Cost Classification and Cost Behavior

Cost Classification and Cost Behavior
EMBA 5403 Fall 2010 Mugan

Types of Costs The opportunity cost is the monetary amount associated with the next best use of the resource. differential costs- (benefits) – costs or benefits that change between/among alternatives Irrelevant costs -Costs that don’t change are irrelevant to the decision Choose the alternatives where differential benefits exceed differential costs Opportunity costs Sunk costs Controllable /avoidable costs/discretionary costs Costs that have already been incurred and cannot be changed no matter what action is taken in the future. Fall 2010 Mugan

Problems in Identifying and Measuring Benefits
How do I measure the benefit of employee training? How do I measure the benefit of improved quality? What is the monetary benefit of a happy customer? What is the monetary benefit of an improved working environment? Fall 2010 Mugan

Problems in Identifying and Measuring Costs
How do I measure the cost of poor quality? What is the cost of a dissatisfied customer? How do I measure the cost of setting my price too high? What is the cost of postponing this year’s training program? Fall 2010 Mugan

Classifications of Costs
Behavior – how costs react to changes in underlying cost driver Variable or Fixed Function – related to production or sales Product or Period Product costs – Direct Material Direct Labor Factory Overhead Traceability (cost of tracing cost to a cost driver directly should be lower than the benefits. Managers need to rely upon different classifications of costs for different purposes. The four main purposes emphasized in this chapter include preparing external financial reports, predicting cost behavior, assigning costs to cost objects, and making business decisions. Our initial focus is on manufacturing companies since their basic activities include most of the activities found in other types of business organizations. Nonetheless, many of the concepts developed here apply to diverse organizations. Fall 2010 Mugan

Non-manufacturing Costs
Marketing or Selling Costs Costs necessary to get the order and deliver the product. Administrative Costs All executive, organizational, and clerical costs. A manufacturing company incurs many other costs in addition to manufacturing costs. For financial reporting purposes most of these other costs are typically classified as marketing or selling costs and administrative costs. These costs are also called selling, general and administrative costs. Marketing and administrative costs are incurred in both manufacturing and merchandising firms. Marketing costs include all costs necessary to secure customer orders and get the finished product into the hands of the customer. These costs are also referred to as order-getting and order-filling costs. Administrative costs include all executive, organizational, and clerical costs associated with the general management of an organization that are not classified as production or marketing costs. Fall 2010 Mugan

Product Costs Versus Period Costs
Product costs include direct materials, direct labor, and manufacturing overhead. Period costs include all marketing or selling costs and administrative costs. Inventory Cost of Good Sold Expense Costs can also be classified as period or product costs. Product costs include all the costs that are involved in acquiring or making a product. More specifically, it includes direct materials, direct labor, and manufacturing overhead. Consistent with the matching principle product costs are recognized as expenses when the products are sold. This can result in a delay of one or more periods between the time in which the cost is incurred and when it appears as an expense on the income statement. Product costs are also known as inventoriable costs. Period costs include all marketing or selling costs and administrative costs. These costs are expensed on the income statement in the period incurred. All selling and administrative costs are typically considered to be period costs. The usual rules of accrual accounting apply to period costs. For example, administrative salary costs are “incurred” when they are earned by the employees and not necessarily when they are paid to employees. Period costs are non-inventoriable costs. Sale Income Statement Income Statement Balance Sheet Fall 2010 Mugan

Product Cost Flows To determine cost of goods sold as well as inventories, it is important to understand the flow of product costs. Raw material purchases made during the period are added to beginning raw materials inventory. The ending raw materials inventory is deducted to arrive at the raw materials used in production. As items are removed from the raw materials inventory and placed into the production process, they are called either direct or indirect materials. Indirect material costs are accumulated under manufacturing or factory overhead control account. Fall 2010 Mugan

Product Cost Flows Prime Costs Conversion Costs
Direct labor and manufacturing overhead (also called conversion costs) used in production are added to direct materials to arrive at total manufacturing costs. Direct labor and direct material costs, on the other hand, are called prime costs. Fall 2010 Mugan

Product Cost Flows Total manufacturing costs are added to the beginning work in process to arrive at total work in process. Manufacturing costs are made up of usually indirect material and labor; factory related costs that are easily traced to the products. For example, factory cleaning wages, security personnel --- indirect labor; bolts, nuts and other small items, or grease and oil --- indirect materials; depreciation of factory building; depreciation of machinery; factory utility costs are all examples of manufacturing costs. Fall 2010 Mugan

Product Cost Flows The ending work in process inventory is deducted from the total work in process for the period to arrive at the cost of goods manufactured. Ending work in process is determined via physical count and estimation procedures employed- depending on the costing system of the company. Fall 2010 Mugan

