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Click to edit Master text styles,Second Level,Third Level,Click to edit Master title style,3,-,49,Activity Cost Behavior,CHAPTER,1.,Define cost behavior for fixed, variable, and mixed costs.,2.,Explain the role of the resource usage model in understanding cost behavior.,3.,Separate mixed costs into their fixed and variable components using the high-low method, the scatterplot method, and the method of least squares.,Objectives,After studying this chapter, you should be able to:,continued,4.,Evaluate the reliability of a cost equation.,5.,Discuss the role of multiple regression in assessing cost behavior.,6.,Describe the use of managerial judgment in determining cost behavior.,Objectives,Fixed Costs,A cost that stays the same as output changes is a,fixed cost.,Cutting machines are leased for $60,000 per year and have the capacity to produce up to 240,000 units a year.,Fixed Costs,Lease of Machines,Number of Units,$60,0000N/A,60,00060,000$1.00,60,000120,0000.50,60,000180,0000.33,60,000240,0000.25,Units Cost,Fixed Costs,Total Fixed Cost Graph,Total Costs,$120,000,$100,000,$80,000,$60,000,$40,000,$20,000,60120180240,0,Units Produced (000),F = $60,000,Lease of Machines,Number of Units,$60,0000N/A,60,00060,000$1.00,60,000120,0000.50,60,000180,0000.33,60,000240,0000.25,Units Cost,Fixed Costs,Unit Fixed Cost Graph,Cost per Unit,$1.00,$0.50,$0.33,$0.25,60120180240,0,Units Produced (000),Variable Cost,A,variable cost,is a cost that, in total, varies in direct proportion to changes in output,.,As the cutting machines cut each unit, they use 0.1 kilowatt-hour at $2.00 per kilowatt hour. Thus, the cost of each unit is $0.20 ($2 x 0.1).,Variable Cost,Total Variable Cost Graph,Cost of Power,Number of Units,$ 00$ 0,12,00060,0000.20,24,000120,0000.20,36,000180,0000.20,48,000240,0000.20,Units Cost,Total Costs,0,Units Produced (000),$48,000,$36,000,$24,000,$12,000,60 120 180240,Variable Cost,Y,v,= .20x,Cost of Power,Number of Units,$ 00$ 0,12,00060,0000.20,24,000120,0000.20,36,000180,0000.20,48,000240,0000.20,Units Cost,Variable Cost,Unit Variable Cost Graph,60120180240,Units Produced (000),$0.40,$0.30,$0.20,$0.10,0,Cost per Unit,A,mixed cost,is a cost that has both a fixed and a variable component.,Mixed Costs,Mixed Costs,Sales representatives often are paid a salary plus a commission on sales.,Mixed,Costs,Inserts Sold,Variable Cost of Selling,40,000$ 20,000$30,000$ 50,000$1.25,80,00040,00030,00070,0000.86,120,00060,00030,00090,0000.75,160,00080,00030,000110,0000.69,200,000100,00030,000130,0000.65,Total Selling Cost,Fixed Cost of Selling,Selling Cost per Unit,Mixed Cost Behavior,Total Costs,0,Units Sold (000),$130,000,$110,000,$90,000,$70,000,$50,000,$30,000,40 80 120 160 180 200,Activity Cost Behavior Model,Input:,Materials,Energy,Labor,Capital,Activities,Activity Output,Cost Behavior,Changes in Output,Changes in Input Cost,Flexible Resources,Flexible resources,are resources acquired as used and needed. Materials and energy are examples.,Committed Resources,Committed resources,are supplied in advance of usage. Buying or leasing a building is an example of this form of advance resource acquisition.,A,step cost,displays a constant level of cost for a range of output and then jumps to a higher level of cost at some point.,Step-Cost Behavior,Cost,Activity Output (units),$500,400,300,200,100,10 20 30 40 50,Step-Cost Behavior,Normal Operating Range (Relevant Range),Step-Fixed Costs,Cost,$150,000,100,000,50,000,2,500 5,000 7,500,Activity Usage,Three engineers hired at $50,000 each,Each engineer is capable of processing 2,500 change orders,$90,000 was spent on supplies for the engineering activity,There were 6,000 orders processed,The company could process as many as 7,500 orders,Step-Cost Behavior,Available orders = Orders used + Orders unused,7,500 orders = 6,000 orders + 1,500 orders,Fixed engineering rate = $150,000/7,500,=,$20,per change order,Variable engineering rate = $90,000/6,000,=,$15,per change order,Step-Cost Behavior,The