Chap 006 managerial accounting Hilton

Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

Chapter 6Chapter 6

Activity Analysis, Cost Behavior,

and CostEstimation

Activity Analysis, Cost Behavior,

and CostEstimation

Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

Learning Objective

1

Learning Objective

1

6-3

Costprediction

Using knowledgeof cost behavior

to forecastlevel of cost at

a particularactivity. Focusis on the future.

IntroductionIntroduction

Costbehavior

Relationshipbetweencost andactivity.

Process ofdetermining

cost behavior,often focusingon historical

data.

Costestimation

Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

Learning Objective

2

Learning Objective

2

6-5

Total Variable Cost ExampleTotal Variable Cost Example

Your total Pay Per View bill is based on how many Pay Per View shows that you watch.

Number of Pay Per View shows watched

Tot

al P

ay P

er V

iew

Bill

6-6

Variable Cost Per Unit ExampleVariable Cost Per Unit Example

Number of Pay Per View shows watched

Cos

t per

Pay

Per

Vie

w

show

The cost per Pay Per View show is constant. For example, $4.95 per show.

6-7

Step-Variable CostsStep-Variable Costs

Activity

Co

st

Total cost remainsconstant within anarrow range of

activity.

6-8

Step-Variable CostsStep-Variable Costs

Activity

Co

st

Total cost increases to a new higher cost for the

next higher range of activity.

6-9

Total Fixed Cost ExampleTotal Fixed Cost Example

Your monthly basic cable TV bill probably does not change no matter how many hours you watch.

Number of hours watched

Mon

thly

Bas

ic

Cab

le B

ill

6-10

Fixed Cost Per Unit ExampleFixed Cost Per Unit Example

Number of hours watched

Mon

thly

Bas

ic c

able

Bill

pe

r ho

ur w

atch

ed

The average cost per hour decreases as more hours are spent watching cable television.

6-11

Example: Office space is available at a rental rate of $30,000 per year in increments of 1,000 square feet. As the

business grows more space is rented,

increasing the total cost.

Step-Fixed CostsStep-Fixed Costs

Continue

6-12

Ren

t C

ost

in

T

ho

usa

nd

s o

f D

oll

ars

0 1,000 2,000 3,000 Rented Area (Square Feet)

30

60

90

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.

Step-Fixed CostsStep-Fixed Costs

6-13

Step-variable costs can be adjusted more

quickly and . . .

The width of the activity steps is much

wider for thestep-fixed cost.

How does this type of fixed cost differ

from a step-variable cost?

Step-Fixed CostsStep-Fixed Costs

6-14

A semivariable cost is partly

fixed and partly variable.

Semivariable Cost Semivariable Cost

Consider thefollowing example.

6-15

Fixed Monthly

Utility Charge

Variable

Utility Charge

Activity (Kilowatt Hours)

To

tal

Uti

lity

Co

st

Total semivariable cost

Semivariable Cost Semivariable Cost Slope is

variable costper unit

of activity.

6-16

Curvilinear CostCurvilinear CostCurvilinear

Cost Function

Relevant Range

Activity

To

tal

Co

stCurvilinear

Cost Function

A straight-line(constant unit

variable cost) closely approximates a

curvilinear line withinthe relevant range.

Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

Learning Objective

3

Learning Objective

3

6-18

Curvilinear CostCurvilinear CostCurvilinear

Cost Function

Relevant Range

Activity

To

tal

Co

stCurvilinear

Cost Function

A straight-Line(constant unit

variable cost) closely approximates a

curvilinear line withinthe relevant range.

Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

Learning Objective

4

Learning Objective

4

6-20

Engineered, Committed and Engineered, Committed and Discretionary CostsDiscretionary Costs

DiscretionaryMay be altered in the short term by current managerial decisions.

CommittedLong-term, cannot be reduced in the short

term.

Engineered

Physical relationship with activity measure.

Depreciation on Buildings and

equipment

Advertising and Research and Development

Direct Materials

6-21

Cost Behavior in Other IndustriesCost Behavior in Other IndustriesMerchandisers

Cost of Goods Sold

Manufacturers

Direct Material, Direct Labor, and Variable

Manufacturing Overhead

Merchandisers and Manufacturers

Sales commissions and shipping costs

Service Organizations

Supplies and travel

Examples of variable costs

6-22

Examples of fixed costs

Merchandisers, manufacturers, and service organizations

Real estate taxesInsurance

Sales salariesDepreciation

Cost Behavior in Other IndustriesCost Behavior in Other Industries

Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

Learning Objective

5

Learning Objective

5

6-24

Account-Classification Method

Visual-Fit Method

High-Low Method

Least-Squares Regression Method

Cost EstimationCost Estimation

6-25

Account Classification MethodAccount Classification Method

Cost estimates are based on areview of each account making up

the total cost being analyzed.

