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Unformatted text preview: Module 14
Cost Behavior, Activity Analysis, and Cost Estimation
©Cambridge Business Publishers, 2009 Basic Cost Behavior Patterns
Variabl e Costs Fixed Costs Mixed Costs Step Costs Change in total in direct proportion to changes in activity Do not change in response to a change in activity volume Contain a fixed and variable cost element; sometimes called semi variable costs Constant within a narrow range of activity, but shift to a higher level when activity exceeds the range ©Cambridge Business Publishers, 2009 • Increases as activity increases • Equals zero dollars when activity is zero Variable cost: Y = bX
Total variable costs (Y) 0
©Cambridge Business Publishers, 2009 Variable Costs Higher variable costs per unit create a steeper line slope. Total activity (X) b = Variable cost per unit • No change as activity increases or decreases • No response to shortrun changes in activity cost drivers Fixed cost: Y = a
Total fixed costs (Y) Fixed Costs Slope is zero, represented by a flat line.
Total activity (X) a = Total fixed costs 0 ©Cambridge Business Publishers, 2009 • Increase in a linear fashion when activity increases • Positive in amount when activity is zero Mixed cost: Y = a + bX
Total mixed costs (Y)
©Cambridge Business Publishers, 2009 Mixed Costs Variable portion Fixed portion Contains both fixed and variable cost elements Total activity (X) • Increase in a step like fashion as activity increases • Total cost shifts to a higher level when activity exceeds a range Step cost: Y = ai Total step costs (Y) Step Costs 0
©Cambridge Business Publishers, 2009 Total activity (X) Cost Behavior Pattern Assumptions
The four cost behavior patterns assume… A unit of final output is the primary cost driver The time period is too short to incorporate changes in strategic cost drivers such as the scale of operations Causes some costs to be viewed as fixed in the short term, but appear variable in the long run ©Cambridge Business Publishers, 2009 Total Cost Equation = Total Fixed Costs + Variable Costs per Unit × Number of Units Exhibit 14.2 Total Cost Behavior a Y = X + b ©Cambridge Business Publishers, 2009 A portion of a range of activity associated with Relevant Range the fixed cost of the current or expected capacity A normal range of activity in which a company expects to operate, where the fixed costs remain linear, i.e., total cost remains the same Example: During normal operations, factory space is adequate for Mattel. However, during the three months preceding the holiday season, Mattel’s operations are out of the relevant range and storage trailers must be rented for the additional merchandise. ©Cambridge Business Publishers, 2009 Relevant Range
Economist’s total cost function, referred to as curvilinear Exhibit 14.3 Accountant’s linear approximation of total cost function ©Cambridge Business Publishers, 2009 Marginal Cost Marginal cost is the varying increment in total cost of making one more unit.
Economist ©Cambridge Business Publishers, 2009 Marginal Costs and Activity Levels
Exhibit 14.3 Excess capacity resulting in high marginal costs
©Cambridge Business Publishers, 2009 Optimal circumstances with marginal costs relatively low Capacity constraints resulting in high marginal costs Predicting Total Costs with a Graph
Total $6,000 costs
$5,000 $4,000 $3,000 $2,000 $1,000 $0 0 Total cost graph is useful in predicting total costs for the coming period. Number of Customers served
©Cambridge Business Publishers, 2009 | 100 | 200 | 300 | 400 | 500 $
Costs Per unit Unit Variable Costs
