Chapter 5 Cost Behavior

Chapter 5 Cost Behavior - Chapter 5 Cost Behavior Analysis...

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Chapter 5 – Cost Behavior: Analysis and Use Managers who understand how costs behave are better able to predict costs and make decisions under various circumstances. This chapter explores the meaning of fixed, variable, and mixed costs (the relative proportions of which define an organization’s cost structure ). It also introduces a new income statement called the contribution approach. Types of Cost Behavior Patterns Variable Costs A variable cost is a cost whose total dollar amount varies in direct proportion to changes in the activity level. Activity Base An activity base (also called a cost driver) is a measure of what causes the incurrence of variable costs. As the level of the activity base increases, the total variable cost increases proportionally. Units produced (or sold) is not the only activity base within companies. A cost can be considered variable if it varies with activity bases such as miles driven, machine hours, or labor hours. As an example of an activity base, consider overage charges on a cell phone bill. The activity base is the number of minutes used above the allowed minutes in the calling plan. Extent of Variable Costs The proportion of variable costs differs across organizations. For example, a public utility like Florida Power and Light, with large investments in equipment, will tend to have fewer variable costs. A manufacturing company like Black and Decker will often have many variable costs associated with the manufacture and distribution of its products to customers. A merchandising company like Wal-Mart usually has a high proportion of variable costs such as the cost of merchandise purchases. Some service companies, such as restaurants, have a high proportion of variable costs due to their raw material costs. Other service companies, such as an architectural firm, have a high proportion of fixed costs in the form of highly trained salaried employees. Here are some examples of variable costs that are likely present in many types of businesses: o Merchandising companies - cost of goods sold. o Manufacturing companies - direct materials, direct labor, and variable overhead. o Merchandising and manufacturing companies - commissions, shipping costs, and clerical costs such as invoicing. o Service companies - supplies, travel, and clerical.
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True Variable Costs The amount of a true variable cost used during the period varies in direct proportion to the activity level. The overage charge on a cell phone bill was one example of a true variable cost. Direct material is an example of a cost that behaves in a true variable pattern. Direct materials purchased but not used can be stored and carried forward to the next period of inventory. Step-Variable Costs
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This note was uploaded on 10/25/2010 for the course MGT 11B taught by Professor Hancock during the Spring '07 term at UC Davis.

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Chapter 5 Cost Behavior - Chapter 5 Cost Behavior Analysis...

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