© 2008 McGraw-Hill Ryerson Limited. Cost Behaviour Merchandisers Cost of Goods Sold Manufacturers Direct Material, Direct Labour, and Variable Manufacturing Overhead Merchandisers and Manufacturers Sales commissions and shipping costs Service Organizations Supplies and travel Examples of normally variable costs Examples of normally fixed costs Merchandisers, manufacturers, and service organizations Real estate taxes, Insurance, Sales salaries Depreciation, Advertising

© 2008 McGraw-Hill Ryerson Limited. The Activity Base Machine hours Labour hours Kilometres driven A measure of the event causing the incurrence of a variable cost – a cost driver Units produced

© 2008 McGraw-Hill Ryerson Limited. Examples Advertising and Research and Development Examples Depreciation on Buildings and Equipment Types of Fixed Costs Fixed Costs Discretionary May be altered in the short term by current managerial decisions Committed Long-term, cannot be reduced in the short term.

© 2008 McGraw-Hill Ryerson Limited. A mixed cost has both fixed and variable components. Mixed Costs

© 2008 McGraw-Hill Ryerson Limited. Fixed Monthly Utility Charge Variable Utility Charge Activity (Kilowatt Hours) Total Utility Cost Mixed Costs X Y Total mixed cost

© 2008 McGraw-Hill Ryerson Limited. Total mixed cost Y = a + bX Fixed Monthly Utility Charge Variable Utility Charge Activity (Kilowatt Hours) Total Utility Cost Mixed Costs X Y

© 2008 McGraw-Hill Ryerson Limited. Fixed Monthly Utility Charge Variable Utility Charge Activity (Kilowatt Hours) Total Utility Cost Total mixed cost Y = a + bX Mixed Costs bX a X Y

Example: Lori Yang leases an automated photo developer for $2,500 per year plus 2¢ per photo developed. Equation of a straight line: Y = a + bX Y = $2,500 + $0.02X So, Total mixed cost for 10,000 photos will be $2,500+ ($0.02*10,000) =$2,700 Lease Cost

© 2008 McGraw-Hill Ryerson Limited. The Analysis of Mixed Costs Engineering Approach Account Analysis Scattergraph Method Least-Square Regression Method High-Low Method

© 2008 McGraw-Hill Ryerson Limited. WiseCo recorded the following production activity and maintenance costs for two months: Using these two levels of activity, compute:  the variable cost per unit;  the fixed cost; and then  express the costs in equation form Y = a + bX. The High-Low Method

© 2008 McGraw-Hill Ryerson Limited.  Unit variable cost = Change in cost Change in units The High-Low Method

© 2008 McGraw-Hill Ryerson Limited. The High-Low Method  Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit

© 2008 McGraw-Hill Ryerson Limited. The High-Low Method  Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit  Fixed cost = Total cost – Total variable cost Fixed cost = $9,700 – ($0.90 per unit × 9,000 units) Fixed cost = $9,700 – $8,100 = $1,600

© 2008 McGraw-Hill Ryerson Limited.  Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit  Fixed cost = Total cost – Total variable cost Fixed cost = $9,700 – ($0.90 per unit × 9,000 units) Fixed cost = $9,700 – $8,100 = $1,600  Total cost = Fixed cost + Variable cost (Y = a + bX) Y = $1,600 + $0.90X The High-Low Method

© 2008 McGraw-Hill Ryerson Limited. If sales salaries and commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the variable portion of sales salaries and commission? A. $0.08 per unit B. $0.10 per unit C. $0.12 per unit D. $0.125 per unit If sales salaries and commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the variable portion of sales salaries and commission? A. $0.08 per unit B. $0.10 per unit C. $0.12 per unit D. $0.125 per unit Quick Check

© 2008 McGraw-Hill Ryerson Limited. If sales salaries and commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the variable portion of sales salaries and commission? A. $0.08 per unit B. $0.10 per unit C. $0.12 per unit D. $0.125 per unit If sales salaries and commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the variable portion of sales salaries and commission? A. $0.08 per unit B. $0.10 per unit C. $0.12 per unit D. $0.125 per unit Quick Check $4,000 ÷ 40,000 units = $0.10 per unit

© 2008 McGraw-Hill Ryerson Limited. If sales salaries and commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the fixed portion of sales salaries and commissions? A. $ 2,000 B. $ 4,000 C. $10,000 D. $12,000 If sales salaries and commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the fixed portion of sales salaries and commissions? A. $ 2,000 B. $ 4,000 C. $10,000 D. $12,000 Quick Check

© 2008 McGraw-Hill Ryerson Limited. If sales salaries and commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the fixed portion of sales salaries and commissions? A. $ 2,000 B. $ 4,000 C. $10,000 D. $12,000 If sales salaries and commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the fixed portion of sales salaries and commissions? A. $ 2,000 B. $ 4,000 C. $10,000 D. $12,000 Quick Check

© 2008 McGraw-Hill Ryerson Limited. Note How does the high-low method work when you have data for more than two periods? Select the two periods with the lowest and highest level of activity. Low High

© 2008 McGraw-Hill Ryerson Limited. Quick Check Using the high-low method, estimate the cost formula Y = a +bX for the patient admitting costs on the previous page. A. Y = $9,720 + $2.00X B. Y = $7,050 + $3.00X C. Y = $8,385 + $2.50X D. Y = $8,480 + $2.50X

© 2008 McGraw-Hill Ryerson Limited. The Scattergraph Method Draw a line through the data points with about an equal numbers of points above and below the line * Total Cost in 1,000s of Dollars * * * * * * * * * Activity, 1,000s of Units Produced X Y

© 2008 McGraw-Hill Ryerson Limited. The Scattergraph Method Estimated fixed cost = $10, * Total Cost in 1,000s of Dollars * * * * * * * * * Activity, 1,000s of Units Produced X Y The slope of this line is the variable unit cost. (Slope is the change in total cost for a one unit change in activity).

© 2008 McGraw-Hill Ryerson Limited. The Scattergraph Method Slope = Change in cost Change in units Horizontal distance is the change in activity * Total Cost in 1,000s of Dollars * * * * * * * * * Activity, 1,000s of Units Produced X Y Vertical distance is the change in cost.

© 2008 McGraw-Hill Ryerson Limited. Software can be used to fit a regression line through the data points. The cost analysis objective is the same: Y = a + bx Least-Squares Regression Method Least-squares regression also provides a statistic, called the adjusted R 2, that is a measure of the goodness of fit of the regression line to the data points.

© 2008 McGraw-Hill Ryerson Limited Total Cost Activity * * * * * * * * * * Least-Squares Regression Method R 2 is the percentage of the variation in total cost explained by the activity. R 2 for this relationship is near 100% since the data points are very close to the regression line. X Y

© 2008 McGraw-Hill Ryerson Limited. Note Let’s plot the data for patient admitting costs.

© 2008 McGraw-Hill Ryerson Limited. Note Problems with the high-low method: –Throws away information contained in all of the data other than the low and the high points. –The low and high levels of activity tend to be unusual. You should always plot the data if you have more than two points to make sure it even makes sense to be using the high-low method.

© 2008 McGraw-Hill Ryerson Limited. The Contribution Format The contribution margin format emphasizes cost behaviour. Contribution margin covers fixed costs and provides for income.

© 2008 McGraw-Hill Ryerson Limited. The Contribution Format Used primarily for external reporting. Used primarily by management.