managerial accounting cost concept : importance and role ... · pdf fileonly those costs and...

FACULTY OF BUSINESS

Nurturing professionals with high moral and ethical values

Managerial AccountingManagerial AccountingManagerial AccountingManagerial Accounting

Assoc. Prof. Dr. Mohd Fuad Mohd [email protected]

4th. August 2012

Managerial AccountingManagerial AccountingManagerial AccountingManagerial Accounting

Cost Concept : Importance and RoleCost Concept : Importance and RoleCost Concept : Importance and RoleCost Concept : Importance and Role

in Decision Makingin Decision Makingin Decision Makingin Decision Making

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Cost Classifications For Decision Making

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� Every decision involves a choice between at least two

alternatives.

� Only those costs and benefits that differ between alternatives

are relevant in a decision. All other costs and benefits can and

should be ignored.

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Summary Of The Types Of Cost Classifications

� Financial reporting

� Predicting cost behavior

� Assigning costs to cost objects

� Decision making

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ISO 9000 STANDARDSISO 9000 STANDARDSISO 9000 STANDARDSISO 9000 STANDARDS

ISO 9000 standards have become ISO 9000 standards have become ISO 9000 standards have become ISO 9000 standards have become

international measures of quality.international measures of quality.international measures of quality.international measures of quality.

To become ISO 9000 certified, a company To become ISO 9000 certified, a company To become ISO 9000 certified, a company To become ISO 9000 certified, a company

must demonstrate:must demonstrate:must demonstrate:must demonstrate:

1. A quality control system is in use, and the system clearly

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1. A quality control system is in use, and the system clearly

defines an expected level of quality.

2. The system is fully operational and is backed up with

detailed documentation of quality control procedures.

3. The intended level of quality is being achieved on a

sustained basis.

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LEARNING OBJECTIVE 1

Understand how fixed and Understand how fixed and variable costs behave and how variable costs behave and how to use them to predict costs.to use them to predict costs.

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Behavior of Cost (within the relevant range)

Cost In Total Per Unit

Variable Total variable cost changes Variable cost per unit remains

as activity level changes. the same over wide ranges

Cost Classifications For Predicting Cost Behavior

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of activity.

Fixed Total fixed cost remains Average fixed cost per unit goes

the same even when the down as activity level goes up.

activity level changes.

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EXAMPLES OF VARIABLE COSTS

1. Merchandising companies – cost of goods sold.

2. Manufacturing companies – direct materials, direct labor, and variable overhead.

3. Merchandising and manufacturing companies –commissions, shipping costs, and clerical costs such as

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commissions, shipping costs, and clerical costs such as invoicing.

4. Service companies – supplies, travel, and clerical.

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THE ACTIVITY BASE (ALSO KNOWN AS COST DRIVER)

A measure of what

Unitsproduced

Machine hours

A measure of what causes the

incurrence of a variable cost

Miles driven

Labor hours

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Total O

verage Charges

on Cell Phone Bill

TRUE VARIABLE COST – AN EXAMPLEAs an example of an activity base, consider overagecharges on a cell phone bill. The activity base is thenumber of minutes used above the allowed minutes inthe calling plan.

Minutes Talked

Total O

verage Charges

on Cell Phone Bill

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TRUE VARIABLE COSTS

The amount of a true variable cost used during the period

varies in direct proportion to the activity level. The overage

charge on a cell phone bill was one example of a true

variable cost.

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Volume

Cost

Direct material is another

example of a cost that

behaves in a true variable

pattern.

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STEP-VARIABLE COSTS

Small changes in the level of production are not likely to have

any effect on the number of maintenance workers employed.

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Volume

Cost

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Cost In Total Per Unit

Variable Total variable cost is Variable cost per unit remains

Average fixed costs per unit decrease as the activity

level increases.

COST BEHAVIOR PATTERNS – FIXED

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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 unit

Fixed level changes within the decrease as the activity

relevant range. level increases.

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TYPES OF FIXED COSTS

Discretionary

May be altered in the short-term by current managerial decisions

Discretionary

May be altered in the short-term by current managerial decisions

Committed

Long-term, cannot be significantly reduced in

the short term.

Committed

Long-term, cannot be significantly reduced in

the short term.

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Examples

Advertising and Research and Development

Examples

Depreciation on Buildings and Equipment and Real

Estate Taxes

managerial decisionsmanagerial decisionsthe short term.the short term.

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THE TREND TOWARD FIXED COSTS

The trend in many industries is toward greater

fixed costs relative to variable costs.

