CHAPTER. Activity Cost Behavior

Transcription

1 3-1 CHAPTER Activity Cost Behavior

2 3-2 Objectives 1. Define cost behavior After for fixed, variable, and studying this mixed costs. chapter, you should 2. Explain the role of be the resource usage model able to: in understanding cost behavior. 3. Separate mixed costs into their fixed and variable components using the high-low method, the scatterplot method, and the method of least squares. continued

3 3-3 Objectives 4. Evaluate the reliability of a cost equation. 5. Discuss the role of multiple regression in assessing cost behavior. 6. Describe the use of managerial judgment in determining cost behavior.

4 Examples of Variable, Fixed, and Mixed Costs 3-4

5 3-5

6 3-6 A cost that stays the same as output changes is is a fixed cost. Fixed Costs

7 3-7 Fixed Costs Cutting machines are leased for $60,000 per year and have the capacity to produce up to 240,000 units a year.

8 Total Fixed Cost Graph 3-8 Total Costs $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 F = $60, Units Produced (000) Fixed Costs Lease of Machines Number of Units Units Cost $60,000 0 N/A 60,000 60,000 $ , , , , , ,

9 Unit Fixed Cost Graph 3-9 Cost per Unit $1.00 $0.50 $0.33 $ Units Produced (000) Fixed Costs Lease of Machines Number of Units Units Cost $60,000 0 N/A 60,000 60,000 $ , , , , , ,

10 A variable cost is is a cost that, in total, varies in direct proportion to changes in output Variable Cost

11 Variable Cost 3-11 As the cutting machines cut each unit, they use 0.1 kilowatt-hour at $2.00 per kilowatt hour. Thus, the cost of each unit is $0.20 ($2 x 0.1).

12 Total Variable Cost Graph 3-12 Total Costs $48,000 $36,000 Y v =.20x $24,000 $12, Units Produced (000) Variable Cost Cost of Power Number of Units Units Cost $ 0 0 $ 0 12,000 60, , , , , , ,

13 Unit Variable Cost Graph 3-13 Cost per Unit $0.40 $0.30 $0.20 $ Units Produced (000) Variable Cost Cost of Power Number of Units Units Cost $ 0 0 $ 0 12,000 60, , , , , , ,

14 Extent of Variable Costs 3-14 The proportion of variable costs differs across organizations. For example... A public utility with large investments in equipment will tend to have fewer variable costs. A service company will normally have a high proportion of variable costs. A manufacturing company will often have many variable costs. A merchandising company usually will have a high proportion of variable costs like cost of sales.

15 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. McGraw-Hill/Irwin Copyright 2006, The McGraw-Hill Companies, Inc.

16 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. Cost McGraw-Hill/Irwin Volume Copyright 2006, The McGraw-Hill Companies, Inc.

17 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. Cost McGraw-Hill/Irwin Volume Copyright 2006, The McGraw-Hill Companies, Inc.

18 Step-Variable Costs Small changes in the level of production are not likely to have any effect on the number of maintenance workers employed. Cost McGraw-Hill/Irwin Volume Copyright 2006, The McGraw-Hill Companies, Inc.

19 Step-Variable Costs Only fairly wide changes in the activity level will cause a change in the number of maintenance workers employed Cost McGraw-Hill/Irwin Volume Copyright 2006, The McGraw-Hill Companies, Inc.

20 Graphical Analysis of Activity Costs and Rate of Output 3-20 Total Dollars Curvilinear Total Cost Curve Marginal Marginal Costs Costs are are the the costs costs to to produce produce one one more more additional additional unit unit of of output=slope output=slope slope. Start-up Range Normal Operations Exceeding Capacity Output Fall 2010 Mugan 20/82

21 Total Dollars Relevant Range Relevant Range Tota l Cost 3-21 The The relevant range is is the the portion of of the the curvilinear total total cost cost curve that that appears in in the the normal operations area. area. } Start-up Range Normal Operations Exceeding Capacity Output Fall 2010 Mugan 21/82

22 A mixed cost is is a cost that has both a fixed and a variable component. 3-22

23 Sales representatives often are paid a salary plus a commission on sales. 3-23

24 Mixed Cost Behavior 3-24 Total Costs $130,000 $110,000 $90,000 $70,000 $50,000 $30, Units Sold (000) Inserts Sold Variable Cost of Selling Fixed Cost of Selling Total Selling Cost Selling Cost per Unit 40,000 $ 20,000 $30,000 $ 50,000 $ ,000 40,000 30,000 70, ,000 60,000 30,000 90, ,000 80,000 30, , , ,000 30, ,

25 Activity Cost Behavior Model 3-25 Input: Materials Energy Labor Changes in Input Cost Capital Activities Cost Behavior Activity Output Changes in Output

26 3-26 Flexible resources are resources acquired as as used and needed. Materials and energy are examples.

