Acct205Weygandt - Managerial Accounting Weygandt, Kieso,...

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Chapter 5 Cost-Volume-Profit Relationships Managerial Accounting Weygandt, Kieso, & Kimmel
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Cost Behavior Analysis Cost behavior analysis is the study of how specific costs respond to changes in activities. The starting point in cost behavior analysis is to measure key activities. Activity levels may be expressed in terms of sales dollars or units (retail company), miles driven (trucking company), room occupancy (hotel), or number of dance classes taught (dance studio).
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Cost Behavior Analysis For an activity level to be useful in cost behavior analysis, there should be correlation between changes in the level or volume of activity and changes in the costs. The activity level selected is referred to as the activity (or volume) index. The activity index identifies the activity that causes changes in the behavior of costs.
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Variable Costs Variable costs are costs that vary in total directly and proportionately with changes in the activity level. A variable cost may also be defined as a cost that remains the same per unit at every level of activity .
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Variable Costs Damon Company manufactures radios that contain a $10 digital clock. The activity index is the number of radios produced. As each radio is manufactured, the total cost of the clocks increases by $10. $100 80 60 40 20 0 Cost (000) 0 2 4 6 8 10 Radios produced in (000) (a) Total Variable Costs (Digital Clocks) 0 5 $25 20 15 10 Cost (per unit) 0 2 4 6 8 10 Radios produced in (000) (b) Unit Variable Costs (Digital Clocks)
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Fixed Costs Fixed costs are costs that remain the same in total regardless of changes in the activity level. Since fixed costs remain constant in total as activity changes, fixed costs per unit vary inversely with activity . As volume increases, unit cost declines and vice versa.
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Fixed Costs Damon Company leases all of its productive facilities at a cost of $10,000 per month. Total fixed costs of the facilities will remain constant at every level of activity. $25 20 15 10 5 0 Cost (000) 0 2 4 6 8 10 Radios produced in (000) (a) Total Fixed Costs (Rent Expense) 0 1 $5 4 3 2 Cost (per unit) 0 2 4 6 8 10 Radios produced in (000) (b) Fixed Costs Per Unit (Rent Expense)
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Nonlinear Behavior of Variable and Fixed Costs We assumed that total variable costs and total fixed costs were linear , and straight lines were used to represent both types of costs. A straight-line relationship does not usually exist throughout the entire range of activity. In the real world, the relationship between variable cost behavior and changes in the activity level is often curvilinear . Cost ($) 0 (b) Total Fixed Costs Nonlinear 20 40 60 80 100 Activity level (%) 0 20 40 60 80 100 Activity level (%) (a) Total Variable Costs Curvilinear
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Linear Behavior Within Relevant Range Operating at zero or at 100% capacity is the exception for most companies. Companies usually operate over a narrower range – such as 40-80% of capacity. The relevant range of the activity index is the
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Acct205Weygandt - Managerial Accounting Weygandt, Kieso,...

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