relationship between resources supplied and resources used is expressed by the following equation:,Resources available = Resources used + Unused capacity,Step-Cost Behavior,Cost of orders supplied = Cost of orders used + Cost of unused orders,= ($20 + $15) x 6,000 + ($20 x 1,500),=,$240,000,Equal to the $150,000 spent on engineers and the $90,000 spent on supplies.,The $30,000 of excess engineering capacity means that a new product could be introduced without increasing current spending on engineering.,Step-Cost Behavior,The High-Low Method,The Scatterplot Method,The Method of Least Squares,Methods for Separating Mixed Costs,Variable Component,Fixed Component,The,linearity assumption,assumes that variable costs increase in direct proportion to the number of units produced (or activity units used).,Methods for Separating Mixed Costs,Y = a + b,x,Total Cost,Total Fixed Cost,Variable Cost per Unit,Number of Units,Month Setup Costs Setup Hours,January $1,000100,February 1,250200,March 2,250300,April 2,500400,May 3,750500,The High-Low Method,Step 1: Solve for variable cost (b),Month Setup Costs Setup Hours,January $1,000100,February 1,250200,March 2,250300,April 2,500400,May 3,750500,b =,High Cost Low Cost,High Units Low Units,The High-Low Method,b =,High Cost Low Cost,High Units Low Units,Month Setup Costs Setup Hours,January $1,000100,February 1,250200,March 2,250300,April 2,500400,May 3,750500,The High-Low Method,b =,$3,750 Low Cost,500 Low Units,Month Setup Costs Setup Hours,January $1,000100,February 1,250200,March 2,250300,April 2,500400,May 3,750500,b =,$3,750 Low Cost,500 Low Units,b =,$3,750 $1,000,500 100,The High-Low Method,b =,$3,750 $1,000,500 100,b = $6.875,Step 2: Using either the high cost or low cost, solve for the total fixed cost (a).,The High-Low Method,Y = a + b (,x,),$3,750 = a + $6.875(500),$312.50 = a,High End,Y = a + b (,x,),$1,000 = a + $6.875(100),$312.50 = a,Low End,The cost formula using the high-low method is:,Total cost = $312.50 + ($6.875 x Setup hours),The High-Low Method,The Scatterplot Method,Activity,Cost,0,Activity Output,*,*,*,*,*,The Scatterplot Method,Nonlinear Relationship,Activity,Cost,0,Activity Output,*,*,*,*,*,*,The Scatterplot Method,Upward Shift in Cost Relationship,Activity,Cost,0,Activity Output,*,*,*,*,*,*,The Scatterplot Method,Presence of Outliers,Estimated regression line,Estimated fixed cost,The Method of Least Squares,Spreadsheet Data for Larson Company,The Method of Least Squares,Regression Output for Larson Company,The Method of Least Squares,The results give rise to the following equation:,Setup costs = $125 + ($6.75 x Setup hours),R,2,=,.944, or,94.4 percent of the variation in setup costs is explained by the number of setup hours variable.,Coefficient of Correlation,Positive Correlation,Machine Hours,Utilities Costs,r,approaches +1,Machine Hours,Utilities Costs,Coefficient of Correlation,Negative Correlation,Hours of Safety Training,Industrial Accidents,r,approaches -1,Hours of Safety Training,Industrial Accidents,Coefficient of Correlation,No Correlation,Hair Length,Accounting Grade,r, 0,Hair Length,Accounting Grade,TC = b,0,+ ( b,1,X,1),+ (b,2,X,2),+ . . .,b,0,= the fixed cost or intercept,b,1,= the variable rate for the first independent variable,X,1,= the first independent variable,b,2,= the variable rate for the second independent variable,X,2,= the second independent variable,Multiple Regression,Multiple Regression,Data for Phoenix Factory Utilities Cost Regression,Multiple Regression,Multiple Regression for Phoenix Factory Utilities Cost,The results gives rise to the following equation:,Utilities cost = $243.11 + $1.097(Machine hours) + ($510.49 x Summer),R,2,=,.967, or,96.7 percent of the variation in utilities cost is explained by the machine hours and summer variables.,Multiple Regression,Managerial Judgment,Managerial judgment is critically important in determining cost behavior, and it is by far the most widely used method in practice.,The End,Chapter Three,
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