1. Copyright © 2013 Nelson Education Ltd.
PowerPoint Presentations for Cornerstones of
Cost Accounting
First Canadian Edition
Adapted by
George Gekas
Ryerson University
Copyright © 2013 Nelson Education Ltd.

2. Copyright © 2013 Nelson Education Ltd.
COST BEHAVIOUR 2
CHAPTER
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3. Basics of Cost Behaviour
OBJECTIVE 1
Cost Objects
An item for which managers want cost information
For manufacturing or merchandising firms: the tangible product
For service firms: the service provided
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4. Basics of Cost Behaviour
OBJECTIVE 1
Activity Drivers
Cause the costs of activities to change:
In a restaurant the cost of tomatoes used in making salads is driven by the number of tomato salads customers order
Unit-level drivers change with the number of units produced (number of salads)
Non-unit-level drivers change by non-unit-based output (number of orders, number of inspections)
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5. Basics of Cost Behaviour
OBJECTIVE 1
Fixed Costs
Fixed costs are costs that in total are constant within the relevant range as the level of the activity driver varies
Echo Audio Systems Inc. produces speakers for home audio systems. One department produces voice coils. There are two production lines that can each make up to 100,000 voice coils per year. The production-line manager is paid $60,000 per year. For production up to 100,000 units only one manager is needed; above that (to 200,000 units), two are needed.
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6. Basics of Cost Behaviour
OBJECTIVE 1
Fixed Costs
The total cost of supervision remains the same within the relevant range, but the unit cost decreases as production increases.
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7. Basics of Cost Behaviour
OBJECTIVE 1
Fixed Costs
The total cost of supervision remains the same within the relevant range, but the unit cost decreases as production increases.
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8. Basics of Cost Behaviour
OBJECTIVE 1
Fixed Costs
2-8
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9. Basics of Cost Behaviour
OBJECTIVE 1
Variable Costs
Variable costs are costs that in total vary in direct proportion to changes in an activity driver.
The cost of direct materials for each voice coil is $3. The total cost of direct materials for each level of production varies, but the unit cost stays the same.
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10. Basics of Cost Behaviour
OBJECTIVE 1
Variable Costs
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11. Basics of Cost Behaviour
OBJECTIVE 1
Variable Costs
2-11
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12. Basics of Cost Behaviour
OBJECTIVE 1
Variable Costs
2-12
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13. Basics of Cost Behaviour
OBJECTIVE 1
Variable Costs
2-13
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14. Basics of Cost Behaviour
OBJECTIVE 1
Nonlinearity of Variable Costs
2-14
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15. Basics of Cost Behaviour
OBJECTIVE 1
Relevant Range for Variable Costs
2-15
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16. Basics of Cost Behaviour
OBJECTIVE 1
Mixed Costs
Mixed costs are costs that has both a fixed and a variable component.
Y = Fixed cost + Total variable cost
Y = F + VX
where
Y = Total cost (Usually a mixed cost)
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17. Basics of Cost Behaviour
OBJECTIVE 1
Mixed Costs
Echo’s sales costs are mixed. There are 10 sales representatives who each earn $30,000 plus receive a commission of $5 per speaker sold.
This function can be represented by the following equation:
Y = $300,000 + $5X
Fixed - salaries
Variable - commission
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18. Basics of Cost Behaviour
OBJECTIVE 1
Mixed Costs
Echo Audio Systems, Inc.
Fixed Cost of Selling
Variable Cost of Selling
Total Cost
Speakers Sold
Selling Cost Per Unit
$300,000 $200,000 $ 500,000 40,000 $12.50
300, , ,000 80,
300, , , ,
300, ,000 1,100, ,
300,000 1,000,000 1,300, ,
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19. Basics of Cost Behaviour
OBJECTIVE 1
Mixed Costs
2-19
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20. Resources, Capacity, and Cost Behaviour
OBJECTIVE 2
Resources
Economic elements that enable one to perform activities
When a firm acquires the resources needed to perform an activity, it obtains activity capacity
Practical capacity is the activity level where the activity is performed efficiently
Discretionary resources—resource spending is flexible
Committed resources—resource spending is fixed independent of the actual usage
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21. Resources, Capacity, and Cost Behaviour
OBJECTIVE 2
Flexible Resources
Supplied as needed and used
Quantity of resource supplied equals quantity demanded
No unused capacity
Committed Resources
Supplied in advance of usage
A given quantity is obtained, whether or not that full amount is used
Unused capacity is possible
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22. Resources, Capacity, and Cost Behaviour
OBJECTIVE 2
Step-Cost Behaviour
A step-cost function displays a constant level of cost for a range of output, then at some point, costs jumps to a higher level
Step-Variable Costs
Many variable costs must be purchased in “chunks”
Step-Fixed Costs
Many fixed costs are actually step-fixed costs
Beyond the relevant range, fixed costs increase “one step”
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23. Resources, Capacity, and Cost Behaviour
OBJECTIVE 2
Step-Cost Function
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24. Resources, Capacity, and Cost Behaviour
OBJECTIVE 2
Step-Fixed Costs
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25. Resources, Capacity, and Cost Behaviour
OBJECTIVE 2
Activities and Mixed Cost Behaviour
Many activities have characteristics of both flexible and committed resources.