27 3-27 Committed resources are supplied in in advance of of usage. Buying or or leasing a building is is an example of of this form of of advance resource acquisition.

28 A step cost displays a constant level of cost for a range of output and then jumps to a higher level of cost at at some point Step-Cost Behavior

29 3-29 Step-Cost Behavior Cost $ Activity Output (units)

30 3-30 Step-Fixed Costs Cost $150, ,000 50,000 Normal Operating Range (Relevant Range) 2,500 5,000 7,500 Activity Usage

31 Step-Cost Behavior 3-31 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 The company could process as many as 7,500 orders

32 Step-Cost Behavior 3-32 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

33 Step-Cost Behavior 3-33 The relationship between resources supplied and resources used is expressed by the following equation: Resources available = Resources used + Unused capacity

34 Step-Cost Behavior 3-34 Cost of orders supplied = Cost of orders used + Cost of unused orders = [($20 + $15) x 6,000] + ($20 x 1,500) = $240,000 The $30,000 of excess engineering capacity means that a new product could be introduced without increasing current spending on engineering. Equal to the $150,000 spent on engineers and the $90,000 spent on supplies.

35 3-35 Methods for Separating Mixed Costs The High-Low Method The Scatterplot Method The Method of Least Squares Variable Component Fixed Component

36 3-36 The linearity assumption assumes that variable costs increase in direct proportion to the number of units produced (or activity units used).

37 3-37 Methods for Separating Mixed Costs Y = a + bx Total Cost Total Fixed Variable Number of Cost Cost Units per Unit

38 3-38 The High-Low Method Month Setup Costs Setup Hours January $1, February 1, March 2, April 2, May 3, Step 1: 1: Solve for variable cost (b)

39 3-39 The High-Low Method Month Setup Costs Setup Hours January $1, February 1, March 2, April 2, May 3, b = High Cost Low Cost High Units Low Units

40 3-40 The High-Low Method Month Setup Costs Setup Hours January $1, February 1, March 2, April 2, May 3, b = High $3,750 Cost Low Cost High 500 Units Low Units

41 3-41 The High-Low Method Month Setup Costs Setup Hours January $1, February 1, March 2, April 2, May 3, b = $3,750 Low $1,000 Cost 500 Low 100 Units

42 The High-Low Method 3-42 b = $3,750 $1, b = $6.875 Step 2: 2: Using either the high cost or or low cost, solve for the total fixed cost (a).

43 3-43 The High-Low Method Y = a + b (x) $3,750 = a + $6.875(500) $ = a Y = a + b (x) $1,000 = a + $6.875(100) $ = a High End Low End The cost formula using the high-low method is: Total cost = $ ($6.875 x Setup hours)

44 Practice Case 3-44

45 3-45 The Scatterplot Method

46 The Scatterplot Method 3-46 Nonlinear Relationship Activity Cost * * * * * 0 Activity Output

47 The Scatterplot Method 3-47 Upward Shift in Cost Relationship Activity Cost * * * * * * 0 Activity Output

48 The Scatterplot Method 3-48 Presence of Outliers Activity Cost Estimated fixed cost 0 * * * * * * Activity Output Estimated regression line

49 The Scattergraph Method 3-49 Cost Y * Plot the data points on a graph (total cost vs. activity). * * * * * * * * * Activity - output Fall 2010 Mugan 49/82 X

50 The Scattergraph Method 3-50 Cost Y * Draw a line through the data points with about an equal numbers of points above and below the line. * * * * * * * * * Activity - output Fall 2010 Mugan 50/82 X

51 The Scattergraph Method 3-51 Cost Y Use one data point to to estimate the the total level of of activity and the the total cost. Total cost = TL11 * * * * * * * * * Intercept = Fixed cost: TL 10 * 0 Activity 0.8 units Activity - output Fall 2010 Mugan 51/82 X

52 The Method of Least Squares 3-52 Month Setup Costs Setup Hours Jan 1, Feb 1, Mar 2, Apr 2, May 3, Spreadsheet Data for Larson Company

53 The Method of Least Squares 3-53 Regression Output: Constant 125 Std. Err of Y Est R Squared No. of Observation 5 Degrees of Freedom 3 X Coefficient(s) 6.75 Std. Err of Coef Regression Output for Larson Company

54 The Method of Least Squares 3-54 The results give rise to the following equation: Setup costs = $125 + ($6.75 x Setup hours) R 2 =.944, or 94.4 percent of the variation in setup costs is explained by the number of setup hours variable.

