2. 9/12/02Prof. Bentz1 212 Review Basic Cost Behavior

3. 9/12/02Prof. Bentz2 Basic Model of Total Cost  In A&MIS 212, we use the basic model of total cost, TC = F + vQ Dependent Variable Independent Variable Parameters (coefficients)

4. 9/12/02Prof. Bentz3 Model Characteristics  Total cost depends exclusively on the volume of activity  Total cost is a linear function of activity volume

5. 9/12/02Prof. Bentz4 Illustration  Consider an illustration of five ways information might be presented to you on a quiz, exam, or practical situation. All five are based on the same fact situation, so the answers will be the same. What differs is the manner in which the information is presented.

6. 9/12/02Prof. Bentz5 Basic Data  Fact situation: ◈ Sales volume measured in units or dollars ◈ Fixed cost, F = $20,000 ◈ Variable cost v = $1.50 per unit

7. 9/12/02Prof. Bentz6 Case A  Given the two cost estimation parameters, estimate total cost for a specified volume level (like GN exercise 5 - 1)

8. 9/12/02Prof. Bentz7 Case A  Variable cost, v = $1.50  Fixed cost, F = $20,000  Compute total cost (TC) of 13, 000 units

9. 9/12/02Prof. Bentz8 Case A  TC=$20,000 + $1.50(13,000) =$20,000 + $19,500 =$39,500

10. 9/12/02Prof. Bentz9 Case B  Given the total cost for a specified level of volume, and the proportion of total cost represented by either the fixed or the variable component of total cost, estimate total cost for a different volume level

11. 9/12/02Prof. Bentz10 Case B  Given: ◈ TC = $50,000 for 20,000 units ◈ Fixed cost is 40% of total cost at this volume  Compute total cost (TC) of 13, 000 units

12. 9/12/02Prof. Bentz11 Case B  TC = F + vQ  vQ = TC – F  vQ = $50,000 – 40%($50,000) = $50,000 - $20,000 v(20,000) = $30,000 v= $30,000 / 20,000 units =$1.50 per unit

13. 9/12/02Prof. Bentz12 Case B  TC=$20,000 + $1.50(13,000) =$20,000 + $19,500 =$39,500

14. 9/12/02Prof. Bentz13 Case C  Given per-unit fixed and variable costs for a specified level of volume, estimate total cost for a different level of volume

15. 9/12/02Prof. Bentz14 Case C  Given the cost per unit by component for 12,000 units: ◈ Variable $ 1.50000 ◈ Fixed 1.66667 ◈ Total$ 3.16667  Compute total cost (TC) of 13, 000 units

16. 9/12/02Prof. Bentz15 Case C  F =12,000 units @ $1.66667 F=$20,000 v=$1.50 per unit (given) Therefore, the cost estimation equation is: TC = $20,000 + $1.50 Q

17. 9/12/02Prof. Bentz16 Case C  Compute total cost of 13,000 units TC=$20,000 + $1.50(13,000) =$20,000 + $19,500 =$39,500

18. 9/12/02Prof. Bentz17 Case D  Given two volume levels, and the total costs at each of those two levels of volume, develop the information required to estimate total cost for a different level of volume and prepare that estimate.

19. 9/12/02Prof. Bentz18 Case D  Given volume in units and total cost at each of the volume levels: Sales 1 Sales 2 ◈ Sales (units) 12,000 14,000 ◈ Total cost$38,000$41,000

20. 9/12/02Prof. Bentz19 Case D  v=Change in cost/change in volume v= ($41,000 - $38,000) (14,000 – 12,000) v= $3,000 / 2,000 units =$1.50 per unit

21. 9/12/02Prof. Bentz20 Case D  F=TC – vQ =$41,000 - $1.50(14,000) F=$41,000 - $21,000 =$20,000

22. 9/12/02Prof. Bentz21 Case D  Compute total cost of 13,000 units TC=$20,000 + $1.50(13,000) =$20,000 + $19,500 =$39,500

23. 9/12/02Prof. Bentz22 Case E  Given two sales levels (in dollars), and the total costs at each of these two levels of sales, develop the information required to estimate total cost for a different level of sales volume and prepare that estimate.

