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Ch.3 - ACIS 2116 Chapter Three Chapter Number Cost Behavior...

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1 Chapter Number ACIS 2116 Chapter Three Cost Behavior

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2 Cost Behavior Refers to how a cost will change as the level of activity changes In order to make planning and operating decisions, managers must understand cost behavior.
3 Common Cost Behaviors Some common types of cost behaviors: w Variable Costs w Fixed Costs w Mixed Costs w Step Costs

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4 Variable Cost Total dollar amount varies in direct proportion to changes in the activity level. Remains constant on a per unit basis.
5 Number of Hokie Bird Suits Produced Total Cost of Fabric Variable Cost Example Let’s assume that the Hokie Bird Suit Co. makes Hokie Bird suits and that each suit produced requires \$40 of fabric. The following graph shows the relationship between the number of Hokie Bird suits produced and the cost of the fabric. \$0 \$400 \$800 \$1,200 \$1,600 \$2,000 \$2,400 0 10 20 30 40 50

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6 Number of Hokie Bird Suits Produced Fabric Cost per unit (per Hokie Bird Suit) Variable Cost Per Unit Example Variable cost remains constant on a per unit basis. \$0 \$20 \$40 \$60 \$80 \$100 0 10 20 30 40 50
7 Examples of Variable Costs 1. Merchandising companies – cost of goods sold. 2. Manufacturing companies – direct materials, direct labor, and variable overhead.

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8 Relevant Range We use the concept of a relevant range to assume a linear cost relationship. Activity Total Cost Curvilinear Cost Function The Linearity Assumption and the Relevant Range Accountant’s Straight-Line Approximation (constant unit variable cost) In reality, a cost may behave in a curvilinear fashion.
9 Relevant Range Normal range of production for particular product and company

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10 Total dollar amount remains constant as the activity level changes within the relevant range. Fixed Cost
11 Number of Hokie Bird Suits Manufactured Monthly Rent Total Fixed Cost Example Assume that The Hokie Bird Suit Co. rents the building that it operates out of. Rent is \$800 per month. Obj102

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12 Number of Hokie Bird Suits Manufactured Rental Cost per Hokie Bird Suit Fixed Cost Per Unit Example Average fixed costs per unit decrease as the activity level increases. Obj103
13 Fixed Costs and Relevant Range The relevant range of activity for a fixed cost is the range of activity over which the graph of the cost is flat.

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14 Monthly Rent Cost 0 1,000 2,000 3,000 Rented Area (Square Feet) 0 \$500 \$800 Fixed Costs and Relevant Range \$1,100 Relevant Range Total cost doesn’t change for a wide range of activity, and then jumps to a new higher cost for the next higher range of activity.
15 The Trend Toward Fixed Costs The trend in many industries is toward greater fixed costs relative to variable costs. Why? Increased automation. Shift from laborers paid by the hour to salaried workers.

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16 Summary of Variable and Fixed Cost Behavior Cost In Total Per Unit Variable Total variable cost is Variable cost per unit remains proportional to the activity the same over wide ranges level within the relevant range.
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Ch.3 - ACIS 2116 Chapter Three Chapter Number Cost Behavior...

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