Module 14

Cost Behavior, Activity Analysis, and Cost Estimation

Variable Costs

 Increases as activity increases    Proportional to activity Equals zero dollars when activity is zero Example : Materials

Total variable costs (Y) 0

Higher variable costs per unit create a steeper line slope.

Variable cost: Y =

b

X

Total activity (X)

b

= Variable cost per unit

Fixed Costs

Total fixed costs (Y)

Slope is zero, represented by a flat line.

Fixed cost: Y =

a

 

0 Total activity (X)

a

= Total fixed costs No change as activity increases or decreases Example: Depreciation

  

Mixed Costs

Increase in a linear fashion when activity increases Positive in amount when activity is zero Example: Maintenance

Total mixed costs (Y) 0

Contains both fixed and variable cost elements.

Variable portion Fixed portion

Total activity (X)

Mixed cost: Y =

a + b

X

b

= Variable cost per unit

 

Step Costs

Increase in a step like fashion as activity increases Example: Supervisors Step cost: Y =

a i

Total step costs (Y) 0 Total activity (X)

Relevant Range

 A portion of a range of activity associated with the fixed cost of the current or expected capacity  A normal range of activity in which a company expects to operate, where the fixed costs remain linear, i.e., total cost remains the same

Classifying Fixed Costs

Classification depends on the immediate impact if the company attempts to change the fixed costs.

Committed fixed costs

, known also as

capacity costs

, are required to maintain the current service or production capacity or to fill previous legal commitments .

Depreciation Real-estate taxes Training Advertising Discretionary fixed costs

, known also as

managed fixed costs

, are set at a fixed amount each period by management .

Cost Estimation

   What is it?

  The determination of the relationship between activity and cost An important part of cost management Identifying variable or fixed costs   Analyzing available accounting records Interviews Purpose of cost estimation  Cost prediction  i.e., forecasting future costs

Estimating Mixed Cost Components

Methods of estimating fixed and variable cost components

 High-low method  Scatter diagrams  Least-squares regression analysis

Mixed Costs Variable Costs Fixed Costs



High-Low Cost Estimation

 Utilizes data from two time periods A high activity period, and a low activity period

Step 1: Step 2: Step 3:

Select a representative high point and a representative low activity point.

Determine variable costs per unit:

Variable Costs Per Unit =

Difference in total costs Difference in activity Subtract total variable costs from total fixed costs using either the high or low point:

Total Fixed Costs = Total costs – [Variable cost per unit × number of units]

High-Low Example: Variable Costs

Low activity period

January

High activity period

February March April

Number of Packaging Shipments Costs

8,600 $25,000 9,800 11,600 11,200 26,000 31,600 33,000 Variable cost per unit (

b

) = $31,600 – $25,000 11,600 – 8,600 = $2.20

The variable cost of each unit produced is $2.20.

High Low Example Fixed Costs

Calculate fixed costs:

Variable cost per unit (

b

) = $2.20 per unit

a

= Total costs – Variable costs

January March $25,000 =

a

+ ($2.20 × 8,600 units)

a

= $6,080 $31,600 =

a

+ ($2.20 × 11,600 units)

a

= $6,080

The same total fixed costs result using either the high or low activity point.

Scatter Diagrams

Examine scatter diagram for abnormal data. Use judgment on the cost line. Can draw any number of lines… • Plot data • Draw line through points.

    

Least-Squares Regression

A mathematical technique to fit a unique cost estimating equation to all the observed data Minimizes the vertical squared difference between the estimated and actual costs at each data point Technique generally reliable Can estimate errors Accomplished using  Microsoft Excel ®   Statistical software Some calculators

Least-Squares Criterion

The least-squares method minimizes the sum of all squared vertical deviations between individual observations and the cost-estimating line.

Cautions in Developing Cost Estimate Equations

 Managers are responsible for making decisions  Mathematical models do not make decisions; they are tools to aid decision making  Not all data are based on normal operating conditions, throw out the abnormal…  Nonlinear relationships could exist  Results should make sense and be explainable

Unit Level Activity

This activity is performed for each unit of product produced or sold, variable on units.

Examples:

 Cost of raw materials  Cost of cutting a component  Cost of a box to package cereal  Sales commission

Batch Level Activity

This activity is performed for each batch of product produced or sold.

Examples:

 Cost of processing sales orders  Cost of equipment setup  Cost of moving a batch between work stations  Cost of inspecting batches

Product Level Activity

This activity is performed to support the production of each different type of product.

Examples:

 Cost of product development  Cost of product marketing such as product-related advertising  Cost of specialized equipment

Facility Level Activity

This activity is performed to maintain general capabilities.

Examples:

 Cost of maintaining factory building and grounds  Cost of non-specialized equipment  Cost of general advertising  Cost of factory supervisor