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chapter5 - Management Accounting | 63 Management Accounting...

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Management Accounting Theory of Cost Behavior Management accounting contains a number of decision‑making tools that require the conversion of all operating costs and expenses into fixed and variable components. The responsibility for providing this cost behavior information falls squarely upon the shoulders of the management accountant. The conversion of ordinary financial data as typically found in the general ledger accounts requires that the management accountant have a thorough understanding of cost behavior theory. The identification and measurement of fixed and variable costs is somewhat complicated by the fact that some costs are fixed or variable at the discretion of management, while other costs are not. Furthermore, for those expenditures that are inherently variable, management has the ability, within limits, to control the magnitude of the variable cost factors. In order to exercise this control, management also needs a solid understanding of the nature of cost behavior. In management accounting, the classification and measurement of fixed and variable cost is based on a body of knowledge that involves a number of assumptions. In many cases, the usefulness of fixed and variable cost data depends on the validity of these assumptions. In order to avoid poor operating results and faulty decision- making that is likely to occur when false cost assumptions are made, the ability to recognize and measure cost behavior is essential. The remainder of this chapter will examine in some depth the theory of cost behavior. Management Accounting Theory of Variable Costs The most volatile variable in any business is volume; that is, units produced or units sold. A change in volume has an immediate impact on variable costs. Variable costs are those costs that increase or decrease with corresponding changes in volume. However, the exact relationship between total variable cost and volume in practice is not always easy to describe or measure. Therefore, in both management accounting and economic theory, the relationship between volume and total variable cost is often determined by assumption.
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64 | CHAPTER FIVE Management Accounting Theory of Cost Behavior In management accounting theory, the relationship between volume and total variable cost is presented as a continuous linear function; that is, a straight line when plotted on a graph. In economic theory, the relationship is assumed to be curvilinear. These differences in assumptions, which are illustrated in Figure 5.1, need to be clearly understood. Figure 5.1 Management Accounting Economic Theory Total Variable Cost - Management Accounting Volume Volume Total Variable Cost - Economic Theory 120000 100000 80000 60000 40000 20000 0 250000 200000 150000 100000 50000 0 0 5000 10000 15000 Cost Cost 1000 3 000 5000 7000 9000 The assumption of a curvilinear relationship is probably more realistic; however, there are special reasons why the relationship is assumed linear. The reasons for use of straight-line relationships will be explained later in this chapter. At this point,
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