Unit variable costs stay the same at all activity levels $$$$0- 0 100 200 300 400 500 Activity ©Cambridge Business Publishers, 2009 Average costs Average Costs
Average cost graph is useful if a manager wants to know the cost of serving a customer $35 -$30 -$25 -$20 -$15 -$10 -$5 -$0 -0 Number of Average Cost Customers Per customer 100 $35.00 300 $15.00 500 $11.00 | 100 | | | 200 300 400 Number of customers served | 500 ©Cambridge Business Publishers, 2009 Classification depends on the immediate impact if the company attempts to change the fixed costs Committed fixed costs, known also as Classifying Fixed Costs capacity costs, are required to maintain the current service or production capacity or to fill previous legal commitments. Discretionary fixed costs , known also as managed fixed costs, are set at a fixed amount each period by management. (Wages,R&D,ad vertising, ©Cambridge Business Publishers, 2009 What is it? Cost Estimation Identifying variable or fixed costs The determination of the relationship between activity and cost An important part of cost management Analyzing available accounting records Interviews Purpose of cost estimation Cost prediction i.e., forecasting future costs Cost Forecasting ©Cambridge Business Publishers, 2009 Estimating Mixed Cost Components
Methods of estimating fixed and variable cost components Highlow method Scatter diagrams Least squares regression analysis
©Cambridge Business Publishers, 2009 Utilizes data from two time periods HighLow Cost Estimation period Step 1: Select a representative high point and a representative low activity point. Step 2: Determine variable costs per unit: Variable Costs Per Unit = Difference in total costs Difference in activity A high activity period, and a low activity Step 3: Subtract total variable costs from total fixed costs using either the high or low point: Total Fixed Costs = ©Cambridge Business Publishers, 2009 Total costs – [Variable cost per unit × number of units] HighLow Example: Variable Costs Number of Shipments Packaging Costs Low activity period High activity period January February March April 8,600 9,800 11,600 11,200 $25,000 26,000 31,600 33,000 = $2.20 Variable cost = $31,600 – $25,000 per unit (b) 11,600 – 8,600 The variable cost of each unit produced is $2.20. ©Cambridge Business Publishers, 2009 High Low Example Fixed Costs
Calculate fixed costs: Variable cost per unit (b) = $2.20 per unit a = Total costs – Variable costs January March $25,000 = a + ($2.20 × 8,600 units) a = $6,080 $31,600 = a + ($2.20 × 11,600 units) a = $6,080 The same total fixed costs result using either the high or low activity point.
©Cambridge Business Publishers, 2009 HighLow Cost Estimation
Variable Costs Per Unit
$30,000 Exhibit 14.5 =
$25,000 $10,000 0 Difference in total costs Difference in activity 8600 11,600 Total Fixed Costs = Total costs – [Variable cost per unit × number of units] Total Cost Equation Y = $2.20X + 6,080
©Cambridge Business Publishers, 2009 A graph of past activity and cost data, with individual observations represented by dots Exhibit 14.6 Scatter Diagrams When used alone to estimate costs, professional judgment is required. ©Cambridge Business Publishers, 2009 LeastSquares Regression Also known as simple regression (one variable) A mathematical technique to fit a cost estimating equation to observed data Minimizes the vertical squared difference between the estimated and actual costs at each data point Accomplished using Microsoft Excel® Statistical software Some calculators Time consuming math calculations ©Cambridge Business Publishers, 2009 LeastSquares Criterion
Exhibit 14.7 The leastsquares method minimizes the sum of all squared vertical deviations between individual observations and the costestimating line.
