View
68
Download
1
Category
Tags:
Preview:
Citation preview
Learning Objective 1
Understand how fixed Understand how fixed and variable costs and variable costs
behave and how to use behave and how to use them to predict costs.them to predict costs.
Summary of Variable and Fixed Cost Behavior
Cost In Total Per Unit
Variable Total variable cost is Variable cost per unit remainsproportional to the activity the same over wide ranges
level within the relevant range. of activity.
Total fixed cost remains thesame even when the activity Fixed cost per unit goes
Fixed level changes within the down as activity level goes up. relevant range.
Recall the summary of our cost behavior discussion from an earlier chapter.
Types of Cost Behavior Patterns
The Activity Base
A measure of what causes the
incurrence of a variable cost
A measure of what causes the
incurrence of a variable cost
Unitsproduced
Unitsproduced
Miles drivenMiles driven
Labor hoursLabor hours
Machine hours
Machine hours
Minutes Talked
To
tal Lo
ng
Dis
tan
ceTele
ph
on
e B
ill
True Variable Cost Example
A variable cost is a cost whose total dollar amount varies in direct proportion to changes in the activity level. Your
total long distance telephone bill is based on how many minutes you talk.
Summary of Variable and Fixed Cost Behavior
Cost In Total Per Unit
Variable Total variable cost is Variable cost per unit remainsproportional to the activity the same over wide ranges
level within the relevant range. of activity.
Total fixed cost remains thesame even when the activity Fixed cost per unit goes
Fixed level changes within the down as activity level goes up. relevant range.
Recall the summary of our cost behavior discussion from an earlier chapter.
Types of Cost Behavior Patterns
Minutes Talked
Per
Min
ute
Tel
ephone
Char
ge
Variable Cost Per Unit Example
A variable cost remains constant if expressed on a per unit basis. The cost per minute talked is constant. For
example, 10 cents per minute.
Extent of Variable Costs
The proportion of variable costs differs across organizations. For example . . .
A public utility withlarge investments inequipment will tend
to have fewervariable costs.
A manufacturing companywill often have many
variable costs.
A merchandising companyusually will have a high
proportion of variable costs,like cost of sales.
A service companywill normally have a high
proportion of variable costs.
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 invoicing.
4. Service companies – supplies, travel, and clerical.
Volume
Co
st
True Variable Cost
Direct materials is a true or proportionately variable cost because the amount used during a period will vary in direct proportion to the level of production activity.
Step-Variable Costs
A resource that is obtainable only in large chunks (such as maintenance workers) and whose costs increase or
decrease only in response to fairly wide changes in activity is known as a step-variable cost.
Volume
Co
st
Step-Variable Costs
Small changes in the level of production are not likely to have any effect on the number of
maintenance workers employed.
Volume
Co
st
Step-Variable Costs
Only fairly wide changes in the activity level will cause a change in the number of maintenance
workers employed
Volume
Co
st
RelevantRange
A straight line closely
approximates a curvilinear variable cost
line within the relevant range.
A straight line closely
approximates a curvilinear variable cost
line within the relevant range.
Activity
To
tal
Co
st
Economist’sCurvilinear Cost
Function
The Linearity Assumption and the Relevant Range
Accountant’s Straight-Line Approximation (constant unit
variable cost)
Summary of Variable and Fixed Cost Behavior
Cost In Total Per Unit
Variable Total variable cost is Variable cost per unit remainsproportional to the activity the same over wide ranges
level within the relevant range. of activity.
Total fixed cost remains thesame even when the activity Fixed cost per unit goes
Fixed level changes within the down as activity level goes up. relevant range.
Let’s look at fixed cost behavior on the next screens.
Types of Cost Behavior Patterns
Number of Local Calls
Mo
nth
ly B
asi
c Tele
ph
on
e B
ill
Total Fixed Cost Example
A fixed cost is a cost whose total dollar amount remains constant as the activity level changes. Your monthly basic
telephone bill is probably fixed and does not change when you make more local calls.
Summary of Variable and Fixed Cost Behavior
Cost In Total Per Unit
Variable Total variable cost is Variable cost per unit remainsproportional to the activity the same over wide ranges
level within the relevant range. of activity.
Total fixed cost remains thesame even when the activity Fixed cost per unit goes
Fixed level changes within the down as activity level goes up. relevant range.
Recall the summary of our cost behavior discussion from an earlier chapter.
