ac102_ch5 - Revised Summer 2010 CHAPTER 5 COST BEHAVIOR:...

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Revised Summer 2010 Page 1 of 17 CHAPTER 5 COST BEHAVIOR: ANALYSIS AND USE Key Terms and Concepts to Know Cost Classifications for Predicting Cost Behavior Costs may be classified by how they behave in total when the activity level changes: In Total Per Unit Variable Cost Varies The same Fixed Cost The same Varies inversely Mixed Cost Varies Varies (often inversely) The relevant range is the range of activity levels throughout which the assumptions for cost behavior are valid. Outside the relevant range, total fixed costs may change and/or variable costs per unit may change. The activity level or allocation base is a measure of the activity that causes total variable cost to change. Common activity bases are: direct labor hours, machine hours, units produced, and units sold. Committed fixed costs relate to costs that the company will incur over the long- term. These costs, such as depreciation expense, property tax expense and insurance expense, cannot be changed during short periods of time and are only somewhat under the control of management. Discretionary fixed costs usually arise from annual decisions by management and can be changed during short periods of time such as advertising, research and public relations. Mixed costs contain both variable and fixed cost elements. For example, a company’s selling expenses may include fixed expenses, such as the advertising costs and the base salary of the sales manager; and variable costs, such as sales commissions paid to the regional salesmen. Contribution Margin Income Statement The traditional income statement separates expenses by function emphasizing the distinction between production, administration and selling expenses. Gross margin is the first key measure of profitability.
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Revised Summer 2010 Page 2 of 17 The contribution margin income statement separates expenses by behavior, emphasizing the distinction those revenues and expenses that change when the level of activity changes and those that are unaffected by changes in the level of activity. Contribution margin is the first key measure of profitability. Key Topics to Know Separating Mixed Costs into Fixed and Variable Elements In order to predict the profits of a company, it is necessary to separate all costs into either fixed costs or variable costs. Many costs are clearly variable, such as direct labor, or, clearly fixed, such as rent. Mixed costs must be separated into their fixed and variable elements using one of three methods and a regression line developed to predict total mixed costs at various levels of activity. The equation of the regression line takes the form: Total Cost = Fixed Cost + Variable Cost Y = a + b(X) Least Squares Regression Method A rigorous, mathematical approach in which a series of data points are used to develop a regression line to predict total costs.
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This note was uploaded on 06/01/2011 for the course ACCOUNTING 102 taught by Professor All during the Spring '11 term at Harper.

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ac102_ch5 - Revised Summer 2010 CHAPTER 5 COST BEHAVIOR:...

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