Demonstration Problem Chapter 12 – Exercise 4 Estimating Costs Based on Behavior Patterns Accounting What the Numbers Mean 9e

Problem Definition The following table shows the amount of cost incurred in May for the cost items indicated. During May 16,000 units of the firm’s single product were manufactured. Raw materials$83,200 Factory depreciation expense 81,000 Direct labor 198,400 Production supervisor’s salary 12,200 Computer rental expense 8,400 Maintenance supplies used 1,600

Problem Requirements a.How much cost would you expect to be incurred for each of the above items during June when 19,200 units of product are planned for production? b.Calculate the average total cost per unit for the 16,000 units manufactured in May. Explain why this figure would not be useful to a manager interested in predicting the cost of producing 19,200 units in June.

Problem Solution Step 1 – Determine the cost behavior pattern for each cost item: Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Cost Behavior

Problem Solution Step 1 – Determine the cost behavior pattern for each cost item: Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Cost Behavior Is the cost item a variable cost or a fixed cost?

Problem Solution Step 1 – Determine the cost behavior pattern for each cost item: Raw materialsVariable Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Cost Behavior Variable costs change as activity changes.

Problem Solution Step 1 – Determine the cost behavior pattern for each cost item: Raw materialsVariable Factory depreciation expense Fixed Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Cost Behavior Fixed costs remain constant as activity changes.

Problem Solution Step 1 – Determine the cost behavior pattern for each cost item: Raw materialsVariable Factory depreciation expense Fixed Direct laborVariable Production supervisor’s salary Computer rental expense Maintenance supplies used Cost Behavior

Problem Solution Step 1 – Determine the cost behavior pattern for each cost item: Raw materialsVariable Factory depreciation expense Fixed Direct laborVariable Production supervisor’s salary Fixed Computer rental expense Maintenance supplies used Cost Behavior

Problem Solution Step 1 – Determine the cost behavior pattern for each cost item: Raw materialsVariable Factory depreciation expense Fixed Direct laborVariable Production supervisor’s salary Fixed Computer rental expense Fixed Maintenance supplies used Cost Behavior

Problem Solution Step 1 – Determine the cost behavior pattern for each cost item: Raw materialsVariable Factory depreciation expense Fixed Direct laborVariable Production supervisor’s salary Fixed Computer rental expense Fixed Maintenance supplies usedVariable Cost Behavior

Problem Solution Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity: Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Cost Behavior 16,000 units $ 83,200 81, ,400 12,200 8,400 1,600 $384,800 Fixed Amount Variable Rate/Unit Variable Fixed Variable Fixed Variable

Problem Solution Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity: Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Cost Behavior 16,000 units $ 83,200 81, ,400 12,200 8,400 1,600 $384,800 $ 5.20 Fixed Amount Variable Rate/Unit Variable Fixed Variable Fixed Variable Variable rate calculation: $83,200 / 16,000 units = $ 5.20/unit

Problem Solution Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity: Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Cost Behavior $ 83,200 81, ,400 12,200 8,400 1,600 $384,800 $ 5.20 Fixed Amount Variable Rate/Unit 81,000 Variable Fixed Variable Fixed Variable Fixed costs items will remain constant regardless of the level of activity (within the relevant range). 16,000 units

Problem Solution Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity: Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Cost Behavior $ 83,200 81, ,400 12,200 8,400 1,600 $384,800 $ Fixed Amount Variable Rate/Unit 40,500 Variable Fixed Variable Fixed Variable Variable rate calculation: $198,400 / 16,000 units = $12.40/unit 16,000 units

Problem Solution Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity: Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Cost Behavior $ 83,200 81, ,400 12,200 8,400 1,600 $384,800 $ Fixed Amount Variable Rate/Unit 40,500 12,200 Variable Fixed Variable Fixed Variable 16,000 units

Problem Solution Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity: Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Cost Behavior $ 83,200 81, ,400 12,200 8,400 1,600 $384,800 $ Fixed Amount Variable Rate/Unit 40,500 6,100 8,400 Variable Fixed Variable Fixed Variable 16,000 units

Problem Solution Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity: Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Cost Behavior $ 83,200 81, ,400 12,200 8,400 1,600 $384,800 $ Fixed Amount Variable Rate/Unit 40,500 6,100 4,200 Variable Fixed Variable Fixed Variable Variable rate calculation: $1,600 / 16,000 units = $ 0.10/unit 16,000 units

