Unformatted text preview: Determining How Costs Behave Costs Introduction Introduction
How do managers know what price to charge, How whether to make or buy, or other questions related to costs. related s They need to have an understanding of how They costs change in relation to various factors. costs s This chapter will focus on how to determine This cost behavior. cost
s Learning Objectives Learning
1 2 3 Explain the two assumptions frequently used Explain in costbehavior estimation in Describe linear cost functions and three Describe common ways in which they behave common Recognize various approaches to cost Recognize estimation estimation Learning Objectives Learning
4 5 6 Outline six steps in estimating a cost function Outline on the basis of current or past cost relationships relationships Describe three criteria to evaluate and choose Describe cost drivers cost Explain and give examples of nonlinear cost Explain functions functions Learning Objectives Learning
7 8 Distinguish between the cumulative averagetime learning model and incremental unittime time model model Understand data problems encountered in Understand estimating cost functions estimating Learning Objective 1 Learning Explain the two assumptions Explain frequently used in costbehavior estimation estimation Assumptions in CostBehavior Estimation Estimation
1 – – Changes in total costs can be explained by Changes changes in the level of a single activity. changes Variation in machine hours can explain Variation variations in total cost . variations Variation in labor hours can explain variations Variation in total cost. in Assumptions in CostBehavior Estimation Estimation
2 – Cost behavior can adequately be approximated Cost by a linear function of the activity level within the relevant range. the A linear cost function is a cost function in linear which the graph of total cost versus the level of a single activity is a straight line. of Learning Objective 2 Learning Describe linear cost functions Describe and three common ways in which they behave which Cost Function... Cost
is a mathematical expression describing how is costs change with changes in the level of an activity. activity. s Output produced s Direct manufacturing labor hours s Machine hours s Batches of production
– Cost Function Cost
La Bella Hotel offers Happy Airline three La alternative cost structures to accommodate its crew overnight: its 1 $60 per night per room usage s Total room usage is the only factor whose Total change causes a change in total costs. s The cost is variable.
s Cost Function Cost
What is the cost function? s y = $60x s y measures the total costs of the rooms used. s x refers to the actual number of rooms used. s The slope of the cost function is $60.
s Cost Function Cost
y = cost y x x = number of rooms Cost Function Cost
$8,000 per month s The total cost will be $8,000 per month The regardless of room usage. regardless s The cost is fixed, not variable. s What is the cost function?
2 Cost Function Cost
y = $8,000 s $8,000 is called a constant or intercept. s The slope of the cost function is zero.
s Cost Function Cost
y = cost y $8,000 x rooms rooms x = number of Cost Function Cost
$3,000 per month plus $24 per room s This is an example of a mixed cost. s y = $3,000 + $24x s y = a + bx bx
3 Cost Function Cost
y = cost y $3,000 x x = number of rooms Cost Classification and Estimation and
– – – Choice of cost object Time span Relevant range Choice of Cost Object Choice
A cost item may be variable with respect cost to one cost item and fixed with respect to another. another. s If the number of taxis owned by a taxi If company is the cost object, annual taxi registration, and license costs would be a variable cost. variable
s Choice of Cost Object Choice
s If miles driven during a year on a particular If taxi is the cost object, registration, and license costs for that taxi is a fixed cost. costs Time Span Time
Whether a cost is variable or fixed with respect Whether to a particular activity depends on the time span. span. s More costs are variable with longer time spans.
s Relevant Range Relevant
Variable and fixed cost behavior patterns are Variable valid for linear cost functions only within the given relevant range. given s Costs may behave nonlinear outside the range.
s Cost Estimation... Cost
is the attempt to measure a past cost is relationship between costs and the level of an activity. activity. s Managers are interested in estimating past Managers costbehavior functions primarily because these estimates can help them make more accurate cost predictions. cost
– The CauseandEffect Criterion In Choosing Cost Drivers In
– – – Physical relationship (materials costs) Contractual agreements (phone charges based Contractual on minutes) on Implicitly established by logic (ordering costs Implicitly driven by number of parts) driven Learning Objective 3 Learning Recognize various approaches Recognize to cost estimation to Cost Estimation Approaches Cost
– – – – Industrial engineering method Conference method Account analysis method Quantitative analysis methods Industrial Engineering Method... Industrial
is also called the workmeasurement method. is workmeasurement method s It estimates cost functions by analyzing the It relationship between inputs and outputs in physical terms. physical
– Conference Method... Conference
estimates cost functions on the basis of estimates analysis and opinions about costs and their drivers gathered from various sources. drivers s This method involves This the pooling of expert knowledge. knowledge.
