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Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Chapter 6Chapter 6
Activity Analysis, Cost Behavior,
and CostEstimation
Activity Analysis, Cost Behavior,
and CostEstimation
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Learning Objective
1
Learning Objective
1
6-3
Costprediction
Using knowledgeof cost behavior
to forecastlevel of cost at
a particularactivity. Focusis on the future.
IntroductionIntroduction
Costbehavior
Relationshipbetweencost andactivity.
Process ofdetermining
cost behavior,often focusingon historical
data.
Costestimation
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Learning Objective
2
Learning Objective
2
6-5
Total Variable Cost ExampleTotal Variable Cost Example
Your total Pay Per View bill is based on how many Pay Per View shows that you watch.
Number of Pay Per View shows watched
Tot
al P
ay P
er V
iew
Bill
6-6
Variable Cost Per Unit ExampleVariable Cost Per Unit Example
Number of Pay Per View shows watched
Cos
t per
Pay
Per
Vie
w
show
The cost per Pay Per View show is constant. For example, $4.95 per show.
6-7
Step-Variable CostsStep-Variable Costs
Activity
Co
st
Total cost remainsconstant within anarrow range of
activity.
6-8
Step-Variable CostsStep-Variable Costs
Activity
Co
st
Total cost increases to a new higher cost for the
next higher range of activity.
6-9
Total Fixed Cost ExampleTotal Fixed Cost Example
Your monthly basic cable TV bill probably does not change no matter how many hours you watch.
Number of hours watched
Mon
thly
Bas
ic
Cab
le B
ill
6-10
Fixed Cost Per Unit ExampleFixed Cost Per Unit Example
Number of hours watched
Mon
thly
Bas
ic c
able
Bill
pe
r ho
ur w
atch
ed
The average cost per hour decreases as more hours are spent watching cable television.
6-11
Example: Office space is available at a rental rate of $30,000 per year in increments of 1,000 square feet. As the
business grows more space is rented,
increasing the total cost.
Step-Fixed CostsStep-Fixed Costs
Continue
6-12
Ren
t C
ost
in
T
ho
usa
nd
s o
f D
oll
ars
0 1,000 2,000 3,000 Rented Area (Square Feet)
30
60
90
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.
Step-Fixed CostsStep-Fixed Costs
6-13
Step-variable costs can be adjusted more
quickly and . . .
The width of the activity steps is much
wider for thestep-fixed cost.
How does this type of fixed cost differ
from a step-variable cost?
Step-Fixed CostsStep-Fixed Costs
6-14
A semivariable cost is partly
fixed and partly variable.
Semivariable Cost Semivariable Cost
Consider thefollowing example.
6-15
Fixed Monthly
Utility Charge
Variable
Utility Charge
Activity (Kilowatt Hours)
To
tal
Uti
lity
Co
st
Total semivariable cost
Semivariable Cost Semivariable Cost Slope is
variable costper unit
of activity.
6-16
Curvilinear CostCurvilinear CostCurvilinear
Cost Function
Relevant Range
Activity
To
tal
Co
stCurvilinear
Cost Function
A straight-line(constant unit
variable cost) closely approximates a
curvilinear line withinthe relevant range.
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Learning Objective
3
Learning Objective
3
6-18
Curvilinear CostCurvilinear CostCurvilinear
Cost Function
Relevant Range
Activity
To
tal
Co
stCurvilinear
Cost Function
A straight-Line(constant unit
variable cost) closely approximates a
curvilinear line withinthe relevant range.
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Learning Objective
4
Learning Objective
4
6-20
Engineered, Committed and Engineered, Committed and Discretionary CostsDiscretionary Costs
DiscretionaryMay be altered in the short term by current managerial decisions.
CommittedLong-term, cannot be reduced in the short
term.
Engineered
Physical relationship with activity measure.
Depreciation on Buildings and
equipment
Advertising and Research and Development
Direct Materials
6-21
Cost Behavior in Other IndustriesCost Behavior in Other IndustriesMerchandisers
Cost of Goods Sold
Manufacturers
Direct Material, Direct Labor, and Variable
Manufacturing Overhead
Merchandisers and Manufacturers
Sales commissions and shipping costs
Service Organizations
Supplies and travel
Examples of variable costs
6-22
Examples of fixed costs
Merchandisers, manufacturers, and service organizations
Real estate taxesInsurance
Sales salariesDepreciation
Cost Behavior in Other IndustriesCost Behavior in Other Industries
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Learning Objective
5
Learning Objective
5
6-24
Account-Classification Method
Visual-Fit Method
High-Low Method
Least-Squares Regression Method
Cost EstimationCost Estimation
6-25
Account Classification MethodAccount Classification Method
Cost estimates are based on areview of each account making up
the total cost being analyzed.
