Transcript Cost Accumulation Tracing and Allocation

Chapter
4
Cost Accumulation
Tracing and Allocation
Types of Cost Behavior Patterns
Recall the summary of our cost behavior discussion from Chapter 1.
Summary of Variable and Fixed Cost Behavior
Cost
In Total
Per Unit
Variable
Total variable cost is
proportional to the activity
level within the relevant range.
Variable cost per unit remains
the same over wide ranges
of activity.
Fixed
Total fixed cost remains the
same even when the activity
level changes within the
relevant range.
Fixed cost per unit goes
down as activity level goes up.
Total Variable Cost Example
Total Long Distance
Telephone Bill
Your total long distance telephone bill is based on how many
minutes you talk.
Minutes Talked
Variable Cost Per Unit Example
Per Minute
Telephone Charge
The cost per minute talked is constant. For example, 10 cents per
minute.
Minutes
Talked
Total Fixed Cost Example
Monthly Basic
Telephone Bill
Your monthly basic telephone bill is probably fixed and does not
change when you make more local calls.
Number of Local
Calls
Fixed Cost Per Unit Example
Monthly Basic Telephone
Bill per Local Call
The fixed cost per local call decreases as more local calls are made.
Number of Local
Calls
Cost Behavior
Examples of normally variable costs
Merchandisers
Cost of Goods Sold
Service
Organizations
Supplies and travel
Manufacturers
Direct Material, Direct
Labor, and Variable
Manufacturing
Overhead
Merchandisers and
Manufacturers
Sales commissions and
shipping costs
Examples of normally fixed costs
Merchandisers, manufacturers, and
service organizations
Real estate taxes, Insurance, Sales
salaries
Depreciation, Advertising
The Activity Base
Machine
hours
Units
produced
A measure of the event
causing the incurrence of a
variable cost – a cost driver
Miles
driven
Labor
hours
Step-Variable Costs
Cost
Total cost remains
constant within a
narrow range of
activity.
Activity
Step-Variable Costs
Cost
Total cost increases to a
new higher cost for the
next higher range of
activity.
Activity
Types of Fixed Costs
Fixed Costs
Committed
Long-term, cannot be
reduced in the short
term.
Examples
Depreciation on
Buildings and
Equipment
Discretionary
May be altered in the
short-term by current
managerial decisions
Examples
Advertising and
Research and
Development
Trend Toward Fixed Costs
Increased automation.
Increase in salaried knowledge workers who are difficult to train
and replace.
Implications
Managers are more “locked-in” with fewer decision
alternatives.
Planning becomes more crucial because fixed costs are
difficult to change with current operating decisions.
Fixed Costs and Relevant Range
Example: Office space is available at
a rental rate of SR.30,000 per year in
increments of 1,000 square feet. As
the business grows more space is
rented, increasing the total cost.
Rent Cost in
Thousands of Dollars
Fixed Costs and Relevant Range
90
Relevant
60
Range
30
00
3,000
1,000
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.
2,000
Rented Area (Square Feet)
Quick Check 
Which of the following statements about
cost behavior are true?
a. Fixed costs per unit vary with the level of activity.
b. Variable costs per unit are constant within the relevant range.
c. Total fixed costs are constant within the relevant range.
d. Total variable costs are constant within the relevant range.
Fixed Costs and Relevant Range
How does this type
of fixed cost differ
from a step-variable
cost?
Step-variable costs
can be adjusted more
quickly and . . .
The width of the
activity steps is much
wider for the fixed
cost.
Mixed Costs
A mixed cost
has both fixed
and variable
components.
Consider the
following
electric utility
example.
Mixed Costs
Total Utility Cost
Y
Variable
Utility
Charge
Fixed Monthly
Activity (Kilowatt Hours)
X
Utility Charge
The total mixed cost line can be expressed
as an equation: Y = a + bX
Mixed Costs
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)
Y
Total Utility Cost
X = the level of activity
Variable
Utility
Charge
Fixed Monthly
Activity (Kilowatt Hours)
X
Utility Charge
Mixed Costs
Total Utility Cost
Y
Variable
bX
a
Activity (Kilowatt Hours)
Utility
Charge
Fixed Monthly
X
Utility Charge
The Analysis of Mixed Costs
Account Analysis
Engineering Approach
High-Low Method
Scattergraph Method
Least-Square Regression Method
Account Analysis
Each account is classified as either
variable or fixed based on the analyst’s
knowledge of how the account behaves.
