Chapter 2 1 Key Topics: Cost Behavior Cost Function and Assumptions Cost Plots and Regression Analysis Using Cost Information for Decisions Chapter 2 The Cost Function

Chapter 2 2 Lari’s Leather produces customized motorcycle jackets. The leather for one jacket costs $50, and Lari rents a shop for $450/month. Compute the total costs per month and the average cost per jacket if she makes: –One jacket per month –10 jackets per month Leather Rent Total TC/MoAC/Jkt 1 Jacket Leather Rent Total TC/MoAC/Jkt 10 Jackets Example: Total Versus Average Cost

Chapter 2 3 Total Versus Average Cost Behavior Graphs of total cost Graphs of average (per unit) cost

Chapter 2 4 Cost Function Refer to the Lari’s Leather Example: Write the Cost Function Using the Cost Function, Calculate Total Monthly Costs, Assuming the Company Makes: –1 Jacket –10 Jackets

Chapter 2 5 Cost Estimation Techniques Our Focus in This Chapter: Cost Plots Regression Analysis: –Simple Regression –Multiple Regression Other Methods: Analysis at the Account Level Engineered Estimate of Cost Activity Based Costing High-Low Method

Chapter 2 6 From Accounting Records Scott Manufacturing Schedule of Expenditures ExpenditureActual Direct materials $500,000 Direct labor 300,000 Rent 25,000 Insurance 15,000 Commissions 200,000 Property tax 20,000 Telephone 10,000 Depreciation 85,000 Power & light 30,000 Admin salaries 100,000 Total$1,285,000 Note: 100,000 units were produced and sold.

Chapter 2 7 Developing a cost function In margin 1. Separate fixed from variable costs 2. Total the fixed costs 3. Total the variable costs 4. Calculate a variable cost per unit 5. Write out the cost function

Chapter 2 8 When There Are No Units Given Need to use variable cost as a percentage of revenues in cost function TC = F + (VC/Revenue) *New Revenue

Chapter 2 9 Exercise: Creating a Cost Function

Chapter 2 10 Cost Function Assumptions Refer to the Wildcat Club Example: If you use the cost function to estimate next month’s costs, what assumptions are you making?

Chapter 2 11 Analyzing Cost Functions

Chapter 2 12 High-Low Method Pick highest and lowest points of either cost or cost driver Solve for variable cost by analyzing change in cost divided by change in volume Solve for fixed cost using highest or lowest point observations in TC = F + VC*Q

Chapter 2 13 Scatter Plot of Potential Cost Driver A.Scatter Plot With Trend Line A.$0 A.$20,000 A.$ 40, 000 A.$60,000 A.$80,000 A.$0A.$300,000A.$600,000A.$900,000A.$1,200,000 A.Sales A.Administrative Costs

Chapter 2 14 Regression Output A.SUMMARY OUTPUT A.Regression Statistics A.Multiple RA A.R SquareA A.Adjusted R SquareA A.Standard ErrorA A.ObservationsA.4 A.ANOVA A.dfA.SSA.MSA.FA.Significance F A.RegressionA.1A A A A.ResidualA.2A A A.TotalA.3A A.CoefficientsA.Standard ErrorA.t StatA.P-valueA.Lower 95% A.InterceptA A A A A A.X Variable 1A A A A A

Chapter 2 15 Regression Output Intercept coefficient = fixed cost Slope coefficient = variable cost R-square - goodness of fit statistic T-statistic - compares coefficient with its standard error P-value - the statistical significance of the T-statistic

Chapter 2 16 Cost Function for Big Jack High Low TC = $11, *Sales Regression TC = $16,800(?) *Sales

Chapter 2 17 Positive Correlation ≠ Cost Driver

Chapter 2 18 Other Types of Cost Functions Activity Outside the Relevant Range: –Fixed costs (step function) –Variable costs No Apparent Cost Driver Discretionary Costs Economies of Scale Learning Curves

Chapter 2 19 Using Cost Information for Decision Making Keep in Mind: Management Decision Making Framework Uncertainties Information Quality Quality of Estimation Techniques Reliability of Cost Estimates