Types of Cost Behavior Patterns
Number of Local Calls
Mo
nth
ly B
asic
Tel
eph
on
e B
ill p
er L
oca
l Ca
ll
Fixed Cost Per Unit Example
Average fixed costs per unit decrease as the activity level increases. The fixed cost per local call decreases as more
local calls are made.
Examples
Advertising and Research and Development
Examples
Depreciation on Equipment and
Real Estate Taxes
Types of Fixed Costs
Discretionary
May be altered in the short-term by current managerial decisions
Committed
Long-term, cannot be significantly reduced in
the short term.
The Trend Toward Fixed Costs
The trend in many industries is toward greater fixed costs relative to variable costs.
As machines take overmany mundane taskspreviously performed
by humans, “knowledge workers”
are demanded fortheir minds ratherthan their muscles.
Knowledge workerstend to be salaried,highly-trained and
difficult to replace. Thecost to compensate
these valued employeesis relatively fixed
rather than variable.
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.
In the United States and the United Kingdom, management has greater latitude. Labor costs are more variable in nature.
Ren
t C
ost
in
Th
ou
san
ds
of
Do
llars
0 1,000 2,000 3,000 Rented Area (Square Feet)
0
30
60
Fixed Costs and Relevant Range
90
Relevant
Range
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.
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.
Fixed Costs and Relevant Range
Example:Example: Office space is Office space is available at a rental rate of available at a rental rate of
$30,000 per year in $30,000 per year in increments of 1,000 square increments of 1,000 square feet. As the business grows, feet. As the business grows,
more space is rented, more space is rented, increasing the total cost.increasing the total cost.
The relevant range of activity for a fixed cost is the range of activity over which the graph of the cost is
flat.
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.
Fixed Costs and Relevant Range
Quick Check
Which of the following statements about cost behavior are true?
1. Fixed costs per unit vary with the level of activity.2. Variable costs per unit are constant within the
relevant range.3. Total fixed costs are constant within the relevant
range.4. Total variable costs are constant within the relevant
range.
Quick Check
Which of the following statements about cost behavior are true?
1. Fixed costs per unit vary with the level of activity.
2. Variable costs per unit are constant within the relevant range.
3. Total fixed costs are constant within the relevant range.
4. Total variable costs are constant within the relevant range.
Fixed Monthly
Utility Charge
Variable
Cost per KW
Activity (Kilowatt Hours)
To
tal
Uti
lity
Co
st
X
Y
A mixed cost has both fixed and variablecomponents. Consider the example of utility cost.
Mixed Costs
Total mixed cost
Fixed Monthly
Utility Charge
Variable
Cost per KW
Activity (Kilowatt Hours)
To
tal U
tility
Co
st
X
Y
Mixed Costs
Total mixed cost
Mixed Costs Example
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 is the amount of your
utility bill?
Y = a + bX
Y = $40 + ($0.03 × 2,000)
Y = $100
Analysis of Mixed Costs
Each account is classified as eithervariable or fixed based on the analyst’s
knowledge of how the account behaves.
Cost estimates are based on an evaluation of production methods, and
material, labor and overhead requirements.
Account Analysis and the Engineering Approach
Learning Objective 2
Use a scattergraph plot Use a scattergraph plot to diagnose cost to diagnose cost
behavior.behavior.
Plot the data points on a graph (total cost vs. activity).
0 1 2 3 4
*
Mai
nte
nan
ce
Co
st
1,0
00’s
of
Do
llars
10
20
0
***
**
**
*
*
Patient-days in 1,000’s
X
Y
The Scattergraph Method
The Scattergraph Method
Draw a line through the data points with about anequal numbers of points above and below the line.
0 1 2 3 4
*
Mai
nte
nan
ce
Co
st
1,0
00’s
of
Do
llars
10
20
0
***
**
**
*
*
Patient-days in 1,000’s
X
Y
The Scattergraph Method
Use one data point to estimate the total level of activity and the total cost.
Intercept = Fixed cost: $10,000
0 1 2 3 4
*
Mai
nte
nan
ce
Co
st
1,0
00’s
of
Do
llars
10
20
0
***
**
**
*
*
Patient-days in 1,000’s
X
Y
Patient days = 800Patient days = 800
Total maintenance cost = $11,000Total maintenance cost = $11,000
The Scattergraph Method
Make a quick estimate of variable cost per unit and determine the cost equation.
