#### Transcript Chapter 6

```Chapter 6
Activity Analysis,
Cost Behavior,
and Cost
Estimation
McGraw-Hill/Irwin
Learning
Objective
1
McGraw-Hill/Irwin
Introduction
Cost
estimation
Cost
behavior
Cost
prediction
Process of
determining
cost behavior,
often focusing
on historical
data.
Relationship
between
cost and
activity.
Using knowledge
of cost behavior
to forecast
level of cost at
a particular
activity. Focus
is on the future.
6-3
Learning
Objective
2
McGraw-Hill/Irwin
Total Variable Cost Example
Total Pay Per View Bill
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
6-5
Variable Cost Per Unit Example
Cost per Pay Per View
show
The cost per Pay Per View show is constant. For
example, \$4.95 per show.
Number of Pay Per
View shows watched
6-6
Step-Variable Costs
Cost
Total cost remains
constant within a
narrow range of
activity.
Activity
6-7
Step-Variable Costs
Cost
Total cost increases to a
new higher cost for the
next higher range of
activity.
Activity
6-8
Total Fixed Cost Example
Monthly Basic
Cable Bill
Your monthly basic cable TV bill probably does not
change no matter how many hours you watch.
Number of hours watched
6-9
Fixed Cost Per Unit Example
Monthly Basic cable Bill
per hour watched
The average cost per hour decreases as more hours
are spent watching cable television.
Number of hours watched
6-10
Step-Fixed Costs
Example: Office space is
available at a rental rate
of \$30,000 per year in
increments of 1,000
square feet. As the
space is rented,
increasing the total cost.
Continue
6-11
Step-Fixed Costs
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.
Rent Cost in
Thousands of Dollars
90
60
30
0
1,000
2,000
3,000
Rented Area (Square Feet)
6-12
Step-Fixed Costs
How does this type
of fixed cost differ
from a step-variable
cost?
Step-variable costs
quickly and . . .
The width of the
activity steps is much
wider for the
step-fixed cost.
6-13
Semivariable Cost
A semivariable
cost is partly
fixed and partly
variable.
Consider the
following
example.
6-14
Semivariable Cost
Total Utility Cost
Slope is
variable cost
per unit
of activity.
Variable
Utility Charge
Fixed Monthly
Utility Charge
Activity (Kilowatt Hours)
6-15
Curvilinear Cost
Total Cost
Curvilinear
Cost Function
Relevant Range
A straight-line
(constant unit
variable cost) closely
approximates a
curvilinear line within
the relevant range.
Activity
6-16
Learning
Objective
3
McGraw-Hill/Irwin
Curvilinear Cost
Total Cost
Curvilinear
Cost Function
Relevant Range
A straight-Line
(constant unit
variable cost) closely
approximates a
curvilinear line within
the relevant range.
Activity
6-18
Learning
Objective
4
McGraw-Hill/Irwin
Engineered, Committed and
Discretionary Costs
Committed
Discretionary
Long-term, cannot be
reduced in the short
term.
May be altered in the
short term by current
managerial decisions.
Engineered
Physical relationship
with activity measure.
Depreciation on
Buildings and
equipment
Direct
Materials
Research and
Development
6-20
Cost Behavior in Other Industries
Merchandisers
Service Organizations
Cost of Goods Sold
Supplies and travel
Examples of variable costs
Manufacturers
Direct Material, Direct
Labor, and Variable
Merchandisers and
Manufacturers
Sales commissions and
shipping costs
6-21
Cost Behavior in Other Industries
Examples of fixed costs
Merchandisers, manufacturers, and
service organizations
Real estate taxes
Insurance
Sales salaries
Depreciation
6-22
Learning
Objective
5
McGraw-Hill/Irwin
Cost Estimation
Account-Classification Method
Visual-Fit Method
High-Low Method
Least-Squares Regression Method
6-24
Account Classification Method
Cost estimates are based on a
review of each account making up
the total cost being analyzed.
6-25
Visual-Fit Method
A scatter diagram of past cost behavior
may be helpful in analyzing mixed costs.
6-26
Visual-Fit Method
Total Cost in
1,000’s of Dollars
Plot the data points on a
graph (total cost vs. activity).
