sketching cost curves 2

8/10/2019 Sketching Cost Curves 2

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Sketching Cost Curves

Objectives: construct cost curves


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LETS RECAP.


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Remember costs include:

Fixed costs

Variable costsMixed costs


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Mixed Cost

Other cost act like a combination of fixedand variable cost.

These kinds of costs are called mixed costs.Like a fixed cost it has an amount even

when volume is at zero. Then unlike a fixed cost it increasessteadily in production to the increase in

volume.


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The simpliest of handling mixed cost is toseparate them into fixed and variablecomponents.

The fixed component is added to other fixedcosts for the planning period and the variablecomponent is added to the other variable costsfor the planning period.


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Cost Classifications forPredicting Cost Behavior

Behavior of Cost (within the relevant range)

Cost In Total Per UnitVariable Total variable cost changes Variable cost per unit rem

as activity level changes. the same over wide rangesof activity.

Fixed Total fixed cost remains Average fixed cost per unit the same even when the down as activity level goes uactivity level changes.


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Fixed Monthly

Phone Charge

VariableCost per minute

Activity (minutes)

T o

t a l M o b

i l e

P h o n e

C o s

t

X

Y

Mixed CostsThe total mixed cost line can be expressedas an equation: Y = a + bX

Where: Y = the total mixed costa = the total fixed cost (the

vertical intercept of the line)b = the variable cost per unit of

activity (the slope of the line)X = the level of activity


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Plot the data points on a graph(total cost vs. activity).

0 1 2 3 4

*

M a i n t e n a n c e

C o s

t

1 , 0

0 0 s o

f D o

l l a r s

10

20

0

***

* ** ***

Patient- days in 1,000s

X

Y

The Scattergraph Method


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The Scattergraph MethodDraw a line through the data points with about anequal numbers of points above and below the line.

0 1 2 3 4

*


C o s

t

1 , 0

0 0 s o

f D o

l l a r s

10

20

0

***

* ** ***


X

Y


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The Scattergraph MethodDraw a line through the data points with about anequal numbers of points above and below the line.

0 1 2 3 4

*


C o s

t

1 , 0

0 0 s o

f D o

l l a r s

10

20

0

***

* ** ***


X

Y


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The Scattergraph MethodMake a quick estimate of variable cost per unit anddetermine the cost equation.

Variable cost per unit = $1,000800 = $1.25/patient-day

Y = $10,000 + $1.25X

Total maintenance at 800 patients $11000Less: Fixed cost $10000Estimated total variable cost for 800 patients $1000

Total maintenance cost Number of patient days


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SKETCHING COST CURVES

Now lets get down to business


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Introduction:

The most important building block for costaccounting is the characterization of how costschange as output volume changes.


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The following discussion examines the volumeof production in a factory, but the sameprinciples apply regardless of the type oforganization and the appropriate measure ofactivity


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Variable Costs:

Variable costs vary in a linear fashion with theproduction level. However, when stated on a perunit basis, variable costs remain constant acrossall production levels within the relevant range .

The following two charts depict this relationshipbetween variable costs and output volume.


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CASE 1

A good example of a variable cost is materials. Ifone pair of pants requires $10 of fabric, thenevery pair of pants requires $10 of fabric, no

matter how many pairs are made. The fabric cost is $10 per unit at every level ofproduction. If one pair is made, the total fabric

cost is $10; if two pairs are made, the total fabriccost is $20; and if 1,000 pairs are made, the totalfabric cost is $10,000. Hence, the total cost isincreasing and linear in the production level.SEE THE TWO GRAPHS BELOW


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Variable Cost Per Unit


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Fixed Costs:

Fixed costs do not vary with the productionlevel. Total fixed costs remain the same, withinthe relevant range .However, the fixed cost per unit decreases asproduction increases, because the same fixedcosts are spread over more units. The followingtwo charts depict this relationship between fixedcosts and output volume.


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Case 2

In this example, fixed costs are $50,000. Thefirst chart shows that fixed costs remain $50,000at all production levels from 100 units to 1,000units. The second chart shows that the fixedcost per unit decreases as production increases.Hence, when 100 units are manufactured, the

fixed cost per unit is $500 ($50,000 100). When 500 units are manufactured, the fixed costper unit is $100 ($50,000 500)


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Total Fixed Cost


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Fixed Cost Per Unit


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Mixed Costs:

If, within a relevant range, a cost is neither fixednor variable, it is called semi-variable or mixed .Following are two common examples of mixedcosts.


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Case 3

In this example, although the total cost lineincreases in production, it does not pass throughthe origin because there is a fixed costcomponent. An example of a cost that fits thisdescription is electricity. A fixed amount ofelectricity is required to run the factory air

conditioning, computers and lights. There is alsoa variable cost component related to running themachines on the factory floor.


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The fixed component in this example is $3,000per month. The variable cost component is $10per unit of output. Hence, at a production levelof 500 units, the total electric cost is $8,000[$3,000 + ($10 x 500)].


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Mixed costs


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What is meant by relevantrange

The relevant range is the range of activity (e.g.,production or sales) over which theserelationships are valid.OrRelevant range : Relevant rangeis a term thatrelates to machinery and equipment. Think ofrelevant range as the maximum level of use forthe item you operate in your business.


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Case 4

The mixed cost illustrated in the chart below iscalled a step function.

An example of such cost behaviour would be the total

salary expense for shift supervisors.If the factory runs one shift, only one shift supervisor isrequired. In order for the factory to produce above themaximum capacity of a single shift, the factory mustadd a second shift and hire a second shift supervisor, sothat total shift supervisor salary expense doubles. If thefactory runs three shifts, three shift supervisors arerequired


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Step Fixed Cost Curve


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Step-variable costs

Step-variable costs are costs that stay fixedover a range of activity and then change afterthis range is overcome. In other words, thesecosts change in increments.


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Step-variable costs

Step-variable costs include characteristic of both variable and fixed costs in a way that (a) step-variablecosts do change as production level changes, and (b)step-variable costs change only when a production level

(range of activity) is overcome. Within that range of activity step-variable costs remainfixed. The major differences between step-variablecosts and fixed costs are that step-variable costs arechanged by activity (rather than by a managementdecision) and step-variable costs are more easilychanged compared to fixed costs.


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Step-variable Costs To illustrate step-variable costs, let us use the example

with valve production. One employee can operateequipment to produce 100 valves per day. If 320 valvesneed to be produced, Friends Company would hire fouremployees (three employees won't be enough becausethree employees can only produce 300 valves). If the

valve production requirement is increased to 400 units,four workers will still be able to cope with the work load.

However, for 410 valves, an additional, fifth employee would be needed. Thus, the company's payroll costschange in steps, from costs for four employees at 320 or400 units, to payroll costs for five employees at 410 units


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Step Variable Cost Curve


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Assignment

Worksheet no. 1

sketching cost curves 2

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