Chap007 7e Edited
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Transcript of Chap007 7e Edited
Chapter 7Activity Analysis, Cost Behavior, and Cost Estimation
McGraw-Hill/Irwin
Copyright 2008 by The McGraw-Hill Companies, Inc. All
Learning Objective 1
McGraw-Hill/Irwin
Copyright 2008 by The McGraw-Hill Companies, Inc. All
IntroductionCost estimationProcess of determining cost behavior, often focusing on historical data.
Cost behaviorRelationship between cost and activity.
Cost predictionUsing knowledge of cost behavior to forecast level of cost at a particular activity. Focus is on the future.
Learning Objective 2
McGraw-Hill/Irwin
Copyright 2008 by The McGraw-Hill Companies, Inc. All
Total Variable Cost ExampleYour total Pay Per View bill is based on how many Pay Per View shows that you watch.Total Pay Per View BillNumber of Pay Per View shows watched
Variable Cost Per Unit ExampleThe cost per Pay Per View show is constant. For example, $4.95 per show.Cost per Pay Per View showNumber of Pay Per View shows watched
Step-Variable CostsTotal cost remains constant within a narrow range of activity.
Activity
Cost
Step-Variable CostsTotal cost increases to a new higher cost for the next higher range of activity.
Activity
Cost
Total Fixed Cost ExampleYour monthly basic cable TV bill probably does not change no matter how many hours you watch.
Monthly Basic Cable BillNumber of hours watched
Fixed Cost Per Unit ExampleThe average cost per hour decreases as more hours are spent watching cable television.Monthly Basic cable Bill per hour watched
Number of hours watched
Step-Fixed CostsExample: 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.
Continue
Step-Fixed CostsTotal cost doesnt change for a wide range of activity, and then jumps to a new higher cost for the next higher range of activity. 90
Rent Cost in Thousands of Dollars
60
30
0
1,000 2,000 3,000 Rented Area (Square Feet)
Step-Fixed Costs
How does this type of fixed cost differ from a step-variable cost?
Step-variable costs can be adjusted more quickly and . . . The width of the activity steps is much wider for the step-fixed cost.
Semivariable CostA semivariable cost is partly fixed and partly variable.
Consider the following example.
Semivariable CostSlope is variable cost per unit of activity.
Total Utility Cost
v mi e ls ota T
iab ar
l
os ec
t
Variable Utility Charge Fixed Monthly Utility Charge
Activity (Kilowatt Hours)
Curvilinear Cost
Curvilinear Cost Function
Total Cost
Relevant Range
A straight-line (constant unit variable cost) closely approximates a curvilinear line within the relevant range.
Activity
Learning Objective 3
McGraw-Hill/Irwin
Copyright 2008 by The McGraw-Hill Companies, Inc. All
Curvilinear Cost
Curvilinear Cost Function
Total Cost
Relevant Range
A straight-Line (constant unit variable cost) closely approximates a curvilinear line within the relevant range.
Activity
Learning Objective 4
McGraw-Hill/Irwin
Copyright 2008 by The McGraw-Hill Companies, Inc. All
Engineered, Committed and Discretionary CostsCommittedLong-term, cannot be reduced in the short term.
DiscretionaryMay be altered in the short term by current managerial decisions.
EngineeredPhysical relationship with activity measure. Depreciation on Buildings and equipment Direct Materials Advertising and Research and Development
Shifting Cost Structure in the New Manufacturing EnvironmentA trend toward more fixed costs because of
Increased automation. Stable workforce.ImplicationsManagers are more locked-in with fewer decision alternatives. Planning becomes more crucial because fixed costs are difficult to change with current operating decisions.
Cost Behavior in Other IndustriesMerchandisersCost of Goods Sold
Service OrganizationsSupplies and travel
Examples of variable costsManufacturersDirect Material, Direct Labor, and Variable Manufacturing Overhead
Merchandisers and ManufacturersSales commissions and shipping costs
Cost Behavior in Other IndustriesExamples of fixed costsMerchandisers, manufacturers, and service organizationsReal estate taxes Insurance Sales salaries Depreciation
Learning Objective 5
McGraw-Hill/Irwin
Copyright 2008 by The McGraw-Hill Companies, Inc. All
Cost EstimationAccount-Classification Method Visual-Fit Method High-Low Method Least-Squares Regression Method Engineering Method of Cost Estimation
Account Classification Method
Cost estimates are based on a review of each account making up the total cost being analyzed.