Variable cost per unit = $1,000 800
= $1.25/patient-day$1.25/patient-day
Y = $10,000 + $1.25XY = $10,000 + $1.25X
Total maintenance at 800 patients 11,000$ Less: Fixed cost 10,000 Estimated total variable cost for 800 patients 1,000$
Learning Objective 3
Analyze a mixed cost Analyze a mixed cost using the high-low using the high-low
method.method.
The High-Low Method
Assume the following hours of maintenance work and the total maintenance costs for six months.
The High-Low Method
The The variable cost variable cost per hourper hour of of
maintenance is maintenance is equal to the change equal to the change
in cost divided by in cost divided by the change in hours.the change in hours.
The High-Low Method
Total Fixed Cost = Total Cost – Total Variable Cost
Total Fixed Cost = $9,800 – ($8/hour × 800 hours)
Total Fixed Cost = $9,800 – $6,400
Total Fixed Cost = $3,400
Quick Check
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 unitb. $0.10 per unit c. $0.12 per unitd. $0.125 per unit
Quick Check
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 unitb. $0.10 per unit c. $0.12 per unitd. $0.125 per unit
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 unitb. $0.10 per unit c. $0.12 per unitd. $0.125 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$
Quick Check
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. $ 2,000b. $ 4,000 c. $10,000d. $12,000
Quick Check
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. $ 2,000b. $ 4,000 c. $10,000d. $12,000
Least-Squares Regression Method
A method used to analyze mixed costs if a scattergraph plot reveals an approximately linear relationship between
the X and Y variables.
This method uses all of thedata points to estimatethe fixed and variablecost components of a
mixed cost.The goal of this method isThe goal of this method isto fit a straight line to theto fit a straight line to thedata that data that minimizes the
sum of the squared errors..
Least-Squares Regression Method
• Software can be used to fit a regression line through the data points.
• The cost analysis objective is the same: Y = a + bX
Least-squares regression also provides a statistic,
called the R2, which is a measure of the goodness
of fit of the regression line to the data points.
0 1 2 3 4
To
tal
Co
st
10
20
0
Activity
****
**
****
Least-Squares Regression Method
R2 is the percentage of the variation in total cost explained by the activity.
R2 varies from 0% to 100%, andthe higher the percentage the better.
X
Y
Learning Objective 4
Prepare an income Prepare an income statement using the statement using the contribution format.contribution format.
Let’s put our knowledge of cost
behavior to work by preparing a
contribution format income statement.
The Contribution Format
The Contribution Format
Total Unit
Sales Revenue 100,000$ 50$
Less: Variable costs 60,000 30
Contribution margin 40,000$ 20$
Less: Fixed costs 30,000
Net operating income 10,000$
The contribution margin format emphasizes cost behavior. Contribution margin covers fixed
costs and provides for income.
Uses of the Contribution Format
The contribution income statement format is used as an internal planning and decision making tool. We will use
this approach for:
1. Cost-volume-profit analysis (Chapter 6).
2. Budgeting (Chapter 9).
3. Segmented reporting of profit data (Chapter 12).
4. Special decisions such as pricing and make-or-buy analysis (Chapter 13).
The Contribution Format
Comparison of the Contribution Income Statement with the Traditional Income Statement
Traditional Approach Contribution Approach (costs organized by function) (costs organized by behavior)
Sales 100,000$ Sales 100,000$ Less cost of goods sold 70,000 Less variable expenses 60,000 Gross margin 30,000$ Contribution margin 40,000$ Less operating expenses 20,000 Less fixed expenses 30,000 Net operating income 10,000$ Net operating income 10,000$
Used primarily forexternal reporting.
Used primarily bymanagement.
Practice question 3
• Sales for a retail store were $250,000. Net operating income totaled $30,000 and cost of goods sold was $110,000. If the contribution margin was $100,000, total variable selling and administrative expenses must have been:
• A) $40,000• B) $100,000• C) $70,000• D) $150,000
Practice question 4
• In January, Verba Corporation, a manufacturing company, reported the following financial data:
•
• Required:• Prepare an income statement in good form for January
using the traditional approach.• Prepare an income statement in good form for January
using the contribution approach.
Sales .......................................................... $460,000 Variable production expense..................... $84,000 Fixed production expense ......................... $100,000 Variable selling expense ........................... $12,000 Fixed selling expense ................................ $47,000 Variable administrative expense ............... $33,000 Fixed administrative expense .................... $132,000
Recommended