20
10
* *
* *
* ** *
**
0
0
1
2
3
4
Activity, 1,000’s of Units Produced
6-27
Visual-Fit Method
Total Cost in
1,000’s of Dollars
Draw a line through the plotted data points so that about
equal numbers of points fall above and below the line.
20
10
* *
* *
* ** *
**
0
0
1
2
3
4
Activity, 1,000’s of Units Produced
6-28
Visual-Fit Method
Total Cost in
1,000’s of Dollars
Estimated fixed cost = \$10,000
20
10
* *
* *
* ** *
Vertical distance
**
is total cost,
approximately
\$16,000.
0
0
1
2
3
4
Activity, 1,000’s of Units Produced
6-29
The High-Low Method
OwlCo recorded the following production activity
and maintenance costs for two months:
High activity level
Low activity level
Units
9,000
5,000
Cost
\$ 9,700
6,100
Using these two levels of activity, compute:
 the variable cost per unit.
 the total fixed cost.
6-30
The High-Low Method
U n its
C o st
H ig h a ctivity le ve l
9,000
\$ 9,700
L o w a ctivity le ve l
5,000
6,100
Cha nge
4,000
\$ 3,600
6-31
The High-Low Method

U n its
C o st
H ig h a ctivity le ve l
9,000
\$ 9,700
L o w a ctivity le ve l
5,000
6,100
Cha nge
4,000
\$ 3,600
in cost
Unit variable cost =
in units
6-32
The High-Low Method
U n its
C o st
H ig h a ctivity le ve l
9,000
\$ 9,700
L o w a ctivity le ve l
5,000
6,100
Cha nge
4,000
\$ 3,600
 Unit variable cost = \$3,600 ÷ 4,000 units = \$0.90 per
unit
6-33
The High-Low Method
U n its
C o st
H ig h a ctivity le ve l
9,000
\$ 9,700
L o w a ctivity le ve l
5,000
6,100
Cha nge
4,000
\$ 3,600
 Unit variable cost = \$3,600 ÷ 4,000 units = \$0.90 per unit
 Fixed cost = Total cost – Total variable cost
6-34
The High-Low Method
U n its
C o st
H ig h a ctivity le ve l
9,000
\$ 9,700
L o w a ctivity le ve l
5,000
6,100
Cha nge
4,000
\$ 3,600
 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)
6-35
The High-Low Method
U n its
C o st
H ig h a ctivity le ve l
9,000
\$ 9,700
L o w a ctivity le ve l
5,000
6,100
Cha nge
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
6-36
Least-Squares Regression
Method
Total Cost
Regression is a statistical procedure used
to determine the relationship between variables
such as activity and cost.
The objective of
the regression
method is the
general cost equation:
Y = a + bX
Activity
6-37
Equation Form of Least-Squares
Regression Line
Y = a + bX
Total Cost is the
dependent variable.
The intercept term (a) is
the estimate of fixed costs.
The activity (X) is the
independent variable.
The X term coefficient (b)
is the estimate of variable
cost per unit of activity,
the slope of the cost line.
6-38
Least-Squares Regression
Method
• Statistics courses and
computer courses deal
with detailed regression
computations using
software.
• Accountants and
managers must be able to
interpret and use
regression estimates.
6-39
Learning
Objective
6
McGraw-Hill/Irwin
Multiple Regression
Multiple regression includes two or more
independent variables:
Y = a + b1X1 + b2X2
Terms in the equation have the same
meaning as in simple regression with
only one independent variable.
6-41
Engineering Method
of Cost Estimation
Cost estimates are based on measurement
and pricing of the work involved.
6-42
Engineering Method
of Cost Estimation
Direct Labor
Direct Material
•Analyze the kind
of work performed.
•Estimate the time
required for each labor
skill for each unit.
•Material required
for each unit is
obtained from
engineering drawings
and specification sheets.
•Use local wage rates to
obtain labor cost
per unit.
•Material prices are
determined from
vendor bids.
6-43
Effect of Learning
on Cost Behavior
As I make more of these
things it takes me less
time for each one. It must
be the learning curve effect
that the boss was
I’ve noticed the same
thing. And if you include
costs that are also
declining, that must be
the experience curve.
6-44
Learning Curve
Average Labor
Time per Unit
Learning effects
are large initially.
Learning effects
become smaller, eventually
Cumulative Production Output
6-45
Learning
Objective
7
McGraw-Hill/Irwin