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MBA 502B Managerial AccountingUniversity of Scranton, Dr. Robyn Lawrence
Analyzing Cost BehaviorAnalyzing Cost Behavior
Session Two
S-II: Analyzing Cost Behavior, MBA 502B,Univ. of Scranton, Dr. R. Lawrence2
Classifying CostsClassifying Costs
In GAAP system, costs are classified according to function– Cost of goods sold– Selling– Administrative
Another classification system generally improves internal (management) decisions—according to cost behavior.
S-II: Analyzing Cost Behavior, MBA 502B,Univ. of Scranton, Dr. R. Lawrence3
Cost BehaviorCost Behavior
Activity Base: – Cost Driver: causes changes in the behavior of costs. – Cost Predictor: accompanied by consistent, observable changes in a cost
item (correlated with)--predicts but may not cause the cost to change
Activity Base Examples:– miles driven – in a trucking company,– room occupancy – in a hotel, – number of customers called on – by a salesperson, or– number of patients—in a hospital.
Relevant (Normal or Practical) Range: – the range of interest; or – the range over which a company expects to operate during a year.
The manner in which a cost changes as a related activity changes
Variable Fixed Mixed
S-II: Analyzing Cost Behavior, MBA 502B,Univ. of Scranton, Dr. R. Lawrence4
Variable CostsVariable Costs
Vary in total directly and proportionately with changes in the activity level;
Remain the same per unit at every level of activity.
Number of Cost per TotalWeekday Minutes Minute Cost 200 .05 $10 400 .05 20 600 .05 30 800 .05 40
200
400
600
800
Number of Weekday Minutes
TotalCost
$20
$80
$60
$40
0
$100
. . . .
S-II: Analyzing Cost Behavior, MBA 502B,Univ. of Scranton, Dr. R. Lawrence5
Fixed CostsFixed Costs Remain the same in total regardless of changes in the activity level (within
the relevant range).
Per unit cost varies inversely with the activity level.
Number of Cost per MonthlyUnits Produced Unit Rent 200 2.50 $500 400 1.25 500 600 .83 500 800 .625 500
200
400
600
800
Number of Units Produced
TotalCost
$200
$800
$600
$400
0
$1,000
. . . .
400
600
800
200
CostPerUnit
0
1.00
2.00
3.00
.
.. .
S-II: Analyzing Cost Behavior, MBA 502B,Univ. of Scranton, Dr. R. Lawrence6
Variable versus Fixed CostsVariable versus Fixed Costs
Varies in direct proportion to
changes in activity
Remains constant throughout
the relevant range
Remains constant throughout the relevant range
Varies inversely with changes in
activity throughout the relevant range
VariableCost
FixedCost
Total Cost Unit Cost
S-II: Analyzing Cost Behavior, MBA 502B,Univ. of Scranton, Dr. R. Lawrence7
Mixed CostsMixed Costs
Contain both variable and fixed cost elements.
Changes in total but not proportionately with changes in the activity level.
200
400
600
800
Number of Miles Driven per Day
Cost
$100
$800
$600
$400
0
$1,000
..
..
50
.Example: Assume that local rental terms for a 17-foot moving truck, including insurance, are $50 per day plus $.50 per mile. The per diem charge is a fixed cost with respect to miles driven in a day, while the mileage charge is a variable cost.
High-low method, Scattergraph method or OLS Regression can be used to identify/estimate the fixed and variable components.
S-II: Analyzing Cost Behavior, MBA 502B,Univ. of Scranton, Dr. R. Lawrence8
Practice Classifying CostsPractice Classifying Costs
Below costs are given for two periods (and two levels of activity). Classify the costs as to variable, fixed, or mixed.
January February
1,000 units 1,200 units Classification
Rent $ 700 $ 700
Maintenance 200 240
Utilities 700 800
Insurance 500 500
Inspection 800 840
Supplies 100 120
Indirect Labor 220 250
Direct Materials 250 300
Fixed
Variable
Mixed
Fixed
Mixed
Variable
Mixed
Variable
S-II: Analyzing Cost Behavior, MBA 502B,Univ. of Scranton, Dr. R. Lawrence9
High-Low Estimation MethodHigh-Low Estimation Method
EXAMPLE: Production Total cost
June 700 units 3,200
July 800 3,800
August 900 4,300
September 500 2,700
October 400 2,050
Essentially finding the slope (variable cost per activity unit)
and then the intercept (total fixed costs) for a line going through two points:
Difference in Total Cost Difference in Activity
= Variable Cost perUnit of Activity
900 – 400
4,300 – 2,050=
2,250 500 = $4.50/unit
Find the slope (variable cost per activity):
Find the intercept (total fixed costs):
Using the higher point: 4,300 – (900 x 4.50) = 4,300 – 4,050 = 250
Using the lower point: 2,050 – (400 x 4.50) = 2,050 – 1,800 = 250
Variable costs are $4.50 per unit and fixed costs are $250.
Cost formula: Total Costs = $250 + $4.50X
S-II: Analyzing Cost Behavior, MBA 502B,Univ. of Scranton, Dr. R. Lawrence10
Graphing CostsGraphing Costs
100
600
700
800
900
400
500
200
3000
$2,000
$1,000
$3,000
$4,000
$5,000
TotalCosts
Units Produced
250FixedCosts
.