©Cambridge Business Publishers, 2009 LeastSquares Advantage Superior to the highlow and scatter diagram methods Statistical measures are available to determine how well the equation fits the line Because it uses all data points, and Does not rely on subjective judgment Coefficient of determination Measures the percent of variation in the dependent variable that the independent variable explains Also called Rsquared (R2) ©Cambridge Business Publishers, 2009 Simple and Multiple Regression
Simple Regression equation (one variable) Multiple Regression equation with two variables Y = a + bX Multiple regression Y = a + b1X1 + b2X2 Often contains more than two variables Can be used to determine the effect of individual product features on the market value of a product ©Cambridge Business Publishers, 2009 Managers are responsible for making decisions Mathematical models do not make decisions; they are tools to aid decision making Not all data are based on normal operating conditions Nonlinear relationships may exist Results should make sense
©Cambridge Business Publishers, 2009 Cautions in Developing Cost Estimate Equations Cost Estimation Problems: Technology & Price
Changes in Technology Data used in developing cost estimates must be based on the same technology. Data used must reflect the same price level, or be restated to a single price level. Changes in Prices ©Cambridge Business Publishers, 2009 Cost Estimation Problems: Matching Activity & Costs
Time Lags Examples: •Vehicle mileage is used consistently but maintenance costs occur every few months •Cell phone bills arrive at the end of the month, but usage occurs throughout the month ©Cambridge Business Publishers, 2009 Actual costs are not known until a future time period Shorter time periods have higher probabilities of error in matching costs and activities Cost Estimation Problems: Identifying Activity Cost Drivers
Which cost driver should be used? Cost driver should have a logical, causal relationship with costs Scatter diagrams and statistical measures are helpful Selection of a driver requires judgment and professional experience ©Cambridge Business Publishers, 2009 Assumes changes in costs are best explained by changes in the number of units of product (or service provided) Inaccurate for analyzing cost behavior when a company changes…… Unit–Level Cost Behavior ©Cambridge Business Publishers, 2009 From laborbased to automated manufacturing From a limited number related products to multiple products, with variations in volume and complexity From a set of similar customers to a diverse set of customers Direct Materials Cost of primary raw materials converted into finished goods
“Direct” costs = easily or directly traceable to a finished product/service Manufacturing Costs
Direct Labor Wages earned by production employees for the time they spend converting raw materials into finished products Manufacturing Overhead All manufacturing costs other than direct materials and direct labor
©Cambridge Business Publishers, 2009 The problem Changing Composition of Total Manufacturing Costs Dealing with overhead causing activities Past tendency was to ignore overhead and focus on direct materials and labor Units produced is no longer adequate in explaining manufacturing costs Include nonunit activity drivers Hierarchy scheme frameworks Customer cost hierarchy Manufacturing cost hierarchy, or ©Cambridge Business Publishers, 2009 Manufacturing Cost Hierarchy
A separate cost driver is selected for each level of cost. ©Cambridge Business Publishers, 2009 Unit Level Activity
This activity is performed for each batch of product produced or sold. Cost of raw materials Cost of cutting a component Cost of a box to package cereal Sales commission Cost of paint brushes used by a painting company to paint an office building
©Cambridge Business Publishers, 2009 Batch Level Activity
This activity is performed for each batch of product produced and sold. Cost of processing sales orders Cost of tracking work orders Cost of equipment setup Cost of moving a batch between workstations Cost of inspecting batches
©Cambridge Business Publishers, 2009 Product Level Activity
This activity is performed to support the production of each different type of product. Cost of product development Cost of product marketing such as advertising Cost of specialized equipment Cost of maintaining specialized equipment
©Cambridge Business Publishers, 2009 This activity is performed to maintain general manufacturing capabilities. Facility Level Activity Cost of maintaining factory building and grounds Cost of real property taxes Cost of nonspecialized equipment Cost of general advertising Cost of factory supervisor
©Cambridge Business Publishers, 2009 • Often used by • Merchandising organizations • Sales divisions of manufacturers • Customer classification scheme Customer Cost Hierarchies for Merchandising and Sales Divisions Unitlevel activities Orderlevel activities Customerlevel activities Facilitylevel activities Answers questions about the cost of individual orders or costs of individual customers
©Cambridge Business Publishers, 2009 • Often used by companies that sell to distinct market segments such as • Notforprofit Answers questions about the profitability • Forprofit of a segment • Government
Customer classification scheme
©Cambridge Business Publishers, 2009 Customer Cost Hierarchy for Distinct Market Segments Unitlevel activities Orderlevel activities Customerlevel activities Marketsegmentlevel activities Facilitylevel activities Often used by Builders Special contracts with the government Customer classification scheme Projectlevel activities Marketsegmentlevel activities Facilitylevel activities
Answers questions about the cost of individual projects.
©Cambridge Business Publishers, 2009 Customer Cost Hierarchy for Unique Projects ...
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This note was uploaded on 11/08/2010 for the course ACC 5056 taught by Professor J.goslinga during the Spring '10 term at University of Florida.
- Spring '10