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**Unformatted text preview: **CHAPTER 10 DETERMINING HOW COSTS BEHAVE 10-1 The two assumptions are: 1. Variations in total costs are explained by variations in the level of a single activity related to those costs (the cost driver). 2. Cost behavior is approximated by a linear cost function within the relevant range. A linear cost function is a cost function where, within the relevant range, the graph of total costs versus the level of a single activity forms a straight line. 10-2 Three alternative linear cost functions are: 1. Variable cost functiona cost function in which total costs change in proportion to the changes in the level of activity in the relevant range. 2. Fixed cost functiona cost function in which total costs do not change with changes in the level of activity in the relevant range. 3. Mixed cost functiona cost function that has both variable and fixed elements. Total costs change but not in proportion to the changes in the level of activity in the relevant range. 10-3 A linear cost function is a cost function where, within the relevant range, the graph of total costs versus the level of a single activity related to that cost is a straight line. An example of a linear cost function is a cost function for use of a telephone line where the terms are a fixed charge of $10,000 per year plus a $2 per minute charge for phone use. A nonlinear cost function is a cost function where, within the relevant range, the graph of total costs versus the level of a single activity related to that cost is not a straight line. Examples include economies of scale in advertising where an agency can double the number of advertisements for less than twice the costs, step-function costs, and learning-curve-based costs. 10-4 No. High correlation merely indicates that the two variables move together in the data examined. It is essential to also consider economic plausibility before making inferences about cause and effect. Without any economic plausibility for a relationship, it is less likely that a high level of correlation observed in one set of data will be similarly found in other sets of data. 10-5 Four approaches to estimating a cost function are: 1. Industrial engineering method. 2. Conference method. 3. Account analysis method. 4. Quantitative analysis of current or past cost relationships. 10-6 The conference method estimates cost functions on the basis of analysis and opinions about costs and their drivers gathered from various departments of a company (purchasing, process engineering, manufacturing, employee relations, etc.). Advantages of the conference method include: 1. The speed with which cost estimates can be developed. 2. The pooling of knowledge from experts across functional areas....

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