Visual-Fit MethodA scatter diagram of past cost behavior may be helpful in analyzing mixed costs.
Visual-Fit MethodPlot the data points on a graph (total cost vs. activity).
Total Cost in 1,000s of Dollars
20
10
* * * *
* ** * **
0
0 1 2 3 4 Activity, 1,000s of Units Produced
Visual-Fit MethodDraw a line through the plotted data points so that about equal numbers of points fall above and below the line.
Total Cost in 1,000s of Dollars
20
10
* * * *
* ** * **
0
0 1 2 3 4 Activity, 1,000s of Units Produced
Visual-Fit MethodEstimated fixed cost = $10,000
Total Cost in 1,000s of Dollars
20
10
* * * *
* ** * Vertical distance ** is total cost,approximately $16,000.
0
0 1 2 3 4 Activity, 1,000s of Units Produced
The High-Low MethodOwlCo recorded the following production activity and maintenance costs for two months:Units 9,000 5,000 Cost $ 9,700 6,100
High activity level Low activity level
Using these two levels of activity, compute: the variable cost per unit. the total fixed cost.
The High-Low MethodHigh activity level Low activity level Change Units 9,000 5,000 4,000 Cost $ 9,700 6,100 $ 3,600
The High-Low MethodHigh activity level Low activity level Change Units 9,000 5,000 4,000 Cost $ 9,700 6,100 $ 3,600
v in cost Unit variable cost = v in units
The High-Low MethodHigh activity level Low activity level Change Units 9,000 5,000 4,000 Cost $ 9,700 6,100 $ 3,600
Unit variable cost = $3,600 4,000 units = $0.90 per unit
The High-Low MethodHigh activity level Low activity level Change Units 9,000 5,000 4,000 Cost $ 9,700 6,100 $ 3,600
Unit variable cost = $3,600 4,000 units = $0.90 per unit Fixed cost = Total cost Total variable cost
The High-Low MethodHigh activity level Low activity level Change Units 9,000 5,000 4,000 Cost $ 9,700 6,100 $ 3,600
Unit variable cost = $3,600 4,000 units = $0.90 per unit Fixed cost = Total cost Total variable costFixed cost = $9,700 ($0.90 per unit 9,000 units)
The High-Low MethodHigh activity level Low activity level Change Units 9,000 5,000 4,000 Cost $ 9,700 6,100 $ 3,600
Unit variable cost = $3,600 4,000 units = $.90 per unit Fixed cost = Total cost Total variable costFixed cost = $9,700 ($.90 per unit 9,000 units) Fixed cost = $9,700 $8,100 = $1,600
Learning Objective 6
McGraw-Hill/Irwin
Copyright 2008 by The McGraw-Hill Companies, Inc. All
Regression is a statistical procedure used to determine the relationship between variables such as activity and cost.
Least-Squares Regression Method
Total Cost
The objective of the regression method is the general cost equation: Y = a + bX Activity
Equation Form of Least-Squares Regression LineY = a + bXTotal Cost is the dependent variable. The activity (X) is the independent variable.
The intercept term (a) is the estimate of fixed costs.
The X term coefficient (b) is the estimate of variable cost per unit of activity, the slope of the cost line.
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 Method
Multiple RegressionMultiple regression includes two or more independent variables: Y = a + b 1 X 1 + b2 X 2
Terms in the equation have the same meaning as in simple regression with only one independent variable.
Engineering Method of Cost Estimation
Cost estimates are based on measurement and pricing of the work involved.
Engineering Method of Cost EstimationDirect Labor Direct Material
Analyze the kind of work performed. Estimate the time required for each labor skill for each unit. Use local wage rates to obtain labor cost per unit.
Material required for each unit is obtained from engineering drawings and specification sheets. Material prices are determined from vendor bids.
Effect of Learning on Cost BehaviorAs I make more of these things it takes me less time for each one. It must be the learning curve effect that the boss was talking about.
Ive noticed the same thing. And if you include all the variable overhead costs that are also declining, that must be the experience curve.
Learning CurveLearning effects are large initially.
Average Labor Time per Unit
Learning effects become smaller, eventually reaching steady state.
Cumulative Production Output
Learning Objective 7
McGraw-Hill/Irwin
Copyright 2008 by The McGraw-Hill Companies, Inc. All
Data Collection ProblemsMissing data. Outlier data points. Mismatched time periods costs. Trade-offs in choosing the time period. Allocated and discretionary costs. Inflation.
End of Chapter 7