Problem Solution Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity: Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Cost Behavior $ 83,200 81, ,400 12,200 8,400 1,600 $384,800 $ $17.70 Fixed Amount Variable Rate/Unit 81,000 12,200 8,400 $ 101,600 Variable Fixed Variable Fixed Variable 16,000 units

Problem Solution Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity: Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Cost Behavior $ 83,200 81, ,400 12,200 8,400 1,600 $384,800 $ $17.70 Fixed Amount Variable Rate/Unit Variable Fixed Variable Fixed Variable Cost formula = $101,600 fixed cost + $17.70 per unit variable cost 16,000 units 81,000 12,200 8,400 $ 101,600

Problem Solution Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determined in Step 2: Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Cost Behavior 19,200 units $ $17.70 Fixed Amount Variable Rate/Unit 81,000 12,200 8,400 $ 101,600 Variable Fixed Variable Fixed Variable

Problem Solution Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determined in Step 2: Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Cost Behavior $ $17.70 Fixed Amount Variable Rate/Unit Variable Fixed Variable Fixed Variable $ 99,840 Calculation: 19,200 units * $5.20 per unit 81,000 12,200 8,400 $ 101,600 19,200 units

Problem Solution Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determined in Step 2: Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Cost Behavior $ $17.70 Fixed Amount Variable Rate/Unit Variable Fixed Variable Fixed Variable $ 99,840 81,000 Fixed costs do not change at 19,200 units. 81,000 12,200 8,400 $ 101,600 19,200 units

Problem Solution Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determined in Step 2: Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Cost Behavior $ $17.70 Fixed Amount Variable Rate/Unit Variable Fixed Variable Fixed Variable $ 99,840 81, ,080 Calculation: 19,200 units * $12.40 per unit 81,000 12,200 8,400 $ 101,600 19,200 units

Problem Solution Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determined in Step 2: Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Cost Behavior $ $17.70 Fixed Amount Variable Rate/Unit Variable Fixed Variable Fixed Variable $ 99,840 81, ,080 12,200 81,000 12,200 8,400 $ 101,600 19,200 units

Problem Solution Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determined in Step 2: Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Cost Behavior $ $17.70 Fixed Amount Variable Rate/Unit Variable Fixed Variable Fixed Variable $ 99,840 81, ,080 12,200 8,400 81,000 12,200 8,400 $ 101,600 19,200 units

Problem Solution Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determined in Step 2: Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Cost Behavior $ $17.70 Fixed Amount Variable Rate/Unit Variable Fixed Variable Fixed Variable $ 99,840 81, ,080 12,200 8,400 1,920 Calculation: 19,200 units * $0.10 per unit 81,000 12,200 8,400 $ 101,600 19,200 units

Problem Solution Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determined in Step 2: Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Cost Behavior $ $17.20 Fixed Amount Variable Rate/Unit Variable Fixed Variable Fixed Variable $ 99,840 81, ,080 12,200 8,400 1,920 $441,440 81,000 12,200 8,400 $ 101,600 19,200 units

Problem Requirements a.How much cost would you expect to be incurred for each of the above items during June when 19,200 units of product are planned for production? b.Calculate the average total cost per unit for the 16,000 units manufactured in May. Explain why this figure would not be useful to a manager interested in predicting the cost of producing 19,200 units in June.

Problem Solution Average total cost for May: It would not be meaningful to use this average total cost figure to predict costs in the subsequent months; that would involve unitizing the fixed expenses – and they do not behave on a per unit basis. $384,800 / 16,000 = $24.05 per unit

Problem Solution Average total cost calculations are only valid for the number of units used in the calculation. Average total cost for any other number of units produced would be different because the fixed expenses per unit would decrease for each additional unit produced. Using the average total cost of $24.05 to estimate the cost of producing 19,200 units would give an estimate of $461,760, which is significantly higher than the $441,440 calculated in part a using the cost formula: Total Cost = $101,600 fixed cost + $17.70 per unit variable cost

Accounting What the Numbers Mean 9e David H. Marshall Wayne W. McManus Daniel F. Viele You should now have a better understanding of using cost behavior information. Remember that there is a demonstration problem for each chapter that is here for your learning benefit.