1. Cost Behavior, Activity Analysis, and Cost Estimation
Module 15
Cost Behavior, Activity Analysis, and Cost Estimation
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2. 1
Identify basic patterns of how costs respond to changes in activity cost drivers.
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3. Basic Cost Behavior Patterns
Variable Costs
Change in total in direct proportion to changes in activity
Fixed Costs
Do not change in response to a change in activity volume
Mixed Costs
Contain a fixed and variable cost element; sometimes called semi-variable costs
Step Costs
Constant within a narrow range of activity, but shift to a higher level when activity exceeds the range
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4. Variable Costs Increases as activity increases
Equals zero dollars when activity is zero
Total variable costs (Y)
Total activity (X)
Higher variable cost per unit creates a steeper line slope.
Total variable cost: Y = bX
b = Variable cost per unit
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5. Slope is zero, represented by a flat line.
Fixed Costs
No change as activity increases or decreases
No response to short-run changes in activity cost drivers
Total fixed costs (Y)
Total activity (X)
Slope is zero, represented by a flat line.
Total fixed cost: Y = a
a = Total fixed costs
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6. Contains both fixed and variable cost elements.
Mixed Costs
Increase in a linear fashion when activity increases
Positive in amount when activity is zero
Contains both fixed and variable cost elements.
Total mixed costs (Y)
Total activity (X)
Fixed portion
Variable portion
Total mixed cost: Y = a + bX
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7. Step Costs Increase in a step-like fashion as activity increases
Total cost shifts to a higher level when activity exceeds a range
Total step costs (Y)
Total activity (X)
Total step cost: Y = ai
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8. Shift in Cost Structure
The importance of managers understanding cost behavior continues to increase efforts to monitor and minimize total cost.
Total cost function in recent years
Has shifted to more fixed costs and lower variable costs
Important for organizations to manage their fixed costs
Example: Vizio acquires television components rather than manufacturing them
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9. Cost Behavior Pattern Assumptions
The four cost behavior patterns assume…
A unit of final output is the primary cost driver
The time period is too short to incorporate changes in strategic cost drivers such as the scale of operations
Causes some costs to be viewed as fixed in the short term, but appear variable in the long run
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10. Determine a linear total cost estimating equation.2
Determine a linear total cost estimating equation.
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11. Total Fixed Costs + (Variable Costs per Unit x Number of Units)
Total Cost Behavior
Total Cost Equation =
Total Fixed Costs + (Variable Costs per Unit x Number of Units)
Y = a + bX
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12. Relevant Range
A portion of a range of activity associated with the fixed cost of the current or expected capacity
A normal range of activity in which a company expects to operate, where the fixed costs remain linear, i.e., total cost remains the same
Example
During normal operations, factory space is adequate for Mattel. However, during the three months preceding the holiday season, Mattel’s operations are out of the relevant range and storage trailers must be rented for the additional merchandise.
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13. Relevant Range
Accountant’s linear approximation of total cost function
Economist’s total cost function, referred to as curvilinear
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14. Marginal Cost
Marginal cost is the varying increment in total cost of making one more unit.
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15. Marginal Costs and Activity Levels
Excess capacity resulting in high marginal costs
Optimal circumstances with marginal costs relatively low
Capacity constraints resulting in high marginal costs
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16. Predicting Total Costs with a Graph $0
$6,000 -
$5,000 -
$4,000 -
$3,000 -
$2,000 -
$1,000 -
| | | | |
Customer repairs
Total cost graph is useful in predicting total costs for the coming period.
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17. Unit variable costs stay the same at all activity levels.
$ -
0 -
Costs Per unit
Customer repairs
Unit variable costs stay the same at all activity levels.
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18. Customers Per customer
Average Costs
Average cost graph is useful if a manager wants to know the cost of serving a customer.
Number of Average Cost
Customers Per customer
100 $ $15.00
$11.00
Notice: Average costs decrease as the number of units produced increases.
