chap005 garisson

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2010 The McGraw-Hill Companies, Inc.

Cost Behavior: Analysis and Use

Chapter 5


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McGraw-Hill/Irwin Slide 2

Learning Objective 1

Understand how fixed andvariable costs behave and

how to use them to predictcosts.


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The Activity Base (also called a cost driver)

A measure of whatcauses the

incurrence of avariable cost

Unitsproduced

Milesdriven

Machinehours

Laborhours


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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. of activity.

Total fixed costs remain the

same even when the activity Average fixed costs per unitFixed level changes within the decrease as the activity

relevant range. level increases.

Average fixed costs per unit decrease as theactivity level increases.

Types of Cost Behavior Patterns Fixed


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Volume

Cost

True Variable Costs

The amount of a true variable cost used during theperiod varies in direct proportion to the activity level.The overage charge on a cell phone bill was oneexample of a true variable cost.

Direct material isanother exampleof a cost thatbehaves in a truevariable pattern.


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Step-Variable Costs

A step-variable costis a resource that is obtainable onlyin large chunks (such as maintenance workers) andwhose costs change only in response to fairly wide

changes in activity.

Volume

C

ost


7/42McGraw-Hill/Irwin Slide 7

Step-Variable Costs

Volume

Cost

Only fairly wide changesin the activity level willcause a change in the

number of maintenanceworkers employed.



Number of Minutes Usedwithin Monthly Plan

M

onthlyBasic

CellP

honeBill

Total Fixed Cost An Example

For example, your cell phone bill probably includes afixed amount related to the total minutes allowed inyour calling plan. The amount does not change when

you use more or less allowed minutes.



ExamplesAdvertising and

Research andDevelopment

ExamplesDepreciation on Buildingsand Equipment and Real

Estate Taxes

Types of Fixed Costs

Discretionary

May be altered in the

short-term by currentmanagerial decisions

Committed

Long-term, cannot be

significantly reduced inthe short term.



Rent

CostinThousands

ofDollars

0 1,000 2,000 3,000Rented Area (Square Feet)

0

30

60

Fixed Costs and the Relevant Range

90

RelevantRange

The relevant rangeof activity for a fixedcost is the range ofactivity over which

the graph of thecost is flat.



Fixed Monthly

Utility Charge

VariableCost per KW

Activity (Kilowatt Hours)

TotalUtilityCost

X

Y

A mixed cost contains both variable and fixed

elements. Consider the example of utility cost.

Mixed Costs (also called semivariable costs)



Mixed Costs

The total mixed cost line can be expressedas an equation: Y= a+ bX

Where: Y = The total mixed cost.

a = The total fixed cost (the

vertical intercept of the line).

b = The variable cost per unit of

activity (the slope of the line).

X = The level of activity.

Fixed Monthly

Utility Charge

VariableCost per KW

Activity (Kilowatt Hours)

Total

UtilityCost

X

Y



Analysis of Mixed Costs

In account analysis, each account isclassified as either variable or fixed based

on the analysts knowledge of howthe account behaves.

The engineering approach classifies

costs based upon an industrialengineers evaluation of production

methods, and material, labor andoverhead requirements.

Account Analysis and the Engineering Approach




Analyze a mixed cost

using the high-lowmethod.



The High-Low Method An Example

The variable costper hourof

maintenance isequal to the change

in cost divided bythe change in hours.

= $6.00/hour$2,400400




Total Fixed Cost = Total Cost Total Variable Cost

Total Fixed Cost = $9,800

($6/hour 850 hours)

Total Fixed Cost = $9,800 $5,100

Total Fixed Cost = $4,700




Y = $4,700 + $6.00X

The Cost Equation for Maintenance



Quick Check

Sales salaries and commissions are $10,000 when80,000 units are sold, and $14,000 when 120,000units are sold. Using the high-low method, what is thevariable portion of sales salaries and commission?

a. $0.08 per unit

b. $0.10 per unit

c. $0.12 per unit

d. $0.125 per unit



Sales salaries and commissions are $10,000 when80,000 units are sold, and $14,000 when 120,000units are sold. Using the high-low method, what is thevariable portion of sales salaries and commission?