Example: Fuel-powered plant acquires buildings and equipment in advance of actual usage an in excess of immediate demands. However, it also acquires fuel to produce power on an as-needed basis.
Need to separate mixed cost into variable and fixed costs
Sometimes easy to spot the variable and fixed portion of a cost
Other times, it is not: thus, the need for a method to separate costs into their fixed and variable components
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26. Quantitative Methods for Separating Mixed Costs
OBJECTIVE 3
Y = F + VX where: Y = Total cost (the dependent variable) F = Fixed cost (the intercept parameter) V = Variable cost per unit (the slope parameter) X = Measure of output (the independent variable)
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27. Quantitative Methods for Separating Mixed Costs
OBJECTIVE 3
The High-Low Method
Take two points (the high and the low by volume of activity) and determine the slope and intercept.
Advantages
Objective
Simple
Disadvantages
High and low points may be “outliers”
High and low points may not be representative of the distribution of points in general
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28. Quantitative Methods for Separating Mixed Costs
OBJECTIVE 3
Scattergraphs
Use a scattergraph to visually assess the relationship between cost and output.
Advantages
Allows for visual inspection of the data
Disadvantages
Subjective
Next let’s look at some scattergraphs…
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29. Scattergraph of a Nonlinear Relationship
OBJECTIVE 3
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30. Scattergraph of an Upward Shift
OBJECTIVE 3
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31. Scattergraph with Outliers
OBJECTIVE 3
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32. The Method of Least Squares: Deviations of Data from a Line
OBJECTIVE 3
The Method of Least Squares: Deviations of Data from a Line
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33. Copyright © 2013 Nelson Education Ltd.
OBJECTIVE 3
The Method of Least Squares
Interpreting the least squares results:
The intercept is the fixed cost
The slope is the variable cost per unit
That is, the cost function equation is:
Y = X
Use the equation to make a point estimate:
At a point of 350 moves the total cost is predicted to be:
Y = (350)
Y = $
See Cornerstone 2-4
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34. Copyright © 2013 Nelson Education Ltd.
OBJECTIVE 4
Reliability of Cost Formulas
Coefficient of Determination, or R2
Shows the percentage of variability in the dependent variable explained by the independent variable(s)
The adjusted R2 takes into account how many independent variables used; therefore, we prefer it to the unadjusted R2
Coefficient of Correlation, or R
Square root of the coefficient of determination
Ranges from positive to negative one
The higher the R, the greater the correlation
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35. Copyright © 2013 Nelson Education Ltd.
OBJECTIVE 4
Reliability of Cost Formulas
Regression
Helps assessing the reliability of the estimated cost formula (HL method does not provide for that)
Goodness Fit
Measures the degree of fit between cost and output. The method of least squares is the best fitting line but does not say how good the fit is.
Confidence Interval
Allows for predicting a rage of actual costs with a predetermined degree of confidence (say 95%) instead of a single prediction where the actual cost will coincide exactly with the anticipated costs.
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36. Methods of Determining Cost Behaviour
OBJECTIVE 5
Industrial Engineering Method
Cost estimation relies on physical observation and analysis of activities needed and in what amounts, including time and motion studies for the production process.
Account Analysis Method
Cost estimation relies on determining and classifying ledger accounts in to fix and variable costs
See Cornerstone 2-5, text p. 68
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37. Methods of Determining Cost Behaviour
OBJECTIVE 5
Managerial Judgment
Most widely used method in practice
Managers may use their experiences and observations to determine fixed and variable costs
Simple method
When manager has good understanding of processes, it can yield good results
However, poor judgment yields poor results
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38. Copyright © 2013 Nelson Education Ltd.
Multiple Regression
OBJECTIVE 6
Multiple Regression
Uses more than one independent variable to explain the dependent variable
The single independent variable, number of moves, explained 85% of the variance material handling the dependent variable.
Adding the weight (kg) moved better explained the material handling costs; that is, adding another independent variable might increase the explanatory power of the model
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39. Copyright © 2013 Nelson Education Ltd.
Multiple Regression
OBJECTIVE 6
Multiple regression would look like:
Y = 7.84X X
X1 number of moves
X2 kilograms moved
Fixed cost is
Interpreting the results:
Like in the single regression “coefficients” represent the intercept and the slope
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40. The Learning Curve and Nonlinear Cost Behaviour
OBJECTIVE 7
Learning Curve
Shows how labour hours worked per unit decrease as the volume produced increases
Relates cost to increased efficiency (the more you perform a task the lower the cost is of doing it)
Management must estimate a learning rate for a process, usually on basis of past experience
Two common forms:
Cumulative average-time learning curve model
Incremental unit-time learning curve model
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41. The Learning Curve and Nonlinear Cost Behaviour
OBJECTIVE 7
Cumulative Average-Time Learning Curve Model
Cumulative average time per unit decreases by a constant percentage
Learning rate is expressed as a percent
See Cornerstone 2-6
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42. The Learning Curve and Nonlinear Cost Behaviour
OBJECTIVE 7
Incremental Unit-Time Learning Curve Model
Decreases by a constant percentage each time the cumulative quantity of units produced doubles
Use of learning curve enables management to be more accurate in budgeting and in performance evaluations for processes in which learning occurs
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43. End of Chapter 2
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