Copyright © 2011 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

6-2

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

6-3

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

6-4

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.

6-5

Step-Variable CostsStep-Variable Costs

Activity

Co

st

Total cost remainsconstant within anarrow range of

activity.

6-6

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

6-7

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.

6-8

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

6-9

Fixed Monthly

Utility Charge

Variable

Utility Charge

Activity (Kilowatt Hours)

To

tal

Uti

lity

Co

st

Total semivariable cost

Semivariable CostSemivariable Cost Slope is

variable costper unit

of activity.

6-10

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.

6-11

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.

6-12

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

6-13

Visual-Fit MethodVisual-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

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

6-14

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

6-15

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 MethodThe High-Low Method