As machines take overAs machines take over

many mundane tasksmany mundane tasks

Knowledge workersKnowledge workers

tend to be salaried,tend to be salaried,

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many mundane tasksmany mundane tasks

previously performedpreviously performed

by humans, by humans,

““knowledge workersknowledge workers””

are demanded forare demanded for

their minds rathertheir minds rather

than their muscles.than their muscles.

tend to be salaried,tend to be salaried,

highlyhighly--trained andtrained and

difficult to replace. Thedifficult to replace. The

cost of compensatingcost of compensating

these valued employeesthese valued employees

is is relatively fixedrelatively fixed

rather than variable.1rather than variable.1

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IS LABOR A VARIABLE OR A FIXED COST?

The behavior of wage and salary costs can differ

across countries, depending on labor regulations,

labor contracts, and custom.

In France, Germany, China, and Japan, management has

little flexibility in adjusting the size of the labor force.

Labor costs are more fixed in nature.

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Labor costs are more fixed in nature.

In the United States and the United Kingdom, management

has greater latitude. Labor costs are more variable in nature.

Within countries managers can view labor costs differently

depending upon their strategy. Most companies in the

United States continue to view direct labor as a variable cost.

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Rent Cost in Thousands

of Dollars

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FIXED COSTS AND THE RELEVANT RANGE

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Relevant

Range

The relevant range of

activity for a fixed

cost is the range of

activity over which

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Rent Cost in Thousands

of Dollars

0 1,000 2,000 3,000

Rented Area (Square Feet)

0

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activity over which

the graph of the cost

is flat.

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For example, assume office space is available at a For example, assume office space is available at a

rental rate of $30,000 per year in increments of rental rate of $30,000 per year in increments of

1,000 square feet. 1,000 square feet.

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Fixed costs would increase in Fixed costs would increase in

a step fashion at a rate of a step fashion at a rate of

$30,000 for each additional $30,000 for each additional

1,000 square feet. 1,000 square feet.

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Step-variable costs can


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How does this stepHow does this step--

function pattern function pattern

differ from a stepdiffer from a step--

variable cost?variable cost?

Step-variable costs can be adjusted more

quickly as conditions change and . . .

The width of the activity steps is much wider for

the fixed cost.

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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.

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relevant range.

c. Total fixed costs are constant within the relevant

range.

d. Total variable costs are constant within the

relevant range.

FACULTY OF BUSINESS


Which of the following statements about costbehavior are true?

a. Fixed costs per unit vary with the level of activity.

b. Variable costs per unit are constant within the

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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.

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Y

A mixed cost contains both variable and fixed

elements. Consider the example of utility cost.

MIXED COSTS (SEMIVARIABLE COSTS) Total Utility Cost

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Fixed Monthly

Utility Charge

Variable

Cost per KW

XActivity (Kilowatt Hours)

Total Utility Cost

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MIXED COSTS Total Utility Cost

Y

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Fixed Monthly

Utility Charge

Variable

Cost per KW

Activity (Kilowatt Hours)

Total Utility Cost

XXXX

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MIXED COSTS – AN EXAMPLE

If your fixed monthly utility charge is $40, your variable cost is $0.03 per If your fixed monthly utility charge is $40, your variable cost is $0.03 per

kilowatt hour, and your monthly activity level is 2,000 kilowatt hours, what kilowatt hour, and your monthly activity level is 2,000 kilowatt hours, what

is the amount of your utility bill?is the amount of your utility bill?

Y Y Y Y = a a a a + bXbXbXbX

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Y Y Y Y = a a a a + bXbXbXbX

Y Y Y Y = $40 + ($0.03 × 2,000)

Y Y Y Y = $100$100$100$100

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ANALYSIS OF MIXED COSTS: INDUSTRY BASED

In In account analysisaccount analysisaccount analysisaccount analysisaccount analysisaccount analysisaccount analysisaccount analysis, each account is , each account is

classified as either variable or fixed basedclassified as either variable or fixed based

on the analyst’s knowledge of how on the analyst’s knowledge of how

Account Analysis vs. the Engineering ApproachAccount Analysis vs. the Engineering Approach

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on the analyst’s knowledge of how on the analyst’s knowledge of how

the account behaves.the account behaves.

The The engineering approachengineering approachengineering approachengineering approachengineering approachengineering approachengineering approachengineering approach classifies costs based classifies costs based

upon an industrial engineer’s evaluation of upon an industrial engineer’s evaluation of

production methods, and material, labor and production methods, and material, labor and

overhead requirements.overhead requirements.

