1 COST-ACTIVITY RELATIONSHIPS Accounting Principles II AC Fall Semester, 1999

2 Activity Terms & Analysis Activity: a basic unit of work performed within an organization –Examples: moving material, setting up a machine, typing a letter, approving a loan Activity Output: the result or product of an activity –Examples: Total pounds moved, number of setups, number of letters typed, number of loans approved Activity Input: the resources consumed by an activity in producing its output –Examples: supplies, labor, electricity, rent, depreciation, telephone

3 Time Horizon Determining whether a cost is fixed or variable depends on the time horizon under consideration In the long-run all costs are variable In the short-run, some costs will be fixed Remember that “fixed” and “variable” refers only to whether a cost is affected by the level of activity The length of the “short-run” will vary depending on the nature of the decision or issue under consideration

4 Calculating Activity Costs Activity Rate – is obtained by dividing the total resources expended by the appropriate volume measure for the activity Cost of Activity Used –is calculated by multiplying the activity rate times the actual activity usage

5 Measures of Activity Output Describing cost behavior requires measurement of activity output Activity output is measured by activity drivers In order to understand the behavior of costs we must first determine the underlying activities –and the associated drivers that measure activity capacity and usage The need to understand this cost-activity relationship leads us to the determination of an appropriate measure of activity output, or activity driver

6 Examples of Activity Outputs & Drivers (Activity drivers explain changes in activity costs by measuring changes in activity output) Activity Outputs Material Handling Shipping Goods Laundering Hospital Bedding Activity Drivers Number of moves Number of units sold Pounds of laundry

7 Two General Categories of Activity Drivers Unit-level Drivers –Explain changes in costs as units produced change Non-unit level Drivers –Explain changes in costs caused by factors other than units changes –There are three nonunit-level categories

8 The Three Types of Nonunit-Level Drivers Batch Level –batch-level costs tend to vary as the number of batches changes –example: setup costs Product Level –product-level costs tend to change as the number of different products change –example: engineering drawing changes Facility Level –facility-level costs tend to stay constant ( in SR) –example: equipment and rental costs

9 Traditional Vs. Contemporary Management Accounting Systems Traditional Systems: –Cost behavior is assumed to be described by unit-based drivers only Contemporary Systems: –Cost behavior is assumed to be affected by both unit-based and nonunit-based factors Contemporary systems produce a much richer, more complete view of cost behavior