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Unformatted text preview: ACIS 2116 Chapter Four Cost Behavior and Relevant Costs Cost Behavior What happens to certain costs as the number of units produced changes? Variable Costs Fixed Costs Step Costs Mixed Costs 2 Variable Cost Total dollar amount varies in direct proportion to changes in the activity level. Remains constant on a per unit basis. 3 True Variable Cost Example Total Cost of Hokie Bird Suits Number of Hokie Bird Suits Produced
4 Variable Cost Per Unit Example
Variable cost remains constant on a per unit basis. Cost of a Hokie Bird Suit Number of Hokie Bird Suits Produced 5 Examples of Variable Costs
1. Merchandising companies cost of goods sold. 2. Manufacturing companies direct materials, direct labor, and variable overhead. 6 The Linearity Assumption and the Relevant Range A straight line Economist's closely Curvilinear Cost approximates a Function curvilinear Total Cost Relevant Range variable cost line within the relevant range. Accountant's StraightLine Approximation (constant unit variable cost) Activity 7 Relevant Range Relevant range of production for particular product and company 8 Fixed Cost Total dollar amount remains constant as the activity level changes within the relevant range. 9 Total Fixed Cost Example Rent paid for Factory Building Number of Hokie Bird Suits Manufactured
10 Fixed Cost Per Unit Example
Average fixed costs per unit decreases as the activity level increases.
Rental Cost per Hokie Bird Suit Number of Hokie Bird Suits Manufactured
11 Fixed Costs and Relevant Range
The relevant range of activity for a fixed cost is the range of activity over which the graph of the cost is flat. 12 Fixed Costs and Relevant Range Rent Cost in Thousands of Dollars 90 Relevant Range
Total cost doesn't change for a wide range of activity, and then jumps to a new higher cost for the next higher range of activity. 60 30 0 0 1,000 2,000 3,000 Rented Area (Square Feet)
13 The Trend Toward Fixed Costs
The trend in many industries is toward greater fixed costs relative to variable costs. Why?
Increased automation. Shift from laborers paid by the hour to salaried knowledge workers.
14 Is Labor a Variable or a Fixed Cost?
The behavior of wage and salary costs can direct across countries, depending on labor regulations, labor contracts, and custom.
In France, Germany, China, and Japan management has little flexibility in adjusting the size of the labor force. Labor costs are more fixed in nature. In the United States and the United Kingdom management has greater latitude. Labor costs are more variable in nature. 15 Types of Cost Behavior Patterns
Remember this...?
Summary of Variable and Fixed Cost Behavior
Cost Variable In Total Total variable cost is proportional to the activity level within the relevant range. Total fixed cost remains the same even when the activity level changes within the relevant range. Per Unit Variable cost per unit remains the same over wide ranges of activity. Fixed cost per unit goes down as activity level goes up. Fixed 16 True Variable Cost
Amount used varies in direct proportion to the level of production activity. Example: Direct Materials
Cost Volume 17 Step Costs
A resource that is obtainable only in large chunks. Costs increase or decrease only in response to fairly wide changes in activity. Cost Example: maintenance workers Volume 18 Step Costs Small change in the level of production are not likely to have any effect on the number of maintenance workers employed. Cost Volume 19 Step Costs
Only fairly wide change in the activity level will cause a change in the number of maintenance workers employed Cost Volume 20 Fixed Costs vs. StepVariable Cost?
Hmm... So what is the difference between a fixed cost and a stepvariable cost? 21 Fixed Costs vs. Step Costs?
Step costs can be adjusted more quickly and . . . The width of the activity steps is much wider for the fixed cost. 22 Test Your Knowledge
Which of the following statements about cost behavior are true?
1. Fixed costs per unit vary with the level of activity.  True 1. Variable costs per unit are constant within the relevant range.  True 2. Total fixed costs are constant within the relevant range. True 3. Total variable costs are constant within the relevant range. False
23 Mixed Costs
A mixed cost has both fixed and variable components. Consider the example of utility cost.