– Account Analysis... Account
estimates cost functions by classifying cost estimates accounts in the ledger as variable, fixed, or mixed with respect to the identified activity. mixed s Typically, managers use qualitative rather than Typically, quantitative analysis when making these costquantitative classification decisions.
– Account Analysis Account
The cost analyst uses experience and The judgment to separate total costs into fixed and variable. and s Quatisha & Co. sells software programs. s Total sales = $390,000 s The company sold 1,000 programs.
s Account Analysis Account
Cost of goods sold = $130,000 s Manager’s salary = $60,000 s Secretary’s salary = $29,000 s Commissions = 12% of sales s What is the total fixed cost? s $60,000 + $29,000 = $89,000 s What is the fixed cost per unit sold?
s Account Analysis Account
$89,000 ÷ 1,000 = $89.00 s What is the variable cost per unit sold? s Cost of goods sold: $130,000 s Commissions: $390,000 × .12 = $46,800 s ($130,000 + $46,800) ÷ 1,000 = $176.80
s Quantitative Analysis Methods Quantitative
s Quantitative analysis uses a formal Quantitative mathematical method to fit linear cost functions to past data observations. functions Learning Objective 4 Learning Outline six steps in estimating Outline a cost function on the basis of current or past cost relationships relationships Steps In Estimating A Cost Function Cost
1 2 3 4 5 6 Choose the dependent variable. Identify the independent variable cost Identify driver(s). driver(s). Collect data on the dependent variable and Collect the cost driver(s). the Plot the data. Estimate the cost function. Evaluate the estimated cost function. Steps In Estimating A Cost Function Cost
Choose the dependent variable. s Choice of the dependent variable (the cost to Choice be predicted) will depend on the purpose for estimating a cost function. estimating
1 Steps In Estimating A Cost Function Cost
Identify the independent variable cost Identify driver(s). driver(s). s The independent variable (level of activity The or cost driver) is the factor used to predict the dependent variable (costs). dependent
2 Steps In Estimating A Cost Function Cost
s A B Two important aspects when identifying a Two cost driver: cost It should have an economically plausible It relationship with the dependent variable. relationship It should be accurately measurable. Steps In Estimating A Cost Function Cost
Collect data on the dependent variable and Collect the cost driver(s). the s Cost analysts obtain data from company Cost documents, from interviews with managers, and through special studies. and – Timeseries data – Crosssectional data
3 Steps In Estimating A Cost Function Cost
Plot the data. s The general relationship between the cost The driver and the dependent variable can readily be observed in a plot of the data. be s The plot highlights extreme observations that The analysts should check. analysts
4 Steps In Estimating A Cost Function Cost
5 – – Estimate the cost function. Highlow method Regression analysis Steps In Estimating A Cost Function Cost
Evaluate the estimated cost function. s A key aspect of estimating a cost function is key choosing the appropriate cost driver. choosing
6 HighLow Method HighLow
Choose the highest and lowest value of the Choose cost driver and their respective costs. cost s Determine a and b using algebra. and using
s HighLow Method HighLow
High capacity December: machine hours machine s Cost of electricity: $80,450 s Low capacity September: machine hours machine s Cost of electricity: $64,200 s What is the variable rate?
s 55,000 30,000 HighLow Method HighLow
($80,450 – $64,200) ÷ (55,000 – 30,000) s $16,250 ÷ 25,000 = $0.65 s What is the fixed cost?
s HighLow Method HighLow
$80,450 = Fixed cost + 55,000 – $0.65 s Fixed cost = $80,450 – $35,750 = $44,700 s $64,200 = Fixed cost + 30,000 x $0.65 s Fixed cost = $64,200 – $19,500 = $44,700 s y = a + bx bx s y = $44,700 + ($0.65 × Machinehours)
s Regression Analysis... Regression
is used to measure the average amount of is change in a dependent variable, such as electricity, that is associated with unit increases in the amounts of one or more independent variables, such as machine hours. independent s Regression analysis uses all available data to Regression estimate the cost function. estimate
– Regression Analysis Regression
Simple regression analysis estimates the Simple relationship between the dependent variable and one independent variable. and s Multiple regression analysis estimates the Multiple relationship between the dependent variable and multiple independent variables. and
s Regression Analysis Regression
The regression equation and regression line The are derived using the leastsquares technique. are s The objective of leastsquares is to develop The estimates of the parameters a and b.
