Principles of Managerial Accounting Chapter 5

Types of Cost Behavior Patterns Variable True Variable Step-variable Fixed Committed Discretionary Mixed

Types of Cost Behavior Patterns Variable Costs whose total dollar amount varies in direct proportion to changes in the activity level. When expressed on a per unit basis, variable costs are constant. To be a variable cost, the cost must be variable with some activity base. (eg. Units produced, machine hours) A true variable cost varies in direct proportion to the level of activity. A step-variable cost varies in large chunks and increases or decreases in response to fairly wide changes in the activity level. (eg. Direct labor where all employees full-time employees.)

Types of cost behavior patterns (cont) Fixed costs remain constant in total dollar amount within the relevant range. The amount of fixed cost computed on a per unit basis will become progressively smaller as the number of units produced increases. Types of fixed costs: Committed Fixed Costs—investments in buildings, equipment and basic organizational structure. Are long-term in nature. Discretionary Fixed Costs—Adjusted by management periodically. Eg. Advertising, R&D

Types of Cost Behavior patterns (cont) Mixed Costs Contains both variable and fixed cost elements. Cost formula Y=a+bX Y – Total estimated cost a – Estimated total fixed cost b – Estimated variable cost per unit of activity X – Estimated units of activity

Three techniques for analyzing mixed costs High-low method Focuses exclusively on the high and low levels of activity within a relevant range. On the graph the Y axis is cost; x axis is activity Refer to Exhibit 5-9 page 207 Scattergraph method The scattergraph method of mixed cost analysis utilizes data from all levels of activity. Costs at all levels of activity are plotted and a regression line is fitted to the plotted points by eye with a straightedge. (with the same number of points above and below the line) This method is subjective and could lead to errors in decision-making.

Analysis of Mixed costs (cont) Least-squares Regression Method More objective and precise method than the scattergraph method The regression line minimizes the sum of the squared errors. Refer to Exhibit 5-11 In addition to estimates of the slop (variable cost per unit) and the intercept (total fixed cost), the regression software can produce a variety of informative statistics.

Two types of income statements Traditional Approach Based on the cost functions of Production Administration Sales Contribution Approach Costs split between variable and fixed costs Refer to Exhibit 5-12 page 211