Copyright © 2008 Prentice Hall All rights reserved 6-1 Cost Behavior Chapter 6.

Copyright © 2008 Prentice Hall All rights reserved

6-1

Cost Behavior

Chapter 6


6-2

Objective 1

Describe key characteristics and graphs of various cost behaviors


6-3

Cost Behavior

There are three common cost behaviors:

1. Variable costs

2. Fixed costs

3. Mixed costs


6-4

Key Characteristics of Variable Costs

• Total variable costs change in direct proportion to changes in volume

• The variable cost per unit of activity (v) remains constant and is the slope of the variable cost line

• Total variable cost graphs always begin at the origin (if volume is zero, total variable costs are zero)

• Total variable costs can be expressed as: y = vx Where:Y = total variable costV = variable cost per unit of activityX = volume of activity


6-5

Total Variable Costs

$0

$500

$1,000

$1,500

$2,000

$2,500

$0 $10,000 $20,000 $30,000 $40,000

Total Sales

To

tal

Sa

les

Co

mm

iss

ion

s


6-6

Key Characteristics of Fixed Costs

• Total fixed costs stay constant over a wide range of volume

• Total fixed cost graphs are always flat lines with no slope• The flat (horizontal) line intersects the y-axis at the level

equal to the fixed cost• Total fixed cost can be expressed as y = f where

Y = total fixed cost F = fixed cost over a given period of time

• Fixed costs per unit of activity vary inversely with changes in volume Fixed cost per unit of activity increases when volume decreases Fixed cost per unit of activity decreases when volume increases


6-7

Total Fixed Costs

$0

$500

$1,000

$1,500

$2,000

$2,500

$0 $10,000 $20,000 $30,000 $40,000

Total Sales

To

tal S

ale

s S

ala

ries


6-8

Key Characteristics of Mixed Costs

• Total mixed costs increase as volume increases because of the variable cost component

• Total mixed cost graphs slope upwards but do not begin at the origin; they intersect at the y-axis at the level of the fixed costs

• Total mixed costs can be expressed as a combination of the variable and fixed cost equations: Total mixed costs = variable cost component + fixed cost

• Y = vx + f• Where

– Y = total mixed cost

– V = variable cost per unit of activity

– X = volume of activity

– F = fixed cost over a given period of time


6-9

Mixed Costs

$0

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

$4,500

$0 $10,000 $20,000 $30,000 $40,000

Total Sales

Sal

es C

om

pen

sati

on

Variable

Fixed


6-10

S6-1 Classify Cost Behavior

____ a. Depreciation on equipment used to cut wood enclosures

____ b. Wood for speaker enclosures____ c. Patents on crossover relays

(internal components)____ d. Crossover relays____ e. Grill cloth____ f. Glue____ g. Quality inspector’s salary

F

?

V

V

F

F

?

What would you consider grill

cloths and glue? Are they fixed or variable costs?


6-11

E6-16 a. Graph of Variable Costs

$0

$20,000

$40,000

$60,000

$80,000

0 5,000 10,000

Units


6-12

E6-16 b. Graph of Mixed Costs

$0

$20,000

$40,000

$60,000

$80,000

0 5,000 10,000

Units


6-13

E6-16 c. Graph of Fixed Costs

$0

$20,000

$40,000

$60,000

$80,000

0 5,000 10,000

Units


6-14

Objective 2

Use cost equations to express and predict costs


6-15

Relevant Range

• Band of volume where total fixed costs remain constant at a certain level

• Variable costs per unit remain constant at a certain level

• If there is a change in cost behavior it means that the relevant range needs to be adjusted


6-16

Other Cost Behaviors

Step Costs – Fixed over small range of activity; then jump to new fixed level

$0

$15,000

$30,000

$45,000

$60,000

Number of Units

To

tal C

ost

s


6-17

$0

$15,000

$30,000

$45,000

$60,000

Number of Units

To

tal C

ost

s

Other Cost Behaviors

Curvilinear Costs – Are not linear and do not fit into any neat pattern


6-18

Garments

2,000 3,500 5,000

Total Variable Costs

Total Fixed Costs

Total Operating Costs

Variable Cost/garment

Fixed Cost/garment

Average cost/garment

E6-18. 1.

7,000 7,000 7,000

$1,500 $2,625 $3,750

$8,500 $9,625 $10,750

Garments

2,000 3,500 5,000

Total Variable Costs $1,500 $2,625 $3,750

Total Fixed Costs 7,000 7,000 7,000

Total Operating Costs $8,500 ? $10,750

Variable Cost/garment $0.75 $0.75 $0.75

Fixed Cost/garment 3.50 2.00 1.40

Average cost/garment $4.25 $2.75 ?

What happens to fixed cost per unit

as the volume increases if

variable costs per unit remain

constant? Can you fill in the

blanks?


6-19

E6-18. 3.

Actual costs at 2,000 garments $8,500

Total predicted costs ($2.15 × 2,000 garments) (4,300 )

Underestimated costs $4,200


6-20

E6-20

a. 1,000 x $26.43 $26,430

b. Total costs $26,430

Less total fixed costs (18,000)

Total variable costs $8,430

÷ 1,000

Variable cost per mailbox $8.43


6-21

E6-20

c. y = $8.43x + $18,000

d. $26.43 x 1,200 mailboxes (=$31,716)

e. y = ?

If the cost equation is used, what will the cost be? Remember, we must add the fixed component to the variable component.