Product Cost Flows The cost of goods manufactured is added to the beginning finished goods inventory to arrive at cost of goods available for sale. The ending finished goods inventory is deducted from this figure to arrive at cost of goods sold. Fall 2010 Mugan

Manufacturing Cost Flows
Income Statement Expenses Balance Sheet Costs Inventories Material Purchases Raw Materials Manufacturing Overhead Work in Process Direct Labor Finished Goods Part I All raw materials, work in process, and unsold finished goods at the end of the period are shown as inventoriable costs in the asset section of the balance sheet. Part II As finished goods are sold, their costs are transferred to cost of goods sold on the income statement. Part III Selling and administrative expenses are not involved in making the product; therefore, they are treated as period costs and reported on the income statement for the period the cost is incurred. Cost of Goods Sold Selling and Administrative Period Costs Fall 2010 Mugan

Graphical Analysis of Activity Costs and Rate of Output
Curvilinear Total Cost Curve Total Dollars Start-up Range Normal Operations Exceeding Capacity Output Marginal Costs are the costs to produce one more additional unit of output=slope. Fall 2010 Mugan

} Relevant Range Total Dollars Output Start-up Range Normal Operations
The relevant range is the portion of the curvilinear total cost curve that appears in the normal operations area. Output Total Dollars Start-up Range Normal Operations Exceeding Capacity Relevant Range } Total Cost Fall 2010 Mugan

The Linearity Assumption and the Relevant Range
A straight line closely approximates a curvilinear variable cost line within the relevant range. Economist’s Curvilinear Cost Function Total Cost Accountant’s Straight-Line Approximation (constant unit variable cost) Part I Economists correctly point out that many costs that accountants classify as variable costs actually behave in a curvilinear fashion. Part II In many important decisions accountants tend to treat costs as linear in nature. Part III As long as the company is operating within the relevant range of activity, the accountant’s approximation of the economist’s curvilinear cost function seems to work quite well. The relevant range is the range of activity within which the assumptions made about cost behavior are valid. Activity Fall 2010 Mugan

Cost Classifications for Predicting Cost Behavior
By reaction to changes in the level of activity within the relevant range. Total variable costs change when activity changes. Total fixed costs remain unchanged when activity changes. Managers often need to be able to predict how costs will change in response to changes in activity. The activity might be the output of goods or services or it might be some measure of activity internal to the company such as the number of purchase orders processed during a period. While there are other ways to classify costs according to how they react to changes in activity, we introduce the simple variable and fixed classifications. Just about any cost will change if there is a big enough change in activity. There is some controversy concerning the proper definition of the “relevant range.” Some refer to the relevant range as the range of activity within which the company usually operates or as the range of activity within which the assumptions about variable and fixed costs are valid. Either definition could be used. Fall 2010 Mugan

Fall 2010 Mugan

Cost Classifications for Predicting Cost Behavior
It is helpful to think about variable and fixed cost behavior in a two by two matrix, as illustrated here. Take a few minutes and review this summary of cost behavior for variable and fixed costs. Fall 2010 Mugan

Extent of Variable Costs
The proportion of variable costs differs across organizations. For example . . . A manufacturing company will often have many variable costs. A public utility with large investments in equipment will tend to have fewer variable costs. A merchandising company usually will have a high proportion of variable costs like cost of sales. A public utility has huge investments in property, plant and equipment, and will tend to have fewer variable costs than a less capital intensive industry. In contrast, a merchandising company usually has a high proportion of variable costs like cost of goods sold. Service companies like law firms and CPA firms also tend to have a high proportion of variable costs. A service company will normally have a high proportion of variable costs. Fall 2010 Mugan

Examples of Variable Costs
Merchandising companies – cost of goods sold. Manufacturing companies – direct materials, direct labor, and variable overhead. Merchandising and manufacturing companies – commissions, shipping costs, and clerical costs such as invoicing. Service companies – supplies, travel, and clerical Here are some examples of variable costs we are likely to find in different types of businesses. Fall 2010 Mugan

Types of Fixed Costs Committed Discretionary Examples Examples
Long-term, cannot be significantly reduced in the short term. Discretionary May be altered in the short-term by current managerial decisions Examples Depreciation on Equipment and Real Estate Taxes Examples Advertising and Research and Development Part I One type of fixed cost is known as committed fixed costs. These are long-term fixed costs that cannot be significantly reduced in the short term. Some examples include depreciation on manufacturing facilities and real estate taxes on factory property. Part II Another type of fixed cost is known as discretionary fixed costs. These types of fixed costs may be altered in the short-term by current management decisions. Some examples of discretionary fixed costs include advertising and research and development costs. Fall 2010 Mugan

