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Unformatted text preview: CHAPTER 5 COST BEHAVIOR I. Cost Behavior Patterns LO 1 - Identify costs as either variable, fixed, step, and mixed. A. The last four chapters describe how to calculate the cost of a physical product. The method used to determine the product costs depends on the type of products (job order costing and process costing) and the need to capture the underlying activities required to make the products (activity based costing). B. The costing systems described in the previous chapters were all examples of full absorption costing , a costing method that assigns all manufacturing costs to the product as it is being produced. Full absorption costing methods are based on the GAAP requirement that all manufacturing costs be treated as product costs. C. Although full absorption costing is required for external reporting, the method is not always useful for internal management decision making. D. In this chapter, we shift gears from product costing to focus on cost behavior . Instead of classifying costs as either manufacturing costs or nonmanufacturing costs, we now classify costs based on how they behave in response to a change to some measure of activity . E. Cost behavior is defined as the way in which total cost behaves, or changes, when some measures of activity changes. Activities that cause total cost to change are referred to as cost drivers . 1. Relevant Range – the range of activity over which we expect our assumptions about cost behavior hold true. 2. Variable Costs – change in total in direct proportion to changes in activities levels. Although total variable costs change with activity, variable cost per unit remains constant. 3. Fixed Costs – remain the same in total regardless of activity level. On a per unit basis, however, fixed costs decrease with increases in activity levels. a. The idea that unit fixed costs decrease with increase in activity levels may give managers the mistaken impression that they can increase profits by increasing the number of units produced during a given time period. b. It is not uncommon for managers to believe that they should drive down costs by producing as many units as possible. Unsold units are stored in a warehouse as the inventory – a solution that adds unnecessary costs for insurance, shipping, and handling. 4. Step Costs – are fixed over a range of activity and then increase in a steplike fashion. a. Step-variable costs tend to be fixed over a fairly narrow range of activity and rise in multiple steps across the relevant range. b. Step-fixed costs are fixed over a much wider range of activity than step-variable costs. 5. Mixed Costs – also known as semivariable costs , have both of a fixed and variable component. a. The fixed portion represents the base amount that will be incurred regardless of activity....
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- Spring '11
- Scattergraph, Keebee, Inc.