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WHY AND HOW TO REDUCE FIXED COSTS

� Typical fixed costs: production facilities, rentals, employees salaries and related

benefits and utilities

� Converting them into variable may reduce risk of financial commitment

and provide flexibility of capacity utilisation

� OutsourcingOutsourcingOutsourcingOutsourcing

� Business with fast and regular change and/or large varieties of

products most likely will benefit from this approach e.g. Nike and

Apple

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Apple

� Non-core business functions with lower value-add to majority

customers e.g. call centers for enquiries, 3rd party logistics, broker-

dealers’ securities back office operations

� OffshoringOffshoringOffshoringOffshoring

� Honda and Toyota Thailand plants

� HSBC back office functions in China

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(1) (1)

Use a scattergraph plot to Use a scattergraph plot to diagnose cost behavior.diagnose cost behavior.

HOW TO DETERMINE COSTS BEHAVIOR?

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diagnose cost behavior.diagnose cost behavior.

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Plot the data points on a graph (Total Cost YYYY vs.

Activity XXXX).

*

Maintenance Cost

1,000’s of Dollars

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**

*

*

*

*

YYYY

THE SCATTERGRAPH METHOD

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0 1 2 3 4

Maintenance Cost


10

0

**

** *

Patient-days in 1,000’s

XXXX

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Draw a line through the data points with about an

equal numbers of points above and below the line.

*

Maintenance Cost


20

**

*

*

*

*

YYYY

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0 1 2 3 4

Maintenance Cost


10

0

**

** *


XXXX

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Use one data point to estimate the total level of activity and the total cost.

*

Maintenance Cost


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*

*

*

*

*

*

*

*

YYYYTotal maintenance cost = $11,000

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Intercept = Fixed cost: $10,000

0 1 2 3 4

Maintenance Cost


10

0

**

* *


XXXX

Patient days = 800

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Make a quick estimate of variable cost per unit and determine the cost

equation.

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Variable cost per unit = $1,000

800= $1.25/patient-day

YY = $10,000 + $1.25= $10,000 + $1.25XX

Total maintenance costTotal maintenance cost Number of patient daysNumber of patient days

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(2) (2)

Analyze a mixed cost using the Analyze a mixed cost using the highhigh--low method.low method.

HOW TO DETERMINE COSTS BEHAVIOR?

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highhigh--low method.low method.

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THE HIGH-LOW METHOD – AN EXAMPLEAssume the following hours of maintenance work and the total

maintenance costs for six months.

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FACULTY OF BUSINESS


THE HIGH-LOW METHOD – AN EXAMPLE

The The variable cost per hourvariable cost per hour of of

maintenance is equal to the maintenance is equal to the

change in cost divided by the change in cost divided by the

change in hours.change in hours.

$2,400

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= $6.00/hour$6.00/hour$2,400

400

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THE HIGH-LOW METHOD – AN EXAMPLE

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Total Fixed Cost = Total Cost Total Fixed Cost = Total Cost –– Total Variable CostTotal Variable Cost

Total Fixed Cost = $9,800 Total Fixed Cost = $9,800 –– ($6/hour ($6/hour ×× 850 hours)850 hours)

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

Total Fixed Cost = Total Fixed Cost = $4,700$4,700

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THE HIGH-LOW METHOD

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YY = $4,700 + $6.00= $4,700 + $6.00XX

The Cost Equation for Maintenance

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Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the variable portion of sales salaries and commission?

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a. $0.08 per unit

b. $0.10 per unit

c. $0.12 per unit

d. $0.125 per unit

FACULTY OF BUSINESS


Sales salaries and commissions are $10,000 when

80,000 units are sold, and $14,000 when 120,000

units are sold. Using the high-low method, what is the

variable portion of sales salaries and commission?

a. $0.08 per unit

b. $0.10 per unit Units Cost

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b. $0.10 per unit

c. $0.12 per unit

d. $0.125 per unit

$4,000 ÷ 40,000 units

= $0.10 per unit

$4,000 ÷ 40,000 units

= $0.10 per unit

$4,000 ÷ 40,000 units

= $0.10 per unit

Units Cost

High level 120,000 14,000$

Low level 80,000 10,000

Change 40,000 4,000$

FACULTY OF BUSINESS


Sales salaries and commissions are $10,000 when

80,000 units are sold, and $14,000 when 120,000

units are sold. Using the high-low method, what is

the fixed portion of sales salaries and

commissions?