Engineering Estimates
Cost estimates are based on an evaluation
of production methods, and material, labor
and overhead requirements.
The High-Low Method
Wise Co recorded the following production activity and
maintenance costs for two months:
High activity level
Low activity level
Change
Units
9,000
5,000
4,000
Cost
$ 9,700
6,100
$ 3,600
Using these two levels of activity, compute:
 the variable cost per unit;
 the fixed cost; and then
 express the costs in equation form Y = a + bX
The High-Low Method
High activity level
Low activity level
Change
 Unit variable cost =
Units
9,000
5,000
4,000
Cost
$ 9,700
6,100
$ 3,600
Change in cost
Change in units
The High-Low Method
High activity level
Low activity level
Change
Units
9,000
5,000
4,000
Cost
$ 9,700
6,100
$ 3,600
The High-Low Method
High activity level
Low activity level
Change
Units
9,000
5,000
4,000
Cost
$ 9,700
6,100
$ 3,600
The High-Low Method
High activity level
Low activity level
Change
Units
9,000
5,000
4,000
Cost
$ 9,700
6,100
$ 3,600
Quick Check 
If sales salaries and commissions are SR.10,000
when 80,000 units are sold and SR.14,000 when
120,000 units are sold, what is the variable
portion of sales salaries and commission?
a.
SR.0.08 per unit
b.
SR.0.10 per unit
c.
SR.0.12 per unit
d.
SR.0.125 per unit
Quick Check 
If sales salaries and commissions are
SR.10,000 when 80,000 units are sold and
SR.14,000 when 120,000 units are sold,
what is the fixed portion of sales salaries
and commissions?
a.
SR. 2,000
b.
SR. 4,000
c.
SR.10,000
d.
SR.12,000
Note
 How does the high-low method work when
you have data for more than two periods?
March
April
Low May
June
High July
Patients
Admitted
2,510
2,550
2,480
2,590
2,670
Costs of
Admitting
$ 15,204
$ 14,976
$ 14,680
$ 15,108
$ 15,060
 Select the two periods with the lowest and
highest level of activity.
The Scattergraph Method
Plot the data points on a
graph (total cost vs. activity).
Total Cost in
1,000’s of Dollars
Y
20
10
0
0
* *
*
**
*
*
*
*
*
1
2
3
X
4
Activity, 1,000’s of Units Produced
The Scattergraph Method
Draw a line through the data points with about an
equal numbers of points above and below the line.
Y
Total Cost in
1,000’s of
Dollars
20
10
0
* *
*
**
*
*
*
*
*
0
1
2
3
4
Activity,
1,000’s of Units
Produced
X
The Scattergraph Method
Total Cost in
1,000’s of Dollars
Y
20
10
The slope of this line is the variable unit cost.
(Slope is the change in total cost for a one unit
change in activity).
* *
*
**
*
*
*
*
*
Estimated fixed cost = SR.10,000
0
0
1
2
3
4
Activity, 1,000’s of Units Produced
X
The Scattergraph Method
Total Cost in
1,000’s of Dollars
Y
20
10
0
Slope=
Change in cost
Change in units
* *
*
**
*
*
*
*
*
Horizontal distance is
the change in activity.
0
1
2
3
4
X
Activity, 1,000’s of Units Produced
Vertical
distance
is the
change
in cost.
Least-Squares Regression Method
Software can be used to
fit a regression line
through the data points.
The cost analysis
objective is the same:
Y = a + bx
Least-squares regression also provides a statistic, called
the adjusted R2, that is a measure of the goodness
of fit of the regression line to the data points.
Least-Squares Regression Method
R2 is the percentage of the variation
in total cost explained by the activity.
Y
Total Cost
20
10
* ** *
* * **
* R2*for this relationship is near
100% since the data points are
very close to the regression line.
0
0
1
2
3
Activity
4
X
Note
Problems with the high-low method:
Throws away information contained in all of
the data other than the low and the high
points.
The low and high levels of activity tend to be
unusual.
You should always plot the data if you
have more than two points to make sure
it even makes sense to be using the
high-low method.
The Contribution Format
Sales Revenue
Less: Variable costs
Contribution margin
Less: Fixed costs
Net income
Total
$ 100,000
60,000
$ 40,000
30,000
$ 10,000
Unit
$ 50
30
$ 20
The contribution margin format emphasizes cost
behavior. Contribution margin covers fixed costs
and provides for income.
The Contribution Format
Used primarily for
external reporting.
Used primarily by
management.