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19. Classifying Fixed Costs
Classification depends on the immediate impact if the company attempts to change the fixed costs.
Committed fixed costs, known also as capacity costs, are required to maintain the current service or production capacity or to fill previous legal commitments.
Discretionary fixed costs, known also as managed fixed costs, are set at a fixed amount each period by management.
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20. Calculate and compare three different approaches to cost estimation.3
Calculate and compare three different approaches to cost estimation.
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21. Cost Estimation What is it? Identifying variable or fixed costs
The determination of the relationship between activity and cost
An important part of cost management
Identifying variable or fixed costs
Analyzing available accounting records
Interviews
Purpose of cost estimation
Cost prediction
i.e., forecasting future costs
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22. Estimating Mixed Cost Components
Variable Costs
Fixed Costs
Mixed Costs
Methods of estimating fixed and variable cost components
High-low method
Scatter diagrams
Least-squares regression analysis
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23. High-Low Cost Estimation
Uses data from two time periods
A high activity period, and a low activity period
Select a representative high point and a representative low activity point.
Step 1:
Difference in total costs
Difference in activity
Variable costs
per unit =
Determine variable costs per unit:
Step 2:
Subtract total variable costs from total fixed costs using either the high or low point:
Step 3:
Total costs – [Variable cost per unit × Number of units]
Total Fixed Costs =
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24. High-Low Example: Variable Costs
Number of Shipments
Packaging Costs
January 8,600 $25,000
February 9,800 26,000
March 11,600 31,600
April 11,200 33,000
Low activity period
Variable cost per unit (b)
$31,600 – $25,000
11,600 – 8,600
= $2.20 =
High activity period
The variable cost of each unit produced is $2.20.
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25. High-Low Example: Fixed Costs
Calculate fixed costs:
Variable cost per unit (b) = $2.20 per unit
a = Total costs – Variable costs
$25,000 = a + ($2.20 x 8,600 units)
a = $6,080
January
The same total fixed costs result using either the high or low activity point.
$31,600 = a + ($2.20 x 11,600 units)
a = $6,080
March
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26. High-Low Cost Estimation
Total Cost Equation: Y = $2.20X + $6,080
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27. When used alone to estimate costs, professional judgment is required.
Scatter Diagrams
A graph of past activity and cost data, with individual observations represented by dots.
When used alone to estimate costs, professional judgment is required.
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28. Least-Squares Regression
Also known as simple regression (one variable)
A mathematical technique to fit a cost-estimating equation to observed data
Minimizes the vertical squared difference between the estimated and actual costs at each data point
Accomplished using
Microsoft Excel®
Statistical software
Some calculators
Time consuming math calculations
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29. Least-Squares Criterion
The least-squares method minimizes the sum of all squared vertical deviations between individual observations and the cost-estimating line.
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30. Least-Squares Advantage
Superior to the high-low and scatter diagram methods
Because it uses all data points, and
Does not rely on subjective judgment
Statistical measures are available to determine how well the equation fits the line
Coefficient of determination
Measures the percent of variation in the dependent variable that the independent variable explains
Also called R-squared (R2)
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31. Simple and Multiple Regression
Simple Regression Equation (one variable)
Multiple Regression Equation (two variables)
Y = a + bX
Y = a + b1X1 + b2X2
Multiple regression
Often contains more than two variables
Can be used to determine the effect of individual product features on the market value of a product
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32. Cautions in Developing Cost Estimate Equations
Managers are responsible for making decisions
Mathematical models do not make decisions; they are tools to aid decision making
Not all data are based on normal operating conditions
Nonlinear relationships may exist
Results should make sense
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33. Identify and discuss problems encountered in cost estimation.4
Identify and discuss problems encountered in cost estimation.
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34. Cost Estimation Problems: Technology & Price
Data used in developing cost estimates must be based on the same technology.
Changes in Technology
Data used must reflect the same price level, or be restated to a single price level.