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a. $ 2,000

b. $ 4,000

c. $10,000

d. $12,000

FACULTY OF BUSINESS


Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the fixed portion of sales salaries and commissions?

a. $ 2,000

b. $ 4,000

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b. $ 4,000

c. $10,000

d. $12,000

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LEAST-SQUARES REGRESSION METHOD

A method used to analyze mixed costs if a

scattergraph plot reveals an approximately linear

relationship between the X and Y variables.

This method uses This method uses allall of theof the

data points to estimatedata points to estimate

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data points to estimatedata points to estimate

the fixed and variablethe fixed and variable

cost components of acost components of a

mixed cost.mixed cost.The goal of this method isThe goal of this method is

to fit a straight line to theto fit a straight line to the

data that data that minimizes theminimizes the

sum of the squared errorssum of the squared errors..

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LEAST-SQUARES REGRESSION METHOD

� Software can be used to fit a regression

line through the data points.

� The cost analysis objective is the same:

YYYY = = = = aaaa + + + + bXbXbXbX

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Least-squares regression also provides a statistic,

called the R2, which is a measure of the goodness

of fit of the regression line to the data points.

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SIMPLE REGRESSION ANALYSIS – AN EXAMPLE

MacroMacro CoCo.. wantswants toto knowknow itsits

averageaverage fixedfixed costcost andand variablevariable costcost

perper unitunit..

UsingUsing thethe datadata toto thethe right,right, let’slet’s seesee

howhow toto dodo aa regressionregression usingusing

MicrosoftMicrosoft ExcelExcel..

MacroMacro CoCo.. wantswants toto knowknow itsits

averageaverage fixedfixed costcost andand variablevariable costcost

perper unitunit..

UsingUsing thethe datadata toto thethe right,right, let’slet’s seesee

howhow toto dodo aa regressionregression usingusing

MicrosoftMicrosoft ExcelExcel..

43

MicrosoftMicrosoft ExcelExcel..MicrosoftMicrosoft ExcelExcel..

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SIMPLE REGRESSION USING EXCEL – AN EXAMPLE

You will need three pieces of information from your regression analysis:

1. Estimated Variable Cost Per Unit (line slope)

2. Estimated Fixed Costs (line intercept)

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intercept)

3. Goodness of fit, or R2

To get these three pieces

information we will need to use

three Excel functions.

SLOPE, INTERCEPT, and RSQ

To get these three pieces

information we will need to use

three Excel functions.

SLOPE, INTERCEPT, and RSQ

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Place your cursor in Place your cursor in cell F4 and press the cell F4 and press the

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cell F4 and press the cell F4 and press the = key. Click on the = key. Click on the pull down menu and pull down menu and scroll down to “More scroll down to “More

Functions . . .”Functions . . .”

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Scroll down to the Scroll down to the ““StatisticalStatistical”, ”,

functions. Now functions. Now scroll down the scroll down the


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statistical statistical functions until you functions until you

highlight highlight ““SLOPESLOPE””

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Here is the Here is the estimate of the estimate of the slope of the line.slope of the line.

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1. In the Known_y’s box, enter C4:C19 for the range.

2. In the Known_x’s box, enter D4:D19 for the range.

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With your cursor in With your cursor in cell F5, press the = cell F5, press the = key and go to the pull key and go to the pull

down menu for down menu for “Special Functions.” “Special Functions.” Select Select Statistical Statistical and and

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Select Select Statistical Statistical and and scroll down to scroll down to highlight the highlight the

INTERCEPTINTERCEPT function.function.

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Here is the Here is the estimate of the estimate of the fixed costs.fixed costs.

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Finally, we will Finally, we will determine the determine the ““goodness of goodness of

fitfit”, or ”, or RR22, by , by using the using the RSQRSQ

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using the using the RSQRSQ

function.function.

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Here is the Here is the estimate of estimate of RR22..

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1. In the Known_y’s box, enter C4:C19 for the range.

2. In the Known_x’s box, enter D4:D19 for the range.

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COMPARING THE THREE METHODS

The three methods just discussed provide slightly The three methods just discussed provide slightly

different estimates of the fixed and variable cost different estimates of the fixed and variable cost

components of the mixed cost.components of the mixed cost.

This is to be expected because each method uses This is to be expected because each method uses

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This is to be expected because each method uses This is to be expected because each method uses

differing amounts of the data points to provide differing amounts of the data points to provide

estimates.estimates.

LeastLeast--squares regression provides the most squares regression provides the most

accurate estimate because it uses all the data accurate estimate because it uses all the data

points.points.

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That’s all for today.That’s all for today.That’s all for today.That’s all for today.

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managerial accounting cost concept : importance and role ... · pdf fileonly those costs and...

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