Measurement of Cost Behavior

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İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,Horngren/Sundem/Stratton

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Measurement of CCoosstt Behaviour

Chapter 3İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,

Horngren/Sundem/Stratton

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Step- and Mixed-CCoosstt Behaviour Patterns

Step costs change abruptly at intervals

of activity because the resources and

their costs come in indivisible chunks.İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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Measurement of Cost Behavior http://webcache.googleusercontent.com/search?q=cache:Rpw2...

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Lease cost example

Oil and gas exploration activity

Relevantrange

Actual costbehavior

Fixed costapproximation

Lease costİ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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Supermarket checker wage cost example


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Shoppers per hour

Relevant range

Variablecost

approximation

Actual costbehaviour

40

440

Wage costİ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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Mixed costs contain elements of both

fixed- and variable-cost behavior.

The fixed-cost element is unchanged


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over a range of cost-driver activity.

The variable-cost element varies

proportionately with cost-driver activity.İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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Facilities maintenancedepartment cost

Number of patient-days per month

$10,000

1,000

5,000

Totalvariablecost Fixed


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cost Relevant range

$5.00 perpatient day


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Product and Service Decisions and the Value Chain

Distribution channels

Choice of process and product design

Quality levels

Product features

Management influence on cost behaviour


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2. Capacity Decisions

What are capacity costs?

They are the fixed costs of being able

to achieve a desired level of production or

to provide a desired level of service while

maintaining product or service attributes,

e.g. qualityİ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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2. Capacity Decisions (Contd.)

Full capacity,

New plant

& assembly lines

Cannot recover

fixed costs


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Overtime, oursource

production

Good economic conditions

Can be eliminated

Adverse economic conditionsİ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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3. Committed Fixed Costs

Salaries of key personnel

Committed fixed costs usually arise

from the possession of facilities,

equipment, and a basic organization.

Lease payments

Property taxesİ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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4. Discretionary Fixed Costs


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Discretionary fixed costs are costs fixed

at certain levels only because managementdecided that these levels of cost should be

incurred to meet the organization’s goals.

These discretionary fixed costs have no

obvious relationship to levels of output

activity but are determined as part

of the periodic planning process.İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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4. Discretionary Fixed Costs (Contd.)

Each planning period, managementwill determine how much to

spend on discretionary items.

These costs then become fixed

until the next planning period.


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Examples of Discretionary Fixed Costs

Advertising and promotion

Research and development

Management salaries

Employee trainingİ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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5. Technology Decisions

Choice of technology (e-commerce vs.

in-store or mail-order sales) positions the

organization to meet its current goals and

to respond to changes in the environment.İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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6. CCoosstt-Control Incentives

Managers use their knowledge of costbehaviour to set cost expectations.

Employees may receive rewards that

are tied to meeting these expectations.İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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CCoosstt Functions

Planning and controlling the activities

of an organization require accurate

and useful estimates of future

fixed and variable costs.İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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CCoosstt Functions (Contd.)

Understanding relationships between costs


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and their cost drivers allows managers to...

evaluate strategic plans and

operational improvement programs.

make short- and long-run decisions.

plan or budget the effects of future activities.İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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CCoosstt Functions (Contd.)

The 1st step in estimating or predicting

costs is measuring cost behaviour as a

function of appropriate cost drivers.

The 2nd step is to use these costmeasures to estimate future costs at

expected levels of cost-driver activity.İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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CCoosstt Function Equation

Y = Total cost

F = Fixed cost

V = Variable cost per unit

X = Cost-driver activity in number of unitsİ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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CCoosstt Function Equation (Contd.)

Mixed-cost function:

Y = F + VX

The mixed-cost function is

called a linear-cost function.

Y = $10,000 + $5.00Xİ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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Developing CCoosstt Functions


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Plausibility:A cost function’s estimates of costs

at actual levels of activity must reliably

conform with actually observed costs.

The cost function must be believable.

Reliability:İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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Choice of CCoosstt Drivers: Activity Analysis

Choosing a cost function starts

with choosing cost drivers.

Managers use activity analysis to

identify appropriate cost drivers.

Activity analysis directs management


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accountants to the appropriate

cost drivers for each cost.İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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Northwestern Computers makes 2

products: Mozart-Plus and Powerdrive

In the past, most of the support costs

were twice as much as labour costs.