55 Coefficient of Correlation 3-55 Positive Correlation r approaches +1 Machine Hours Utilities Costs Machine Hours Utilities Costs

56 Coefficient of Correlation 3-56 Negative Correlation r approaches -1 Hours of Safety Training Industrial Accidents Hours of Safety Training Industrial Accidents

57 Coefficient of Correlation 3-57 No Correlation r ~ 0 Hair Length Accounting Grade Hair Length Accounting Grade

58 Multiple Regression 3-58 TC = b 0 + ( b 1 X 1) + (b 2 X 2) +... b 0 = the fixed cost or intercept b 1 = the variable rate for the first independent variable X 1 = the first independent variable b 2 = the variable rate for the second independent variable X 2 = the second independent variable

59 Multiple Regression 3-59 Month Mhrs Summer Utilities Cost Jan 1,340 0 $1,688 Feb 1, ,636 Mar 1, ,734 April 1, ,770 May 1, ,390 June 1, ,304 July 1, ,166 August 1, ,284 Sept 1, ,730 Oct 1, ,991 Nov 1, ,840 Dec 1, ,833 Data for Phoenix Factory Utilities Cost Regression

60 Multiple Regression 3-60 Constant Std Err of Y Est R Squared No. of Observation 12 Degrees of Freedom 9 X Coefficient(s) Std Err of Coef Multiple Regression for Phoenix Factory Utilities Cost

61 Multiple Regression 3-61 The results gives rise to the following equation: Utilities cost = $ $1.097(Machine hours) + ($ x Summer) R 2 =.967,, or 96.7 percent of the variation in utilities cost is explained by the machine hours and summer variables.

62 3-62 Managerial Judgment Managerial judgment is is critically important in in determining cost behavior, and it it is is by far the most widely used method in in practice.

63 3-63 Chapter Three The End

64 3-64 Least-Squares Regression Using Microsoft Excel.

65 Simple Regression Analysis Example 3-65 Matrix, Inc. wants to know its average fixed cost and variable cost per unit. Using the data to the right, let s s see how to do a regression using Microsoft Excel. 65/82

66 Simple Regression Using Excel 3-66 You will need three pieces of information from your regression analysis: Estimated Variable Cost per Unit (line slope) Estimated Fixed Costs (line intercept) Goodness of fit, or R 2 To get these three pieces information we will need to use three different Excel functions. LINEST, INTERCEPT, & RSQ 66/82

67 Simple Regression Using Excel 3-67 Place your cursor in cell F4 and press the = key. Click on the pull down menu and scroll down to More Functions...

68 Simple Regression Using Excel 3-68 Scroll down to to the Statistical, functions. Now scroll down the statistical functions until you highlight LINEST Fall 2010 Mugan

69 Simple Regression Using Excel In the Known_y s s box enter C4:C19 for the range. 2. In the Known_x s s box enter D4:D19 for the range. Fall 2010 Mugan

70 Simple Regression Using Excel 3-70 Here is the estimate of the slope of the line. 1. In the Known_y s s box enter C4:C19 for the range. 2. In the Known_x s s box enter D4:D19 for the range. Fall 2010 Mugan

71 Simple Regression Using Excel 3-71 With you cursor in in cell F5, press the = key and go to to the pull down menu for special functions. Select Statistical and scroll down to to highlight the INTERCEPT function. Fall 2010

72 Simple Regression Using Excel 3-72 Here is the estimate of the fixed costs. 1. In the Known_y s s box enter C4:C19 for the range. 2. In the Known_x s s box enter D4:D19 for the range. Fall 2010 Mugan 72/82

73 Simple Regression Using Excel 3-73 Finally, we will determine the goodness of fit, or R 2, by using the RSQ function. Fall 2010

74 Simple Regression Using Excel 3-74 Here is the estimate of R In the Known_y s s box enter C4:C19 for the range. 2. In the Known_x s s box enter D4:D19 for the range. Fall 2010 Mugan