review19 - CHAPTER 19 Cost Behavior Analysis 00001REVIEWING...

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CHAPTER 19 Cost Behavior Analysis 00001REVIEWING THE CHAPTER 00001Objective 1: Define cost behavior and explain how managers use this concept. 10. Cost behavior —the way costs respond to changes in volume or activity—affects decisions that managers make in all steps of the management process. When managers plan, they use cost behavior to determine how many units must be sold to generate a targeted amount of profit and how changes in operating, investing, and financing activities will affect operating income. When performing daily operating activities, managers must understand cost behavior to determine the impact of their decisions on operating income. When evaluating operations and preparing reports, managers use cost behavior to analyze how changes in cost and sales affect the profitability of various business segments, as well as to make decisions about whether to eliminate a product line, accept a special order, or outsource certain activities. Objective 2: Identify variable, fixed, and mixed costs, and separate mixed costs into their variable and fixed components. 20. Total costs that change in direct proportion to changes in productive output (or any other measure of volume) are variable costs. Examples include hourly wages and the costs of direct materials and operating supplies. a0. Because variable costs change in relation to volume or output, it is important to know an organization’s operating capacity —that is, its upper limit of productive output, given its existing resources. There are three common measures of operating capacity. Theoretical (ideal) capacity is the maximum productive output for a given period in which all machinery is operating continuously at optimal speed. Practical capacity (sometimes called engineering capacity ) is theoretical capacity reduced by normal and expected work stoppages. Theoretical capacity and practical capacity are useful when estimating maximum production levels, but they are unrealistic measures when planning operations. In contrast, normal capacity —the average annual level of operating capacity needed to meet expected sales demand—is a realistic measure of what an organization is likely to produce, not what it can produce. b0. The traditional definition of variable cost assumes a linear relationship between costs and activity levels. However, many variable costs behave in a nonlinear fashion; for example, an additional hourly rental rate for computer usage may be higher than the previous hour’s rental rate. Linear approximation is a method of converting nonlinear variable costs into linear variable costs. It relies on the concept of relevant range, which is the range of volume or activity in which a company’s actual operations are likely to occur.
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This note was uploaded on 06/10/2009 for the course ACG 2071 taught by Professor Magoulis,b during the Spring '08 term at Pasco-Hernando Community College.

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review19 - CHAPTER 19 Cost Behavior Analysis 00001REVIEWING...

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