6-26
A scatter diagram of past cost behavior may be helpful in analyzing mixed costs.
Visual-Fit MethodVisual-Fit Method
6-27
Plot the data points on a graph (total cost vs. activity).
0 1 2 3 4
*
To
tal
Co
st i
n1,
000’
s o
f D
oll
ars
10
20
0
***
**
**
*
*
Activity, 1,000’s of Units Produced
Visual-Fit Method
6-28
Draw a line through the plotted data points so that about equal numbers of points fall above and below the line.
Visual-Fit Method
0 1 2 3 4
*
To
tal
Co
st i
n1,
000’
s o
f D
oll
ars
10
20
0
***
**
**
*
*
Activity, 1,000’s of Units Produced
6-29
Visual-Fit Method
Vertical distance is total cost,
approximately $16,000.
0 1 2 3 4
*
To
tal
Co
st i
n1,
000’
s o
f D
oll
ars
10
20
0
***
**
**
*
*
Activity, 1,000’s of Units Produced
Estimated fixed cost = $10,000
6-30
OwlCo recorded the following production activity and maintenance costs for two months:
Using these two levels of activity, compute: the variable cost per unit. the total fixed cost.
The High-Low MethodThe High-Low Method
Units Cost
High activity level 9,000 9,700$ Low activity level 5,000 6,100
6-31
Units Cost
High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$
The High-Low Method
6-32
Units Cost
High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$
Unit variable cost =in costin units
The High-Low Method
6-33
Units Cost
High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$
Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit
The High-Low Method
6-34
Units Cost
High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$
Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit Fixed cost = Total cost – Total variable cost
The High-Low Method
6-35
Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit Fixed cost = Total cost – Total variable cost
Fixed cost = $9,700 – ($0.90 per unit × 9,000 units)
Units Cost
High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$
The High-Low Method
6-36
Units Cost
High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$
Unit variable cost = $3,600 ÷ 4,000 units = $.90 per unit Fixed cost = Total cost – Total variable cost
Fixed cost = $9,700 – ($.90 per unit × 9,000 units)
Fixed cost = $9,700 – $8,100 = $1,600
The High-Low Method
6-37
Regression is a statistical procedure usedto determine the relationship between variables
such as activity and cost.
Least-Squares Regression Least-Squares Regression MethodMethod
Activity
To
tal
Co
st The objective ofthe regressionmethod is the
general cost equation:Y = a + bX
6-38
Y = a + bX
Total Cost is thedependent variable.
The activity (X) is theindependent variable.
The X term coefficient (b)is the estimate of variablecost per unit of activity,
the slope of the cost line.
The intercept term (a) isthe estimate of fixed costs.
Equation Form of Least-Squares Equation Form of Least-Squares Regression LineRegression Line
6-39
• Statistics courses and computer courses deal with detailed regression computations using computer spreadsheet software.
• Accountants and managers must be able to interpret and use regression estimates.
Least-Squares Regression Least-Squares Regression MethodMethod
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Learning Objective
6
Learning Objective
6
6-41
Terms in the equation have the samemeaning as in simple regression with
only one independent variable.
Multiple RegressionMultiple Regression
Multiple regression includes two or more independent variables:
Y = a + b1X1 + b2X2
6-42
Engineering MethodEngineering Methodof Cost Estimationof Cost Estimation
Cost estimates are based on measurement and pricing of the work involved.
6-43
Direct Labor
•Material requiredfor each unit isobtained from
engineering drawings and specification sheets.
•Material prices are determined from
vendor bids.
•Analyze the kindof work performed.
•Estimate the time required for each labor
skill for each unit.
•Use local wage rates to obtain labor cost
per unit.
Direct Material
Engineering MethodEngineering Methodof Cost Estimationof Cost Estimation
6-44
Effect of LearningEffect of Learningon Cost Behavioron Cost Behavior
As I make more of thesethings it takes me less
time for each one. It mustbe the learning curve effect
that the boss wastalking about.
I’ve noticed the same thing. And if you
include all the variable overhead costs that are also declining, that must be the experience curve.
6-45
Learning CurveLearning Curve
Cumulative Production Output
Ave
rag
e L
abo
rT
ime
per
Un
it
Learning effectsare large initially.
Learning effectsbecome smaller, eventually
reaching steady state.
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Learning Objective
7
Learning Objective
7
6-47
Data Collection ProblemsData Collection Problems
1. Missing data.
2. Outlier data points.
3. Mismatched time periods costs.
4. Trade-offs in choosing the time period.
5. Allocated and discretionary costs.
6. Inflation.
6-48
End of Chapter 6End of Chapter 6