Northwest has upgraded the production

function, which has increased support

costs and reduced labour cost.İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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Choice of CCoosstt Drivers:


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Activity Analysis

Using the old cost driver, labour cost, the

prediction of support costs would be:

Labour cost $ 8.50 $130.00

Support cost:2 × Direct labour cost $17.00 $260.00

Mozart-Plus

Powerdriveİ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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Using the more appropriate cost driver,

the number of components added to

products, the predicted support costs are:İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,



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Support cost at $20/component

$20 × 5 components $100.00

$20 × 9 components $180.00

Difference in predicted

support cost $ 83.00 $ 80.00

higher lower

Mozart-Plus

Powerdriveİ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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Methods of Measuring CCoosstt Functions


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1. Engineering analysis2. Account analysis3. High-low analysis4. Visual-fit analysis5. Least-squares regression analysisİ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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1. Engineering Analysis

It measures cost behaviour according to what

costs should be, not by what costs have been.

Engineering analysis entails a systematic

review of materials, supplies, labor,

support services, and facilities

needed for products and services.İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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2. Account Analysis

The simplest method of account


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analysis selects a plausible

cost driver and classifies each

account as a variable or fixed cost.İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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Account Analysis Example

Supervisor’s salary and benefits $3,800 $3,800Hourly workers’ wages and benefits 14,674 $14,674Equipment depreciation and rentals 5,873 5,873Equipment repairs 5,604 5,604Cleaning supplies 7,472 7,472Total maintenance costs $37,423 $9,673 $27,750

Monthly cost

Amount


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Fixed

Variableİ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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Account Analysis Example

Fixed cost per month = $9,673

Variable cost per patient-day

= $27,750 ÷ 3,700

= $7.50 per patient-day

3,700 patient-days

Y = $9,673 + ($7.50 × patient-days)İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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3. High-Low Method

The focus of this method is normally on

the highest- and lowest-activity points.

The first step is to plot the historical


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data points on a graph.İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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High-Low Method Example

High month: April

Maintenance cost: $47,000

Number of patient-days: 4,900

Low month: September

Maintenance cost: $17,000

Number of patient-days: 1,200

What is the variable cost?İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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($47,000 – $17,000) ÷ (4,900 – 1,200)

= $30,000 ÷ 3,700 = $8.1081

What is the fixed cost?


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$47,000 = Fixed cost + ($8.1081× 4,900)

$47,000 – $39,730 = $7,270

$17,000 = Fixed cost + ($8.1081× 1,200)

$17,000 – $9,730 = $7,270İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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4. Visual-Fit Method

In the visual-fit method, the cost analyst

visually fits a straight line through a plot

of all of the available data, not just

between the high point and the

low point, making it more reliable

than the high-low method.İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,



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5. Least-Squares Regression Method

Regression analysis measures

a cost function more objectively

by using statistics to fit a costfunction to all the data.

Regression analysis measures

cost behavior more reliably than

other cost measurement methods.İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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Coefficient of Determination

One measure of reliability,

or goodness of fit, is the

coefficient of determination,

R² (or R-squared).


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The coefficient of determination

measures how much of the

fluctuation of a cost is explained

by changes in the cost driver.İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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Exercise 3-50 (Page 120)

Sandra, a cost analyst at ABC Company, was asked to predict overhead costs for the company’s operations in 2005, when 510 units are expected to be produced. She collected the following quarterly data:


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991

90

3/04

1050


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122

2/04

835

84

1/04

957

84

4/03

996

115

3/03

1066

129

2/03

997

124

1/03

1042

133

4/02


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1119

125

3/02

1111

128

2/02

1001

125

1/02

1131

136

4/01

655

72

3/01

715

79

2/01

721

76


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1/01

Overhead costs (RM)

Production (units)

Quarterİ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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Exercise 3-50 (Page 120) (Contd.)

Using the high-low method to estimate costs, prepare a prediction of overhead costs for 2005.

Variable cost/unit

= ($1,131 - $655) (136 - 72)

= $476 64 = $7.4375

Fixed cost= $1,131 - (136 x 7.4375)

= $119.50İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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Predicted cost for 510 units

= ($119.50 x 4) + (510 x $7.4375)

= $4,271.13

Notice that the data are quarterly observations. Thus, the annual fixed cost is 4 times the computed (quarterly) fixed cost.


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2. Sandy ran a regression analysis using the data she had collected. The result was:

Y = RM337 + 5.75X

Using this cost function, predict costs for 2005.

Predicted cost for 510 units

= ($337 x 4) + (510 x $5.75)


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= $4,280.50İ2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e,


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3. Which prediction do you prefer? Why?

The regression analysis gives better cost estimates because it uses all the data to form a cost function.

The 2 points used by the high-low method may not be representative of the general relation between costs and volume.


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Measurement of Cost Behavior

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