Changes in Prices
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35. Cost Estimation Problems: Matching Activity & Costs
Actual costs are not known until a future time period.
Time Lags
Examples
Cell phone bills arrive at the end of the month, but usage occurs throughout the month.
Vehicle mileage is used consistently but maintenance costs occur every few months.
Shorter time periods have higher probabilities of error in matching costs and activities.
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36. Cost Estimation Problems: Identifying Activity Cost Drivers
Which cost driver should be used?
Selection of a driver requires judgment and professional experience
Cost driver should have a logical, casual relationship with costs
Scatter diagrams and statistical measures are helpful
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37. 5
Describe and develop alternative classifications for activity cost drivers.
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38. Unit-Level Cost Behavior
Assumes changes in costs are best explained by changes in the number of units of product (or service provided)
Inaccurate for analyzing cost behavior when a company changes…
From labor-based to automated manufacturing
From a limited number related products to multiple products, with variations in volume and complexity
From a set of similar customers to a diverse set of customers
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39. Cost of primary raw materials converted to finished goods
Manufacturing Costs
Direct Materials
Cost of primary raw materials converted to finished goods
Direct Labor
Wages earned by production employees for the time they spend converting raw materials into finished products
“Direct costs: easily or directly traceable to a finished product or service
Manufacturing Overhead
All manufacturing costs other than direct materials and direct labor
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40. Changing Composition of Total Manufacturing Costs
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41. Changing Composition of Total Manufacturing Costs
The problem
Past tendency was to ignore overhead and focus on direct materials and labor
Units produced is no longer adequate in explaining manufacturing costs
Dealing with overhead causing activities
Include non-unit activity drivers
Hierarchy scheme frameworks
Manufacturing cost hierarchy, or
Customer cost hierarchy
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42. Manufacturing Cost Hierarchy
Performed for each unit of product produced
Unit level activities
Batch level activities
Performed to support the production of each different type of product
Product level activities
Performed to maintain general manufacturing capabilities
Facility level activities
A separate cost driver is selected for each level of cost.
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43. This activity is performed for each UNIT of product produced or sold.
Unit Level Activity
Examples
Cost of raw materials
Cost of cutting a component
Cost of a box to package cereal
Sales commission
Cost of paint brushes used by a painting company to paint an office building
This activity is performed for each UNIT of product produced or sold.
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44. This activity is performed for each BATCH of product produced or sold.
Batch Level Activity
Examples
Cost of processing sales orders
Cost of tracking work orders
Cost of equipment setup
Cost of moving a batch between workstations
Cost of inspecting batches
This activity is performed for each BATCH of product produced or sold.
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45. Product Level Activity
Examples
Cost of product development
Cost of specialized equipment
Cost of maintaining specialized equipment
This activity is performed to support the production of each different type of product.
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46. Facility Level Activity
Examples
Cost of maintaining factory building and grounds
Cost of real property taxes
Cost of non-specialized equipment
Cost of general advertising
Cost of factory supervisor
This activity is performed to maintain general manufacturing capabilities.
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47. Customer Cost Hierarchies for Merchandising and Sales Divisions
Often used by
Merchandising organizations
Sales divisions of manufacturers
Customer classification scheme
Unit-level activities
Order-level activities
Customer-level activities
Facility-level activities
Answers questions about the cost of individual orders or costs of individual customers.
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48. Customer Cost Hierarchy for Distinct Market Segments
Often used by companies that sell to distinct market segments such as:
Not-for-profit
For-profit
Government
Customer classification scheme
Unit-level activities
Order-level activities
Customer-level activities
Market-segment-level activities
Facility-level activities
Answers questions about the profitability of a segment.
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49. Customer Cost Hierarchy for Unique Projects
Often used by
Builders
Special contracts with the government
Customer classification scheme
Project-level activities
Market-segment-level activities
Facility-level activities
Answers questions about the cost of individual projects.
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