Mowen3e Ch03--Revised

# Mowen3e - Chapter Three Cost Behavior OBJECTIVE 1 Explain the meaning of cost and behavior and define and describe fixed and variable costs Cost

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Chapter Three Cost Behavior

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OBJECTIVE 1 Explain the meaning of cost and behavior, and define and describe fixed and variable costs.
Cost Behavior The way costs change as the related activity changes. 3 A cost that does not change in total as output changes Fixed Cost =

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Cost Behavior The way costs change as the related activity changes. 4 Increases in total with an increase in output and decreases in total with a decrease in output Variable Cost =
Measures of Output To determine if a cost is fixed or variable, we must first determine the underlying business activity and ask ourselves… 5 “What causes the cost of this particular activity to go up (or down)?” In other words, we are trying to identify its driver.

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Relevant Range The range of output over which the assumed cost relationship is valid for the normal operations of a firm. 6 Let’s take a closer look at fixed, variable, and mixed costs, in light of the relevant range. Avoids extremely high levels of activity Avoids extremely low levels of activity
Fixed Costs 7 Cost that in total are constant within the relevant range as the level of output increases or decreases.

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Example It process up to 50,000 computers per year. The production-line manager (supervisor) is paid \$32,000 per year. The company was established 5 years ago. Currently the factory produces 40,000 – 50,000 computers per year. Production has never fallen below 20,000 computers in a year. 8 Colley Computers Inc. wants to look at the cost relationship between supervision cost and the number of computers processed. Let’s look at the cost of supervision at several production levels.
We know the total cost of supervision, but what about per computer? Example 9 # of Computers Produced 20,000 30,000 40,000 50,000 Total Cost of Supervision \$32,000 \$32,000 \$32,000 \$32,000 Unit Cost

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Example 10 # of Computers Produced 20,000 30,000 40,000 50,000 Total Cost of Supervision \$32,000 \$32,000 \$32,000 \$32,000 Unit Cost \$1.60 1.07 0.80 0.64 Unit cost changes! As production increases, the per unit amount of a fixed cost decreases.
Discretionary Fixed Costs 11 Fixed costs that can be changed relatively easily at management discretion.

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Committed Fixed Costs 12 A fixed costs that can not be easily changed. Often these involve a long-term contract.
Variable Costs 13 Costs that in total vary in direct proportion to changes in output within the relevant range.

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Variable Cost Behavior Example 14 Each computer requires one DVD-ROM drive costing \$40. The cost of DVD-ROM drives for various levels of production is as follows: Expanding our Colley Computers example…. Let’s look at the cost of DVD-ROM’s at several production levels.
We know the total cost increases as production increases. But what about the cost per computer? Variable Cost Behavior Example 15 # of Computers Produced 20,000 30,000 40,000 50,000 Total Cost of DVD-ROM Drives \$800,000 \$1,200,000 \$1,600,000 \$2,000,000 Unit Cost

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Variable Cost Behavior Example 16 # of Computers Produced 20,000 30,000 40,000 50,000 Total Cost of DVD-ROM Drives \$800,000 \$1,200,000 \$1,600,000 \$2,000,000 Unit Cost \$40 40 40 40 Unit cost stays the same! The per unit variable cost of DVD-ROM drives is always \$40 per computer.
Variable Cost Relationship Total Variable Cost = Variable Rate Amount of output x 17 Let’s look at the DVD-ROM costs for 50,000 computers.

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## This note was uploaded on 05/04/2011 for the course ACCOUNTING 2102 taught by Professor Wurst during the Spring '11 term at Temple.

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Mowen3e - Chapter Three Cost Behavior OBJECTIVE 1 Explain the meaning of cost and behavior and define and describe fixed and variable costs Cost

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