AMIS 310 Foundations of Accounting Chapter 12 Module 3 CHAPTER 1 MODULE 1 AMIS 310 Foundations of Accounting Professor Marc Smith

Chapter 12 Module 3: Cost Behaviors The ideas behind cost behavior analysis are very useful in management decision- making. Why? Cost behavior analysis allows managers to develop expectations of costs at any level of activity.

Chapter 12 Module 3: Cost Behaviors In utilizing cost behavior analysis, managers should use (work with) variable costs expressed on a per unit basis and fixed costs in total. The reason? Both variable costs per unit and total fixed costs are considered ‘constant’ at all activity levels. This assumption of being ‘constant’ allows managers to make predictions about future costs.

Chapter 12 Module 3: Mixed Costs PROBLEM: What do we do with mixed costs as they do NOT have a constant component SOLUTION: We need a means of separating the mixed cost into its fixed and variable components so that we can isolate these ‘constant components’

Chapter 12 Module 3: Mixed Costs Method used to separate a mixed cost into its fixed and variable components: HIGH-LOW METHOD

Chapter 12 Module 3: High-Low Method HIGH-LOW METHOD – STEPS 1. From a set of data, choose 2 data points - the high and the low ACTIVITY LEVEL (Note: do not choose your 2 data points based on the high and low cost) 2. Calculate the variable cost per unit = change in cost for 2 data points ÷ change in activity level for 2 data points 3. Calculate the total fixed cost

Chapter 12 Module 3: Example #1 Month Material Handling Costs Units Produced January $2,000 100 February 3,090 125 March 2,780 175 April 1,990 200 May 7,500 500 June 5,300 300 July 4,300 250 August 6,300 400 September 5,600 475 October 6,240 425 Step 1: Choose the two data points

Chapter 12 Module 3: Example #1 Month Material Handling Costs Units Produced January $2,000 100 February 3,090 125 March 2,780 175 April 1,990 200 May 7,500 500 June 5,300 300 July 4,300 250 August 6,300 400 September 5,600 475 October 6,240 425 Step 2: Calculate the variable cost per unit $7,500 – $2,000 500 – 100 = $13.75

Chapter 12 Module 3: Example #1 Step 3: Using either the high cost or low activity point, solve for the total fixed cost. Total Cost = Fixed Cost + Variable Cost High End $7,500 = F + $13.75(500) $625 = F Low End $2,000 = F + $13.75(100) $625 = F

Chapter 12 Module 3: Example #1 The cost formula using the high-low method is: Total cost = $625 + $13.75X Where X = activity (in this problem, units produced) If 150 units are expected to be produced in November, the expected material handling cost would be: Total cost = 625 + 13.75(150) Total cost = 625 + 2,063 Total cost = $2,688