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.