6-22

E6-20

f. Using average at 1,000 $31,716

Using cost equation 28,116

$3,600


6-23

Objective 3

Use Account Analysis and Scatter Plots to analyze cost behavior


6-24

Account Analysis

• Account Analysis as it applies to cost behavior determination is the use of judgment to classify each general ledger account as variable, fixed or mixed cost

• Three common methods used to perform the analysis:

• Scatter Plots• High-Low Method• Regression Analysis


6-25

Scatter Plots

• Use historical data to determine a cost’s behavior

• A scatter plot is the graph of historical cost data on the y-axis and volume data on the x-axis

• Helps managers visually determine how strong the relationship is between the cost and the volume of the chosen activity base


6-26

Scatter Plot Example

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$7,000

0 5000 10000 15000 20000


6-27

Objective 4

Use the High-Low Method to analyze cost behavior


6-28

High-Low Method

• Method to separate mixed costs into variable and fixed components

• Select the highest level and the lowest level of activity over a period of time

• Uses the selected activity levels to create a total cost equation that defines the cost behavior


6-29

High-Low Method: E6-23

Step 1: Find slope of the mixed cost line (variable cost/unit) = Δ in cost (y) / Δ in volume (x)

The slope represents the variable cost per unit of activity

($5,830-$4,935) ÷ (17,300-14,500)$895 ÷ 2,800 = $0.32


6-30


Step 2: Find the vertical intercept (fixed costs) =

Total mixed cost – Total variable cost

$5,830 – ($0.32 • 17,300) = $295 or

$4,935 – ($0.32 • 14,500) = $295


6-31


Step 3: Create and use an equation to show the behavior of a mixed cost

Y = $0.32 per mile + $1,250

Predicted operating costs at 15,000 miles:($0.32 • 15,000) + $1,250 = $6,050


6-32

Objective 5

Use Regression Analysis to analyze cost behavior


6-33

Regression Analysis

• Statistical procedure to find the line that best fits data

• Uses all data points

• Results in equation of line and an R-square value


6-34

Three Pieces of Information Needed for Regression Analysis

1. The Intercept Coefficient – the vertical intercept; it is the fixed cost component of the mixed cost

2. The X Variable 1 coefficient is the line’s slope, or the variable cost per unit.

3. The R-square value – the goodness-of-fit statistic


6-35

R-Square Value

• “Goodness of fit”

• How well does the line fit the data points?

• Ranges from 0 to 1 “0” – no relationship between costs and

volume; activity is not a cost driver “1” – perfect relationship; activity is a cost

driver


6-36

Data Concerns

• Seasonal variations

• Inflation

• Outliers – abnormal data points


6-37

Objective 6

Prepare contribution margin income statements for service firms and

merchandising firms


6-38

Traditional Income Statement

Sales

- Cost of Goods Sold

Gross Margin

- Selling,general & administrative costs

Operating Income


6-39

Contribution Margin Income Statement

Sales

- Variable Costs

Contribution Margin

- Fixed Costs

Operating Income


6-40

Contribution Margin Income Statement

• Predicts how changes in volume will affect operating income

6-41

Rachel’s Rock ShopIncome Statement

For the year ending 20XXRevenue:

Sales Revenue (27,000 + 7,000) $34,000Rental Revenue 22,000Lesson Revenue 40,000

Total Revenue $96,000Less: Cost of Goods Sold (7,500 + 2,000) (9,500)Gross Margin $86,500Less Operating Costs: Depreciation $ 4,000 Employee Salary expenses 30,000 Musician wages 25,000 Lease 12,000Total operating costs 71,000

Operating Income $15,500

P6-40b


6-42

E6-25

Rachel’s Rock ShopContribution Margin Income Statement

For the year ending 20XXRevenue:

Sales Revenue (27,000 + 7,000) $34,000Rental Revenue 22,000Lesson Revenue 40,000

Total Revenue $96,000Less: Variable Costs

Cost of Goods Sold (7,500 + 2,000) $ 9,500Musician wages 25,000

Total Variable costs (34,500)Contribution Margin $61,500Less Fixed Costs:

Depreciation $ 4,000Employee Salary expenses 30,000Lease 12,000

Total fixed costs (46,000)Operating Income $15,500


6-43

Objective 7

Use variable costing to prepare contribution margin income statements

for manufacturers (Appendix)


6-44

Variable Costing

• Assigns only variable manufacturing costs to products Direct materials Direct labor Variable manufacturing overhead

• Fixed manufacturing overhead = period cost

• Contribution margin income statements For internal management decisions


6-45

Absorption Costing

• Required by GAAP for external reporting

• Assign all manufacturing costs to product Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead

• Traditional income statement


6-46

Rays

Conventional (Absorption Costing) Income Statement

Year Ended December 31, 2008

Sales revenue (185,000 $35) $6,475,000

Less: Cost of Goods Sold:

Beginning finished goods inventory $ 0

Cost of goods manufactured 5,000,000

Cost of goods available for sale 5,000,000

Ending finished goods inventory (375,000)

Cost of goods sold 4,625,000

Gross profit 1,850,000

Operating expenses 1,175,000

Operating income $ ?

E6-32

How do we derive

operating income?


6-47

E6-32Rays

Contribution Margin (Variable Costing) Income Statement

Year Ended December 31, 2008

Sales revenue $6,475,000

Variable expenses:

Variable cost of goods sold $2,775,000*

Sales commission expense 925,000 3,700,000

Contribution margin $2,775,000

Fixed expenses:

Manufacturing overhead $2,000,000

Operating expenses 250,000 2,250,000

Operating income $ ? computation of variable cost of goods sold

What is difference in

operating income? How

does it compare to the operating income on the previous slide?


6-49

E6-32

Incremental analysis:

Increase in contribution margin(($35-20) x 15,000 goggles) $225,000

Increase in fixed costs (150,000)

Increase in operating income $75,000


6-50

End of Chapter 6

Copyright © 2008 Prentice Hall All rights reserved 6-1 Cost Behavior Chapter 6.

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