24. 9/12/02Prof. Bentz23 Case E  Given total sales and total costs for two different volumes: Sales 1 Sales 2 ◈ Sales$40,000$48,000 ◈ Total cost$35,000$38,000

25. 9/12/02Prof. Bentz24 Case E  v=Change in cost / change in sales volume v= ($38,000 - $35,000) ($48,000 - $40,000) v= $3,000 / $8,000 =3/8 or 37.5% of sales $

26. 9/12/02Prof. Bentz25 Case E  F=TC – vQ =$38,000 – 0.375($48,000) F=$38,000 - $18,000 =$20,000

27. 9/12/02Prof. Bentz26 Case E  Compute total cost for sales of $52,000: TC=$20,000 + 0.375($52,000) =$20,000 + $19,500 =$39,500

28. 9/12/02Prof. Bentz27 Review of Illustration  Obviously, there any number of ways one might encounter the information necessary to compute the cost estimation equation to be able to predict total costs for a given level of volume. But they are all based on the same fundamental relationship of cost to volume.

29. 9/12/02Prof. Bentz28 Exercise 5 -1  With exercise 5 -1 we have three ways to estimate the equation that describes the behavior of total shipping expense with respect to the number of units shipped.

30. 9/12/02Prof. Bentz29 Exercise 5 -1  The method shows that, in fact, we will can get three different answers using the three methods. The similarity of the three estimates is totally determined by the data presented and one cannot generalize about the differences.

31. 9/12/02Prof. Bentz30 Exercise 5 -1  Zerbel Company, a wholesaler of large, custom-built air conditioning units or commercial buildings, has noticed considerable fluctuation in its shipping expense from month to month, as shown on the following slide:

32. 9/12/02Prof. Bentz31 Data for Exercise 5 -1

33. 9/12/02Prof. Bentz32 Ex. 5 –1, Requirement 1 1.Using the high-low method, estimate the cost formula for shipping expense.

34. 9/12/02Prof. Bentz33 Ex. 5 –1, Requirement 1

35. 9/12/02Prof. Bentz34 Ex. 5 –1, Requirement 1

36. 9/12/02Prof. Bentz35 Estimation equation TC = $ 800 + $ 350 Q

37. 9/12/02Prof. Bentz36 Ex. 5 –1, Requirement 2 2.The president has no confidence in the high-low method and would like you to “check out” your results using the scattergraph method. Do the following: a.Prepare a scattergraph using the data given above.

38. 9/12/02Prof. Bentz37 Ex. 5 –1, Requirement 2 b.Using your scatter graph, estimate the approximate variable cost per unit shipped and the approximate fixed cost per month with the “quick-and-dirty method (see below).

39. 9/12/02Prof. Bentz38 Req. 2: Scattergraph Method

40. 9/12/02Prof. Bentz39 Req. 2: Scattergraph Method

41. 9/12/02Prof. Bentz40 Req. 2: Estimation equation TC = $1,100 + $300 Q

42. 9/12/02Prof. Bentz41 Regression Analysis Results Intercept (fixed cost)$ 1,010.71 Slope (variable unit cost)$ 317.86 Regression results provide the theoretically correct standard against which we can compare ad-hoc methods.

43. 9/12/02Prof. Bentz42 Estimation equation TC = $1,100.71 + $317.86 Q

44. 9/12/02Prof. Bentz43 Summary of results 1.High-Low method (unique answer) TC = $800 + $350 Q 2.Scatter graph method (judgment) TC = $1,100 + $300 Q 3.Regression analysis method (unique answer) TC = $1,010.71 + $317.86 Q

45. 9/12/02Prof. Bentz44 High-Low Method  In summary, the High-Low method is the least accurate of the three methods assuming the regression model best captures the information contained in all the data points.

46. 9/12/02Prof. Bentz45 Ex. 5 –1, Requirement 3 3.What factors, other than the number of units shipped, are likely to affect the company’s shipping expense? a.Weather b.Road construction and repairs c.Fuel costs d.Car and truck traffic

47. 9/12/02Prof. Bentz46 General Assumption  In the absence of evidence to the contrary, for testing and homework purposes in A&MIS 212, assume that all costs can be modeled as semi-variable (mixed) costs. This is the assumption that underlies the high-low method!