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

b = Variable cost per unit

Total variable costs (Y)

Total activity (X)0

Variable cost: Y = bX

Higher variable costs per unit

create a steeper line

slope.

Fixed Costs

No change as activity increases or decreases

Example: Depreciation

a = Total fixed costs

Total fixed

costs (Y)

Total activity (X)0

Fixed cost: Y = a

Slope is zero, represented by

a flat line.

Mixed Costs Increase in a linear fashion when

activity increases Positive in amount when activity is

zero Example: Maintenance

b = Variable cost per unit

Mixed cost: Y = a + bX

Total mixed

costs (Y)

Total activity (X)0

Contains both fixed and

variable cost elements.

Fixed portion

Variable portion

Step Costs Increase in a step like fashion as

activity increases Example: Supervisors

Step cost: Y = ai

Total step

costs (Y)

Total activity (X)0

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 CostsClassification 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.

Committed fixed costs, known also as capacity costs, are required to

maintain the current service or production capacity or to

fill previous legal

commitments. Discretionary fixed costs , known also as

managed fixed costs, are set at a fixed amount each

period by management.

Discretionary fixed costs , known also as

managed fixed costs, are set at a fixed amount each

period by management.

DepreciationReal-estate taxes

TrainingAdvertising

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

High-low method

Scatter diagrams

Least-squares regression analysis

Methods of estimating fixed and variable

cost components

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

Select a representative high point and a representative low activity point.Determine variable costs per unit:

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

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

Step 2:Step 2:

Step 3:Step 3:

Step 1:Step 1:

Total Fixed Costs =Total Fixed Costs =

Difference in total costsDifference in activity

Variable CostsPer Unit =

High-Low Example: Variable Costs

Low activity period

Number of Packaging Shipments Costs

January 8,600 $25,000February 9,800 26,000March 11,600 31,600April 11,200 33,000

High activity period

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

Variable cost per unit (b) = $2.20 per unit

January

a = Total costs – Variable costs

$25,000 = a + ($2.20 × 8,600 units)

a = $6,080

March $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.

Calculate fixed costs:

Scatter DiagramsExamine 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

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

Examples:

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

product produced or sold, variable on units.

Batch Level Activity

Cost of processing sales orders Cost of equipment setup Cost of moving a batch between

work stations Cost of inspecting batches

Examples:

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

Product Level Activity

Cost of product development Cost of product marketing such as

product-related advertising Cost of specialized equipment

Examples:

This activity is performed to support the production of each

different type of product.

This activity is performed to support the production of each

different type of product.

Facility Level Activity

Cost of maintaining factory building and grounds

Cost of non-specialized equipment Cost of general advertising Cost of factory supervisor

Examples:

This activity is performed to maintain general capabilities.

This activity is performed to maintain general capabilities.