03 Activiy Cost Behavior

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Chapter 1 - 1

AGUS SISWANDI

01153056

MANAGEMENT

ACCOUNTING


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Chapter 1 - 2

Chapter ThreeActivity Cost

Behavior


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Chapter 1 - 3

Learning Objectives

Define and describe cost behavior forfixed, variable, and mixed costs.

Explain the role of the resource usagemodel in understanding cost behavior.

Separate mixed costs into their fixed and

variable components using the high-lowmethod, the scatterplot method, and themethod of least squares.


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Chapter 1 - 4

Learning Objectives (continued)

Evaluate the reliability of a cost equation.

Explain the role of multiple regression inassessing cost behavior.

Describe the use of managerial judgment

in determining cost behavior.


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Chapter 1 - 5

Cost Behavior

Fixed-Cost Behavior Variable-Cost Behavior

$ $Relevant Range

Units Produced Units Produced


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Chapter 1 - 6

Mixed-Cost Behavior

Total Costs

Cost

Number of Units Produced

Fixed Costs

Variable Costs

Linearity Assumption

Total cost = Fixed cost + Total variable cost


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Chapter 1 - 7

Activity Cost Behavior Model

Inputs:

Materials

Energy

Labor

Capital

Cost Behavior

Activities Activity Output

Changes in Input Cost Changes in Output


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Chapter 1 - 8

Basic Terms

The linearity assumption assumes that variable

costs increase in direct proportion to the number

of units produced (or activity units used).Practical capacityis the efficient level of activity

performance.


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Chapter 1 - 9

Types of Fixed Resources

Flexible Resources

Committed Resources

Discretionary Fixed Expenses


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Chapter 1 - 10

Flexible Resources

Flexible resources are supplied as used and needed.

They are acquired from outside sources, where the terms

of acquisition do not require any long-term commitment

for any given amount of the resource

Example: Materials and energy


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Chapter 1 - 11

Committed Resources

Committed resources are resources that are supplied in

advance of usage.They are acquired by the use of either an explicit or implicit

contract to obtain a given quantity of resource, regardless of

whether the amount of the resource available is fully used or

not. Committed resources may have unused capacity.

Example: Buying or leasing a building or equipment


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Chapter 1 - 12

Discretionary Fixed Expenses

Discretionary fixed expenses are shorter-term

committed resources.

Example: The hiring of new receiving clerks


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Chapter 1 - 13

Step-Cost Function

Cost

Activity Output (units)

Narrow Width


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Chapter 1 - 14

Step-Fixed Costs

Cost

Activity Usage

Normal

Operating

Range

(Relevant Range)


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Chapter 1 - 15

Resource Relationships

The relationship between resources supplied and

resources used is expressed by the following

equation:

Resources available = Resources used + Unused capacity


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Chapter 1 - 16

Resource Relationships Example

Three engineers hired at $50,000 each

Each engineer is capable of processing 2,500 change

orders

$90,000 was spent on supplies for the engineering

activity

There were 6,000 orders processed

R R l ti hi E l


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Chapter 1 - 17


(continued)

Available orders = Orders used + Orders unused

7,500 orders = 6,000 orders + 1,500 orders

Fixed engineering rate = $150,000/7,500

= $20 per change order

Variable engineering rate = $90,000/6,000

= $15 per change order

R R l ti hi E l


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Chapter 1 - 18


(continued)

Cost of orders supplied = Cost of orders used + Cost of unused orders

= [($20 + $15) x 6,000] + ($20 x 1,500)

= $240,000

Of course, the $240,000 is precisely equal to the $150,000 spent on engineers

and the $90,000 spent on supplies.

The $30,000 of excess engineering capacity means that a new product could

be introduced without increasing current spending on engineering.

M th d f S ti Mi d C t


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Chapter 1 - 19

Methods for Separating Mixed Costs

into Fixed and Variable Components

The High-Low Method

The Scatterplot Method

The Method of Least Squares


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Chapter 1 - 20

Month Setup Costs Setup Hours

January $1,000 100

February 1,250 200

March 2,250 300

April 2,500 400

May 3,750 500

High-Low Method: An Example


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Chapter 1 - 21

The High-Low Method (continued)

Variable

Rate (V) = Change in cost/Change in output

V = (High cost - Low cost) / (High output - Low output)

V = ($3,750 - $1,000) / (500 - 100)

V = $2,750 / 400

V = $6.875 per setup hour


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Chapter 1 - 22

The High-Low Method (continued)

$3,750 = Fixed costs + $6.875 (500)

Fixed costs = $3,750.00 - $3,437.50

Fixed costs =$312.50

The cost formula using the high-low method is:

Total cost = $312.50 + ($6.875 x setup hours)


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Chapter 1 - 23

Activity Hours

Activity

Cost

$4,000

3,000

2,000

1,000

0100 200 300 400 500

.

Scatterplot Method

.

..

.

Analyst can fit line

based on his or her

experience

Important: Cost function is only

relevant within relevant range


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Chapter 1 - 25

Upward Shift in Cost Relationship

Activity

Cost

0 Activity Output

**

*

*

*

*


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Chapter 1 - 26

Presence of Outliers

Activity

Cost

0 Activity Output

**

*

*

*

*


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Chapter 1 - 27

Least Squares

Constant 125

Std Err of Y Est 299.304749934466

R squared 0.944300518134715No. of Observations 5

Degrees of Freedom 3

X Coefficient(s) 6.75

Std Err of Coef. 0.9464847243


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Chapter 1 - 28

Least Squares (continued)

The results give rise to the following equation:

Setup Costs = $125 + ($6.75 x # of setup hours)

R2 = .944, or 94.4 percent of the variation in setup costs is explained by

the number of setup hours variable.


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Chapter 1 - 29

TC = b0 + b1X1 + b2X2 + . . .

b0 = the fixed cost or intercept

bi = the variable rate for the ith independent variable

Xi = the ith independent variable

Multiple Regression


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Chapter 1 - 30

Multiple Regression (continued)Utility

Month MHrs Summer CostJanuary 1,340 0 $1,688

February 1,298 0 1,636

March 1,376 0 1,734

April 1,405 0 1,770

May 1,500 1 2,390

June 1,432 1 2,304

July 1,322 1 2,166

August 1,416 1 2,284

September 1,370 1 1,730

October 1,580 0 1,991

November 1,460 0 1,840

December 1,455 0 1,833


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Chapter 1 - 31

Multiple Regression (continued)

Constant 243.11149907159

Std Err of Y Est 55.5082829356447

R squared 0.96717927255452No. of Observations 12

Degrees of Freedom 9

X Coefficient(s) 1.09715750519456 510.49073361447

Std Err of Coef. 0.210226332115593 32.5489645352191


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Chapter 1 - 32

Multiple Regression (continued)

The results gives rise to the following equation:

Utilities cost = $243.11 + $1.097(MH) + $510.49(Summer)

R2 = .967, or 96.7 percent of the variation in utilities cost is explained by

the machine hours and summer variables.


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Chapter 1 - 33

Cost Behavior and Managerial

Judgment

Use past experience

Try to confirm results with operating personnel

Use common sense to confirm statistical studies

Some Tips


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Chapter 1 34

End of Chapter 3

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03 Activiy Cost Behavior