropriate cost drivers. The second step is to use these cost measures to estimate future costs at expected levels of cost-driver activity.

Cost Function Equation Let: Y = Total cost F = Fixed cost V = Variable cost per unit X = Cost-driver activity in number of units Mixed-cost function: Y = F + VX Y = $10,000 + $5.00X. The mixed-cost function is called a linear-cost function.

Developing Cost Functions A cost function’s estimates of costs at actual levels of activity must reliably conform with actually observed costs. The cost function must be believable.

Choice of Cost Drivers: Activity Analysis Choosing a cost function starts with choosing cost drivers. Managers use activity analysis to identify appropriate cost drivers. Activity analysis directs management accountants to the appropriate cost drivers for each cost. Learning Objective 4

Choice of Cost Drivers: Activity Analysis Northwestern Computers makes two products: Mozart-Plus and Powerdrive In the past, most of the support costs were twice as much as labor costs. Northwest has upgraded the production function, which has increased support costs and reduced labor cost.

Choice of Cost Drivers: Activity Analysis Using the old cost driver, labor cost, the : prediction of support costs would be: Mozart-Plus Powerdrive Labor cost$ 8.50 $ Support cost: 2 × Direct labor cost$17.00 $260.00

Choice of Cost Drivers: Activity Analysis Using the more appropriate cost driver, the number of components added to products, the predicted support costs are: Mozart-Plus Powerdrive Support cost at $20/component $20 × 5 components $ $20 × 9 components $ Difference in predicted support cost$ 83.00$ higher lower

Methods of Measuring Cost Functions   1. Engineering analysis   2. Account analysis   3. High-low analysis   4. Visual-fit analysis   5. Least-squares regression analysis Learning Objective 5

Engineering Analysis Engineering analysis measures cost behavior according to what costs should be, not by what costs have been. Engineering analysis entails a systematic review of materials, supplies, labor, support services, and facilities needed for products and services.

Account Analysis The simplest method of account analysis selects a plausible. cost driver and classifies each account as a variable or fixed cost. Supervisor’s salary and benefits $ 3,800$3,800 Hourly workers’ wages and benefits 14,674$14,674 Equipment depreciation and rentals 5,873 5,873 Equipment repairs 5,604 5,604 Cleaning supplies 7,472 7,472 Total maintenance costs$37,423$9,673$27,750 e Monthly cost Amount Fixed Variable Parkview Medical Center

Account Analysis Example Fixed cost per month = $9,673 Variable cost per patient-day = $27,750 ÷ 3,700 = $7.50 per patient-day 3,700 patient-days Y = $9,673 + ($7.50 × patient-days)

High-Low Method s. Focus on the highest- and lowest-activity points. Plot historical data points on a graph. High month: April Maintenance cost: $47,000 Number of patient-days: 4,900 Low month: September Maintenance cost: $17,000 Number of patient-days: 1,200

High-Low Method Example st. The point at which the line intersects the Y axis is the intercept, F, or estimate of Fixed Costs, and the slope of the line measures the variable cost.

High-Low Method Example Variable costs = Change in costs change in activity V = ($47,000 – $17,000) ÷ (4,900 – 1,200) = $30,000 ÷ 3,700 = $ What is the variable cost (V)? Using algebra to solve for variable and fixed costs.

High-Low Method Example F = Total mixed cost – total variable cost At X (high) F = $47,000 - ($8.1081× 4,900 patient days) = $47,000 – $39,730 = $7,270 a month At X (low) F = $17,000 = ($8.1081× 1,200 patient days) = $17,000 – $9,730 = $7,270 a month Cost function measured by high-low method: Y = $7,270 per month + ($ × patient-days) What is the fixed cost (F)?

Visual-Fit Method In the visual-fit method, the cost analyst visually fits a straight line through a plot of all of the available data, not just between the high point and the low point, making it more reliable than the high-low method.

Example of Visual Fit Cost

Least-Squares Regression Method Regression analysis measures a cost function more objectively by using statistics to fit a cost function to all the data. Regression analysis measures cost behavior more reliably than other cost measurement methods.

Coefficient of Determination One measure of reliability, or goodness of fit, is the coefficient of determination, R² (or R-squared). The coefficient of determination measures how much of the fluctuation of a cost is explained by changes in the cost driver.

End of Chapter 3 The End