Chapter 4 Cost Behavior

Chapter 4 Cost Behavior - 4/19/2011 Chapter 4 Cost Behavior...

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Cost Behavior This chapter presents methods of estimating and predicting cost behavior. When managers are able to predict cost behavior, managers can estimate the amount of costs that are expected to be incurred at different levels of activity. Estimated costs is the heart of budgeting and forecasting which is one of the primary functions of managerial accounting. Assumptions To predict/estimate cost behavior, you must assume the following: The number of units produced is equal to the number of units sold. In other words, there is no change in inventory levels. The cost behavior is linear. The level of activity (sales/production) occurs within the relevant range. The Relevant Range A relevant range is a range of activity within which cost behavior holds true. It is the normal range of production or sales that can be expected for a particular product or company. For example, a particular retail store may have normal monthly revenues of $500,000, with occasional lows of $400,000 or highs of $600,000. The relevant range is the range of normal activity from $400,000 to $600,000. The costs that are identified as fixed, such as manager salaries, are the same throughout the entire range. If sales were to increase to $700,000, the company would likely acquire an additional manager thereby increasing it salary costs. Conversely, if sales drop to $320,000, the company would likely eliminate a manager to reduce total fixed costs. A relevant range ignores extreme levels of activity. Above or below the relevant range, forecasts of cost behavior may be linear and likely be less accurate in predictions of future costs. Variable Cost Behavior Total variable costs vary in direct proportion to volume. In other words, the more units produced the higher the total variable cost. Total variable cost is zero if no units are produced. As weekly sales climb, each dollar of additional sales generates 20 cents of variable costs. The total variable labor cost rises to $5,000 when sales activity reaches $25,000. Note the rising variable cost line. The math function that names this line is shown as: y = 0.20X, where y is the total cost and X represents the activity. In this case the activity is weekly sales. 4/19/2011
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This note was uploaded on 04/20/2011 for the course ACC 101 taught by Professor Xyz during the Spring '11 term at Ohio State.

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Chapter 4 Cost Behavior - 4/19/2011 Chapter 4 Cost Behavior...

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