a. $0.08 per unit

b. $0.10 per unit

c. $0.12 per unit

d. $0.125 per unit

Quick Check



Quick Check

Sales salaries and commissions are $10,000 when80,000 units are sold, and $14,000 when 120,000units are sold. Using the high-low method, what isthe fixed portion of sales salaries and commissions?

a. $ 2,000

b. $ 4,000

c. $10,000

d. $12,000



Sales salaries and commissions are $10,000 when80,000 units are sold, and $14,000 when 120,000units are sold. Using the high-low method, what isthe fixed portion of sales salaries and commissions?

a. $ 2,000

b. $ 4,000

c. $10,000

d. $12,000

Quick Check

Total cost = Total fixed cost +

Total variable cost

$14,000 = Total fixed cost +

($0.10 120,000 units)

Total fixed cost = $14,000 - $12,000

Total fixed cost = $2,000



Least-Squares Regression Method

A method used to analyze mixed costs if ascattergraph plot reveals an approximately linear

relationship between theXand Yvariables.

This method uses allof thedata points to estimatethe fixed and variablecost components of a

mixed cost.The goal of this method isto fit a straight line to thedata that minimizes the

sum of the squared errors.


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Software can be used to fita regression line throughthe data points.

The cost analysis objectiveis the same: Y= a+ bX

Least-squares regression also provides a statistic, calledthe R2, which is a measure of the goodness

of fit of the regression line to the data points.


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0 1 2 3 4

T

otalCost

10

20

0

Activity

****

**

****


R2is the percentage of the variation in the dependentvariable (total cost) that is explained by variation in the

independent variable (activity).

R2varies from 0% to 100%, andthe higher the percentage the better.

X

Y


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Prepare an incomestatement using the

contribution format.


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Lets put our

knowledge of cost

behavior to work

by preparing acontribution

format income

statement.

The Contribution Format


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Total UnitSales Revenue 100,000$ 50$

Less: Variable costs 60,000 30

Contribution margin 40,000$ 20$Less: Fixed costs 30,000

Net operating income 10,000$

The contribution margin format emphasizes costbehavior. Contribution margin covers fixed costs

and provides for income.


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Uses of the Contribution Format

The contribution income statement format is usedas an internal planning and decision-making tool.

We will use this approach for:

1.Cost-volume-profit analysis (Chapter 6).

2.Budgeting (Chapter 9).

3.Segmented reporting of profit data (Chapter 12).

4.Special decisions such as pricing and make-or-buy analysis (Chapter 13).


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Used primarily forexternal reporting.

Used primarily bymanagement.


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2010 The McGraw-Hill Companies, Inc.

Least-Squares RegressionComputations

Appendix 5A


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Analyze a mixed costusing the least-squares

regression method.


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Simple Regression Analysis An Example

Matrix, Inc. wants toknow its average

fixed cost and

variable cost per unit.

Using the data to theright, lets see how todo a regression using

Microsoft Excel.


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Simple Regression Using Excel An Example

You will need three pieces ofinformation from yourregression analysis:

1. Estimated Variable Cost PerUnit (line slope)

2. Estimated Fixed Costs (lineintercept)

3. Goodness of fit, or R2

To get these three piecesinformation we will need touse three Excel functions.

SLOPE, INTERCEPT, and RSQ


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Place your cursor in

cell F4 and press the= key. Click on the

pull down menu andscroll down to More

Functions . . .


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Scroll down to theStatistical,

functions. Now

scroll down thestatistical

functions until youhighlightSLOPE



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1. In the Known_ys box, enter C4:C19 for the range.

2. In the Known_xs box, enter D4:D19 for the range.



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Here is theestimate of the

slope of the line.





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With your cursor in

cell F5, press the =key and go to the pull

down menu forSpecial Functions.Select Statistical and

scroll down tohighlight the

INTERCEPT function.



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Here is theestimate of the

fixed costs.



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Finally, we willdetermine thegoodness of

fit, orR2, by

using the RSQfunction.



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Here is theestimate ofR2.



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End of Chapter 5

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