.(400, 2,050)
.(900, 4,300)
Total Variable Costs
Fixed Costs
Total Cost Line
S-II: Analyzing Cost Behavior, MBA 502B,Univ. of Scranton, Dr. R. Lawrence11
Scattergraph EstimationScattergraph Estimation
100
600
700
800
900
400
500
200
3000
$2,000
$1,000
$3,000
$4,000
$5,000
TotalCosts
Units Produced
.(700, 3,200)
.(900, 4,300)
.(800, 3,800)
.(400, 2,050)
.(500, 2,700)
1. Plot all of the observations
2. Draw the most representative line.
3. Pick two points on the line & use high-low method to determine variable and fixed costs
$4,250 - $3,000 900 - 600
= 1,250/300 = 4.1667 variable cost per unit
$3,000 – 4.1667 x 600= 3,000 – 2,500 = 500Total Fixed Costs
Total Cost = 4.17X + 500
S-II: Analyzing Cost Behavior, MBA 502B,Univ. of Scranton, Dr. R. Lawrence12
OLS Regression MethodOLS Regression Method
MS Excel Ordinary Least Squares Output: For slope (variable cost per unit) use =INDEX(LINEST(known_y's,known_x's)1) For the intercept (total fixed costs) use =INDEX(LINEST(known_y's,known_x's)2) For the full regression output use =LINEST(known_y's,known_x's,const,stats)
m = 4.227
(Variable cost per unit)
b = 420.349
(Total fixed costs)
Total Cost =
4.227X + 420.349
X Y700 3200800 3800900 4300500 2700400 2050
Slope = 4.227 420.349 = InterceptSE X = 0.366 250.982 = SE intercept
R2 = 0.978 151.830 = SE YF = 133.299 3.000 = degrees of freedom
SS Regresssion = 3072843.02 69156.98 = SS Residual
The formula must be entered as an array formula. After copying the example to a blank worksheet, select the range A14:E18 starting with the formula cell. Press F2, and then press CTRL+SHIFT+ENTER.
For Example:
S-II: Analyzing Cost Behavior, MBA 502B,Univ. of Scranton, Dr. R. Lawrence13
Comparison of Methods to Calculate Mixed Cost
Components
Comparison of Methods to Calculate Mixed Cost
Components High-low method – Uses the total costs incurred at the high and low levels of activity to calculate
the variable cost per unit and the total fixed costs using the line formula. – Advantage: easy to calculate.– Disadvantages:
relies on the representativeness of the high point and the low point. does examine whether a line (linear model) is appropriate.
Scattergraph Method– Plots observations, draws in the “best” line and calculates the line’s values.– Advantage: examines whether there is a linear relationship.– Disadvantage: the line drawn might be different from person to person.
Ordinary Least Squares Regression– Estimates a line that minimizes sum of the squared differences between the
actual y-values and the average of the y-values.– Advantages:
uses all of the points—efficient estimator; provides more information about how much of the variability is explained by the line.
– Disadvantages: harder to use and explain overly affected by outliers.
S-II: Analyzing Cost Behavior, MBA 502B,Univ. of Scranton, Dr. R. Lawrence14
Nonlinear Cost BehaviorNonlinear Cost Behavior
Total Mixed costs are fixed over some range then vary over the succeeding range.
Total Cost
Example: Monthly phone fee plus per call fee if number of calls exceed a preset number.
Step-Fixed are fixed for a range, then jump and remain fixed for a range…
Example: A salaried supervisor for every ten employees
Total Cost
Curvilinear (variable) do not have a linear pattern
Example: Total cost of direct labor where overtime is sometimes involved.
Total Cost
S-II: Analyzing Cost Behavior, MBA 502B,Univ. of Scranton, Dr. R. Lawrence15
Linear Estimation of Nonlinear Cost
Behavior
Linear Estimation of Nonlinear Cost
Behavior
Total Mixed
Total Cost
Step-Fixed
Total Cost
Curvilinear (variable)
Total Cost
Relevant Range is the range over which a company expects to operate during a year.
Within this range, a relationship approximating a straight-line might exist.
S-II: Analyzing Cost Behavior, MBA 502B,Univ. of Scranton, Dr. R. Lawrence16
Why Does Cost Behavior Matter?
Why Does Cost Behavior Matter?
Determining Cost Behavior: Improves cost forecasts at different levels of activity.
Management’s volume response differs for variable versus fixed costs. For example:
– If fixed costs are $1,000 for the relevant range of 1 to 100 units, then if 10 units are produced, the unit cost is $100; if 100 units are produced, the unit cost is $10.
With fixed costs, unit costs change proportionately--there is incentive to produce more units with fixed costs to lower unit costs.
– If variable costs are $1 per unit, then the unit cost will be $1 per unit whether 1 or 100 are produced. Unit costs will not decline if more units are produced.
S-II: Analyzing Cost Behavior, MBA 502B,Univ. of Scranton, Dr. R. Lawrence17
Session 2:
Analyzing Cost Behavior
This EndsThis Ends
S-II: Analyzing Cost Behavior, MBA 502B,Univ. of Scranton, Dr. R. Lawrence18
Concluding ActivitiesConcluding Activities Read Chapter 11: pp. 417-423 Suggested homework:
– E11-1 [Classify costs]– E11-2 [Identify cost graphs]– E11-3 [Identify activity bases]– E11-6 [Relevant range; calculating variable & fixed costs]– E11-7 [High-low method; making an estimate]– E11-8 [High-low method]– P11-1 [Classify costs]
Submit to the Session Two Dropbox your solutions to the following:Required: For each of the different costs given below, indicate whether it is a variable, fixed, or mixed cost. Use the high-low technique to estimate the variable cost per unit and the total fixed costs for each.
Cost 400 hours 550 hours A $ 875 $ 875 B 360 480
C 1,440 1,980 D 3,900 5,250 E 1,000 1,000 F 785 845 G 171.6 172.2 H 120 165