6-26

A scatter diagram of past cost behavior may be helpful in analyzing mixed costs.

Visual-Fit MethodVisual-Fit Method

6-27

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

0 1 2 3 4

*

To

tal

Co

st i

n1,

000’

s o

f D

oll

ars

10

20

0

***

**

**

*

*

Activity, 1,000’s of Units Produced

Visual-Fit Method

6-28

Draw a line through the plotted data points so that about equal numbers of points fall above and below the line.

Visual-Fit Method

0 1 2 3 4

*

To

tal

Co

st i

n1,

000’

s o

f D

oll

ars

10

20

0

***

**

**

*

*

Activity, 1,000’s of Units Produced

6-29

Visual-Fit Method

Vertical distance is total cost,

approximately $16,000.

0 1 2 3 4

*

To

tal

Co

st i

n1,

000’

s o

f D

oll

ars

10

20

0

***

**

**

*

*

Activity, 1,000’s of Units Produced

Estimated fixed cost = $10,000

6-30

OwlCo recorded the following production activity and maintenance costs for two months:

Using these two levels of activity, compute: the variable cost per unit. the total fixed cost.

The High-Low MethodThe High-Low Method

Units Cost

High activity level 9,000 9,700$ Low activity level 5,000 6,100

6-31

Units Cost

High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$

The High-Low Method

6-32

Units Cost

High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$

Unit variable cost =in costin units

The High-Low Method

6-33

Units Cost

High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$

Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit

The High-Low Method

6-34

Units Cost

High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$

Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit Fixed cost = Total cost – Total variable cost

The High-Low Method

6-35

Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit Fixed cost = Total cost – Total variable cost

Fixed cost = $9,700 – ($0.90 per unit × 9,000 units)

Units Cost

High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$

The High-Low Method

6-36

Units Cost

High activity level 9,000 9,700$Low activity level 5,000 6,100 Change 4,000 3,600$

Unit variable cost = $3,600 ÷ 4,000 units = $.90 per unit Fixed cost = Total cost – Total variable cost

Fixed cost = $9,700 – ($.90 per unit × 9,000 units)

Fixed cost = $9,700 – $8,100 = $1,600

The High-Low Method

6-37

Regression is a statistical procedure usedto determine the relationship between variables

such as activity and cost.

Least-Squares Regression Least-Squares Regression MethodMethod

Activity

To

tal

Co

st The objective ofthe regressionmethod is the

general cost equation:Y = a + bX

6-38

Y = a + bX

Total Cost is thedependent variable.

The activity (X) is theindependent variable.

The X term coefficient (b)is the estimate of variablecost per unit of activity,

the slope of the cost line.

The intercept term (a) isthe estimate of fixed costs.

Equation Form of Least-Squares Equation Form of Least-Squares Regression LineRegression Line

6-39

• Statistics courses and computer courses deal with detailed regression computations using computer spreadsheet software.

• Accountants and managers must be able to interpret and use regression estimates.

Least-Squares Regression Least-Squares Regression MethodMethod

Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

Learning Objective

6

Learning Objective

6

6-41

Terms in the equation have the samemeaning as in simple regression with

only one independent variable.

Multiple RegressionMultiple Regression

Multiple regression includes two or more independent variables:

Y = a + b1X1 + b2X2

6-42

Engineering MethodEngineering Methodof Cost Estimationof Cost Estimation

Cost estimates are based on measurement and pricing of the work involved.

6-43

Direct Labor

•Material requiredfor each unit isobtained from

engineering drawings and specification sheets.

•Material prices are determined from

vendor bids.

•Analyze the kindof work performed.

•Estimate the time required for each labor

skill for each unit.

•Use local wage rates to obtain labor cost

per unit.

Direct Material

Engineering MethodEngineering Methodof Cost Estimationof Cost Estimation

6-44

Effect of LearningEffect of Learningon Cost Behavioron Cost Behavior

As I make more of thesethings it takes me less

time for each one. It mustbe the learning curve effect

that the boss wastalking about.

I’ve noticed the same thing. And if you

include all the variable overhead costs that are also declining, that must be the experience curve.

6-45

Learning CurveLearning Curve

Cumulative Production Output

Ave

rag

e L

abo

rT

ime

per

Un

it

Learning effectsare large initially.

Learning effectsbecome smaller, eventually

reaching steady state.

Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill/Irwin

Learning Objective

7

Learning Objective

7

6-47

Data Collection ProblemsData Collection Problems

1. Missing data.

2. Outlier data points.

3. Mismatched time periods costs.

4. Trade-offs in choosing the time period.

5. Allocated and discretionary costs.

6. Inflation.

6-48

End of Chapter 6End of Chapter 6