Chapter 5 Lecture SP2007

# Chapter 5 Lecture SP2007 - Cost Behavior: Analysis and Use...

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Phillip A. Blanchard Phillip A. Blanchard Cost Behavior: Analysis and Use COST POOLS COST DRIVERS RELEVANT RANGE MATH MATH

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Phillip A. Blanchard Phillip A. Blanchard Types of Fixed Costs Fixed Costs Discretionary May be altered in the short-term by current managerial decisions Committed Long-term, cannot be reduced in the short term. Examples Depreciation on Buildings and equipment Examples Advertising and Research and Development
Phillip A. Blanchard Phillip A. Blanchard Trend Toward Fixed Costs Increased automation. Implications Managers are more “locked-in” with fewer decision alternatives. Planning becomes more crucial because fixed costs are difficult to change with current operating decisions.

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Phillip A. Blanchard Phillip A. Blanchard The Flexible Budget Equation: Management assumes that costs behave in a specific linear fashion. Dependent Variable = Constant + Dependent variable rate (times) some Activity Y = FC + VC (X)
Phillip A. Blanchard Phillip A. Blanchard Activity Total Cost Accountant’s Straight-Line Approximation (constant unit variable cost) The Linearity Assumption and the Relevant Range A straight line closely approximates a curvilinear total cost line within the relevant range: TC = FC +VC(X)

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Phillip A. Blanchard Phillip A. Blanchard To be useful in management decision making, this Flexible Budget Equation must be reliable and relevant . It must be based upon past observations of specific cost (or revenue) behavior. Unfortunately, not all costs behave in a strictly FIXED, or in a strictly VARIABLE fashion. In fact most costs are MIXED. That is, made up of some FIXED and some VARIABLE components.
Phillip A. Blanchard Phillip A. Blanchard Therefore, management must be able to breakdown these MIXED costs into the FIXED and VARIABLE components. To do that, we need to look at alternative mathematical manipulations that will accomplish the task.

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Phillip A. Blanchard Phillip A. Blanchard A MIXED COST is partly fixed and partly variable. An Example: Mixed Costs Consider the Consider the following Chicken following Chicken Wing example. Wing example.
Phillip A. Blanchard Phillip A. Blanchard Total Cost of Dinner Bill includes BOTH: The Cover Charge, plus a set charge for each wing ordered times the total number of wings ordered. Number of Chicken Wings Ordered Total Customer Check Total Fixed Cost Total Variable Cost Assume the meal cost includes two cost components: Some flat cover charge, plus a set amount per wing ordered. Mixed Costs

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Phillip A. Blanchard Phillip A. Blanchard Fixed Portion of Dinner Bill (Cover Charge) not dependent on any number of wings ordered.
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## Chapter 5 Lecture SP2007 - Cost Behavior: Analysis and Use...

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