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Ch 03 Summary

# Ch 03 Summary - CHAPTER 3 COST BEHAVIOR Chapter 3 provides...

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CHAPTER 3 COST BEHAVIOR Chapter 3 provides the basics of cost behavior, focusing on expanded definitions of fixed and variable costs and introducing the concept of mixed costs. Methods of separating mixed costs into fixed and variable elements are presented and discussed. In addition, the resource usage model is presented. This chapter is an important foundation for the activity-based costing system discussed in Chapter 4. LEARNING OBJECTIVES After studying Chapter 3, you should be able to: 1. Define and describe fixed, variable, and mixed costs. 2. Explain the use of resources and activities and their relationship to cost behavior. 3. Separate mixed costs into their fixed and variable components using the high-low method, the scatterplot method and the method of least squares. 4. Evaluate the reliability of the cost formula. 5. Explain how multiple regression can be used to assess cost behavior. 6. Define the learning curve, and discuss its impact on cost behavior. 7. Discuss the use of managerial judgment in determining cost behavior. KEY TOPICS The following major topics are covered in this chapter (related learning objectives are listed for each topic): 1. Basics of Cost Behavior (LO 1) 2. Resources, Activities, and Cost Behavior (LO 2) 3. Methods for Separating Mixed Costs into Fixed and Variable Components (LO 3) 4. Reliability of Cost Formulas (LO 4) 5. Multiple Regression (LO 5) 6. The Learning Curve and Nonlinear Cost Behavior (LO 6) 7. Managerial Judgment (LO 7) 13

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I. BASICS OF COST BEHAVIOR Cost behavior refers to whether a cost changes when the level of output changes. Usually costs are placed into one of four categories: fixed costs, variable costs, mixed costs, and step costs. These categories are reasonably accurate within a relevant range of activity. Relevant range: The range of activity over which the assumed cost relationship is valid for the normal operations of a firm is called the relevant range. While the cost function may not be linear, we will often assume linearity because the function will appear to be linear within the relevant range. Fixed costs: Fixed costs are costs that do not change in total as the activity level changes. All costs are considered to be fixed in the short run. The term fixed cost does not infer that the cost cannot change over time but that a change in the activity level will not cause a change in the total cost. The duration of the short run can change depending on the cost under consideration. Total fixed costs can be described in equation format to be: F = Total fixed costs Variable cost: A variable cost is a cost that will vary in total in direct proportion to changes in activity level, which is commonly defined as some measure of production or sales activity (e.g., direct labor hours, units produced, or units sold). Activity level can refer to the level of any cost driver (e.g., setup time, number of material moves, etc.) in an activity-based costing system. Total variable costs can be described in equation format to be: Y v = VX where: Y v = Total variable costs V =
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Ch 03 Summary - CHAPTER 3 COST BEHAVIOR Chapter 3 provides...

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