s Regression Analysis Regression
The vertical difference (residual term) (residual measures the distance between the actual cost and the estimated cost for each observation. and s The regression method is more accurate than The the highlow method. the
s Learning Objective 5 Learning Describe three criteria Describe to evaluate and choose cost drivers cost Criteria to Evaluate and Choose Cost Drivers Choose
1 2 3 Economic plausibility Goodness of fit Slope of the regression line Goodness of Fit Goodness
The coefficient of determination (r ) The coefficient expresses the extent to which the changes in (x) explain the variation in (y). (y) s An (r ) of 0.80 indicates that more than 80 An (r percent of the change in the dependent variable can be explained by the change in the independent variable. the
s
2 2 Slope of Regression Line Slope
A relatively steep slope indicates a strong relatively relationship between the cost driver and costs. relationship s A relatively flat regression line indicates a relatively weak relationship between the cost driver and costs. costs.
s Slope of Regression Line Slope
The closer the value of the correlation The coefficient (r) to ±1, the stronger the statistical coefficient (r) relation between the variables. relation s As (r) approaches +1, a positive relationship As is implied, meaning the dependent variable (y) increases as the independent variable (x) increases. increases.
s Slope of Regression Line Slope
s As (r) approaches –1, a negative, or inverse, As relationship is implied, meaning the dependent variable (y) decreases as the independent variable (x) increases. increases. Learning Objective 6 Learning Explain and give examples of Explain nonlinear cost functions nonlinear Nonlinearity and Cost Functions Nonlinearity
s – – – A nonlinear cost function is a cost function in nonlinear which the graph of total costs versus the level of a single activity is not a straight line within the relevant range. the Economies of scale Quantity discounts Step cost functions Nonlinearity and Cost Functions Nonlinearity
s Economies of scale in advertising may enable Economies an advertising agency to double the number of advertisements for less than double the cost. advertisements Nonlinearity and Cost Functions Nonlinearity
s Quantity discounts on direct materials Quantity purchases produce a lower cost per unit purchased with larger orders. purchased Nonlinearity and Cost Functions Nonlinearity
s A step function is a cost function in which the step cost is constant over various ranges of the level of activity, but the cost increases by discrete amounts as the level of activity changes from one range to the next. one Learning Objective 7 Learning Distinguish between the Distinguish cumulative averagetime learning model and incremental unittime model unittime Learning Curves
s A learning curve is a function that shows how learning laborhours per unit decline as units of output increase. increase. Experience Curve... Experience
– is a function that shows how the costs per unit is in various value chain areas decline as units produced and sold increase. produced Cumulative AverageTime Learning Model Learning
s Cumulative average time per unit is reduced Cumulative by a constant percentage each time the cumulative quantity of units produced is doubled. doubled. Incremental UnitTime Learning Model Learning
s The time needed to produce the last unit is The reduced by a constant percentage each time the cumulative quantity of units produced is doubled. doubled. Learning Objective 8 Learning Understand data problems Understand encountered in estimating cost functions cost Data Collection and Adjustment Issues Adjustment
s 1 2 The ideal database for cost estimation has two The characteristics: characteristics: It contains numerous reliably measured It observations of the cost driver(s) and the cost that is the dependent variable. that It considers many values for the cost driver It that span a wide range. that Data Collection and Adjustment Issues Adjustment
Time periods do not match. s Fixed costs are allocated as if they were Fixed variable. variable. s Data are either not available or not reliable. s Inflation may play a role.
s Data Collection and Adjustment Issues Adjustment
Extreme values of observations occur from Extreme errors in recording costs. errors s Analysts should adjust or eliminate unusual Analysts observations before estimating a cost relationship. relationship. s There is no homogeneous relationship. s The relationship between the cost driver and The the cost is not stationary. the
s Data Collection and Adjustment Issues Adjustment
s The most difficult task in cost estimation is The collecting highquality, reliably measured data on the dependent variable and the cost driver(s). driver(s). ACCOUNTING(FINANCIAL & COST) OF ICMAP STAGE 1,2,3,4 (CRASH CLASSES) CA..MODULE A,B,C,D PIPFA (FOUNDATION,INTERMEDIATE,FINAL) ACCAF1,F2,F3 BBA,MBA B.COM(FRESH),M.COM MAECONOMICS..O/A LEVELS KHALID AZIZ…..03223385752 http://finance.groups.yahoo.com/group/costaccountants ATTENTION COMMERCE STUDENTS STUDENTS ...
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This note was uploaded on 12/10/2009 for the course ACCT 315 taught by Professor Siebert during the Fall '09 term at Saginaw Valley.
 Fall '09
 SIEBERT
 Cost Accounting

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