Fixed Monthly Phone Charge Total Mobile Phone Cost
Mixed Costs Fixed Monthly Phone Charge Total Mobile Phone Cost X Y Total mixed cost A mixed cost has both a fixed and variable element. If you pay your mobile phone bill, you know that a portion of your total bill is fixed. This is the standard monthly charge. The variable portion of your phone costs depends upon the number of minutes you consume. Your total bill has both a fixed and variable element. The graph demonstrates the nature of a normal utility bill. Activity (minutes) Fall 2010 Mugan

Mixed Costs Y Total mixed cost X Activity (minutes)
Total Mobile Phone Cost The mixed cost line can be expressed with the equation Y equals A plus B times X. This equation should look familiar, from your algebra and statistics classes. In the equation, Y is the total mixed cost; A is the total fixed cost (or the vertical intercept of the line); B is the variable cost per unit of activity (or the slope of the line), and X is the actual level of activity. In our utility example, Y is the total mixed cost; A is the total fixed monthly utility charge; B is the cost per kilowatt hour consumed, and X is the number of kilowatt hours consumed. Variable Cost per minute Fixed Monthly Phone Charge Activity (minutes) Fall 2010 Mugan

The Scattergraph Method
Plot the data points on a graph (total cost vs. activity). * Cost 10 20 Activity - output X Y A scattergraph plot is a quick and easy way to isolate the fixed and variable components of a mixed cost. The first step is to identify the cost, which is referred to as the dependent variable, and plot it on the Y axis. The activity, referred to as the independent variable, is plotted on the X axis. If the plotted dots do not appear to be linear, do not analyze the data any further. If there does appear to be a linear relationship between the level of activity and cost, we will continue our analysis. Fall 2010 Mugan

Draw a line through the data points with about an equal numbers of points above and below the line. * Cost 10 20 Activity - output X Y Next, we draw a straight line where, roughly speaking, an equal number of points reside above and below the line. Make sure that the straight line goes through at least one data point on the scattergraph. Fall 2010 Mugan

Use one data point to estimate the total level of activity and the total cost. * Cost 10 20 Activity - output X Y Total cost = TL11 Intercept = Fixed cost: TL 10 Part I Where the straight line crosses the Y axis determines the estimate of total fixed costs. In this case the fixed costs are ten thousand dollars. Part II Next, select one data point to estimate the variable cost per patient day. In our case, we used the first data point that was on the straight line. From this point we estimate that the total number of patient days and the total maintenance cost. Part II Our estimate of the total number of patient days at this data point is eight hundred, and the estimate of the total maintenance cost is eleven thousand dollars. We will use this information to estimate the variable cost per patient day. Activity 0.8 units Fall 2010 Mugan

Make a quick estimate of variable cost per unit and determine the cost equation. Variable cost per unit = TL1 0.8 = TL1.25/ unit of output Part I Subtract the fixed cost from the total estimated cost for eight hundred patient days. We arrive at an estimate of the total variable cost for eight hundred patients of one thousand dollars. Part II Divide the total variable cost by the eight hundred patients and we have determined that the variable cost per patient day is one dollar and twenty five cents. We can use this information to setup of basic cost equation. Part II Our maintenance cost equation tells us the Y, the total maintenance cost is equal to ten thousand dollars, the total fixed cost, plus one dollar and twenty five cents times X, the number of patient days. Y = TL10 + TL1.25X Number of units Total cost Fall 2010 Mugan

The High-Low Method High level of activity Low level of activity
Assume the following hours of maintenance work and the total maintenance costs for six months. High level of activity Low level of activity The high-low method can be used to analyze mixed costs if a scattergraph plot reveals an approximately linear relationship between the X and Y variables. We will use the data shown in the Excel spreadsheet to determine the fixed and variable portions of maintenance costs. We have collected data about the number of hours of maintenance and total cost incurred. Let’s see how the high-low method works. Part I The first step in the process is to identify the high level of activity and its related total cost and the low level of activity with its related total cost. You can see that the high level of activity is eight hundred hours with a cost of nine thousand eight hundred dollars. The low level of activity is five hundred hours with a related total cost of seven thousand four hundred dollars. Now we subtract the low level of activity from the high level and do the same for the costs we have identified. In our case, the change in level of activity is three hundred hours and two thousand four hundred dollars. Part II The variable cost per unit of activity is determined by dividing the change in total cost by the change in activity. For our maintenance example, we divide two thousand four hundred dollars by three hundred hours and determine that the variable cost per hour of maintenance is eight dollars. Fall 2010 Mugan

Assigning Costs to Cost Objects
Direct costs Costs that can be easily and conveniently traced to a unit of product or other cost object. Examples: direct material and direct labor Indirect costs Costs that cannot be easily and conveniently traced to a unit of product or other cost object. Example: manufacturing overhead A cost object is anything for which cost data are desired including products, customers, jobs, organizational subunits, etc. For purposes of assigning costs to cost objects costs are classified two ways: Direct costs are costs that can be easily and conveniently traced to a unit of product or other cost object. Examples of direct costs are direct material and direct labor. Indirect costs are costs that cannot be easily and conveniently traced to a unit of product or other cost object. An example of an indirect cost is manufacturing overhead. Common costs are indirect costs incurred to support a number of cost objects. These costs cannot be traced to any individual cost object. Fall 2010 Mugan