Y Total Utility Cost
st o dc ixe m al t To Variable Cost per KW Activity (Kilowatt Hours) X Fixed Monthly Utility Charge
24 Mixed Costs Y Total Utility Cost
st o dc ixe m al t To Variable Cost per KW Activity (Kilowatt Hours) X Fixed Monthly Utility Charge
25 Mixed Costs Example
If your fixed monthly utility charge is $40, your variable cost is $0.03 per kilowatt hour, and your monthly activity level is 2,000 kilowatt hours, what is the amount of your utility bill? Y = a + bX Y = $40 + ($.03 2,000) Y = $100
26 Analysis of Mixed Costs For planning purposes, mixed costs should be broken down into variable and fixed components. Two methods used to analyze mixed costs are: the highlow method the leastsquares regression method. 27 The HighLow Method
Assume the following hours of maintenance work and the total maintenance costs for six months. 28 The HighLow Method Find the periods with the highest activity level and the lowest activity level. 29 The HighLow Method
The variable cost per hour of maintenance is equal to the change in cost divided by the change in hours. $2,400 = $8.00/hour 300 30 The HighLow Method Total Cost = Total Fixed Cost + Total Variable Cost Rearrange the above formula to determine the total fixed cost: Total Fixed Cost = Total Cost Total Variable Cost 31 The HighLow Method Total Fixed Cost = Total Cost Total Variable Cost Total Fixed Cost = $9,800 ($8/hour 800 hours) Total Fixed Cost = $9,800 $6,400 Total Fixed Cost = $3,400
32 The HighLow Method The Cost Equation for Maintenance Y = $3400 + $8.00X
33 Test Your Knowledge
Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the highlow method, what is the variable portion of sales salaries and commission? a. $0.08 per unit b. $0.10 per unit c. $0.12 per unit d. $0.125 per unit 34 Test Your Knowledge
Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the highlow method, what is the variable portion of sales salaries and commission? Units Cost a. $0.08 per unit High level 120,000 $ 14,000 b. $0.10 per unit Low level 80,000 10,000 40,000 $ 4,000 c. $0.12 per unit Change d. $0.125 per unit 35 Test Your Knowledge
Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the highlow method, what is the fixed portion of sales salaries and commissions? a. $ 2,000 b. $ 4,000 c. $10,000 d. $12,000 36 Test Your Knowledge
Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the highlow method, what is the fixed portion of sales salaries and commissions? a. $ 2,000 b. $ 4,000 c. $10,000 d. $12,000 37 LeastSquares Regression Method
Uses statistics to derive the linear relationship between the X and Y variables. Uses all of the data points
Tries to fit a straight line to the data and minimize the sum of the squared errors.
38 LeastSquares Regression Method Software can be used to fit a regression line through the data points. The cost analysis objective is the same: Y = a + bX 39 LeastSquares Regression Method Y
Cost of Electricity 1,000's of Dollars 20 10 * * * *
0 1 2 * ** * **
X 0 3 4 Machinehours in 1,000's
40 LeastSquares Regression Method
Fit a line to the data by using statistics. Y
Cost of Electricity 1,000's of Dollars 20 10 * * * *
0 1 2 * ** * **
X Intercept = Fixed cost: $10,000 0 3 4 Machinehours in 1,000's
41 LeastSquares Regression Method Y = $10,000 + $1.25X
Total cost of electricity Number of machine hours Leastsquare regression provides more accurate estimates than High/Low method
42 Taxes and Decision Making Managers must consider the impact of taxes when making decisions. 43 Taxes and Decision Making Many costs of operating businesses are tax deductible; that is, costs reduce taxes. Most revenues are taxable. Thus, revenues increase taxes. Form or structure of transaction matters. Payment of tax requires cash outflow.
44 Effect of Changes in Costs on Taxes and Income If costs increase, then taxes decrease. Thus, net income decreases by cost net of tax (i.e., the aftertax cost). Aftertax cost = Pretax cost X (1 tax rate) Assume tax rate is 30%. If costs increase by $100, then taxes decrease by .3 X $100 or $30. Overall effect on income is decrease of $70 ($100  $30).
45 Effect of Changes in Revenue on Taxes and Income If revenue increases, then taxesincrease. Thus, net income increases by revenue net of tax (i.e., the aftertax benefit). Aftertax benefit = Pretax receipts X (1 tax rate) Assume tax rate is 30%. If revenues increase by $100, then taxes increase by .3 X $100 or $30. Overall effect on income is increase of $100 $30 or $70.
46 Test Your Knowledge Hokie Paraphernalia, Inc. is considering adding several new product lines. Hokie estimates that adding these new product lines will increase revenues by $1,000 per month. Extra production costs incurred are estimated to be $500 per month. Assuming that Hokie's tax rate is 30%, what estimated aftertax income will Hokie earn from adding the new product lines? 47 Test Your Knowledge Aftertax income = Pretax income X (1 Tax Rate). Aftertax income = (1000500)*(130%) Aftertax income = 500*70% Aftertax income = 350 48 ...
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 Spring '08
 CMEasterwood
 Accounting

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