Cost Classifications for Decision Making
Every decision involves a choice between at least two alternatives. Only those costs and benefits that differ between alternatives are relevant in a decision. All other costs and benefits can and should be ignored. It is important to realize that every decision involves a choice between at least two alternatives. The goal of making decisions is to identify those costs that are either relevant or irrelevant to the decision. Costs and benefits that differ between alternatives are relevant in a decision. All other costs and benefits are irrelevant and can and should be ignored. Fall 2010 Mugan

Differential Costs and Revenues
Costs and revenues that differ among alternatives. Example: You have a job paying TL 1,500 per month in your hometown. You have a job offer in a neighboring city that pays TL 2,000 per month. The commuting cost to the city is TL 300 per month. Differential costs (or incremental costs) is a difference in cost between any two alternatives. A difference in revenue between two alternatives is called differential revenue. Differential costs can be either fixed or variable. For example, assume you have a job paying one thousand five hundred dollars per month in your hometown. You have a job offer in a neighboring city that pays two thousand dollars per month. The commuting cost to the city is three hundred dollars per month. In this example, the differential revenue is five hundred dollars and the differential cost is three hundred dollars. Differential revenue is: TL2,000 – TL1,500 = TL500 Differential cost is: TL 300 Fall 2010 Mugan

Opportunity Costs The potential benefit that is given up when one alternative is selected over another. Example: If you were not attending this program, you could save TL 10,000 per year. Your opportunity cost? Opportunity cost is the potential benefit that is given up when one alternative is selected over another. These costs are not usually entered into the accounting records of an organization, but must be explicitly considered in all decisions. Fall 2010 Mugan

Sunk Costs Sunk costs have already been incurred and cannot be changed now or in the future. They should be ignored when making decisions. Example: You bought an automobile that cost TL10,000 two years ago. The TL10,000 cost is sunk because whether you drive it, park it, trade it, or sell it, you cannot change the TL10,000 cost. A sunk cost is a cost that has already been incurred and that cannot be changed by any decision made now or in the future. Since sunk costs cannot be changed and therefore cannot be differential costs, they should be ignored in decision making. While students usually accept the idea that sunk costs should be ignored on an abstract level, like most people they often have difficulty putting this idea into practice. Fall 2010 Mugan

Summary of the Types of Cost Classifications
Financial reporting Predicting cost behavior Assigning costs to cost objects- products- determining unit costs Decision making We have looked at the cost classifications used for financial reporting, predicting cost behavior, assigning costs to cost objects, and making business decisions. Now, let’s look at how to classify idle time, overtime, and fringe benefits. Fall 2010 Mugan

Income Statement Presentation
The contribution approach differs from the traditional approach covered in Financial Accounting The traditional approach organizes costs in a functional format. Costs relating to production, administration and sales are grouped together without regard to their cost behavior. The traditional approach is used primarily for external reporting purposes. Used primarily for external reporting. Used primarily by management. Fall 2010 Mugan

Idle Time Machine Breakdowns Material Shortages Power Failures The labor costs incurred during idle time are ordinarily treated as manufacturing overhead. Machine breakdowns, material shortages, power failures and the like result in idle time. The labor costs incurred during idle time are ordinarily treated as manufacturing overhead. This enables the costs to be spread across all the production rather than the units in process when the disruptions occur. Fall 2010 Mugan

Overtime The overtime premiums for all factory workers are usually considered to be part of manufacturing overhead. The overtime premiums for all factory workers are usually considered to be part of manufacturing overhead. This is done to avoid penalizing particular products or customer orders simply because they happen to fall on the tail end of the daily production schedule. Fall 2010 Mugan

Unit Costs Direct Material- determined as actual usage of materials or by engineering estimates (standard costs) Direct Labor- determined as actual usage of materials or by engineering estimates (standard costs) MOVH – common production costs assigned to each unit Traditional ABC Unit cost = DM + DL + MOVH per unit Fall 2010 Mugan

Some companies include all of these costs in manufacturing overhead.
Labor Fringe Benefits Fringe benefits include employer paid costs for insurance programs, retirement plans, supplemental unemployment programs, Social Security, Medicare, workers’ compensation and unemployment taxes. Labor fringe benefits costs are employment-related costs paid by an employer such as insurance programs, retirement plans, and supplemental unemployment programs. They also include the employer’s share of Social Security, Medicare, workers’ compensation, federal employment tax, and state unemployment insurance. These costs often add up to thirty to forty percent of an employee’s base pay. Some companies include all of these costs in manufacturing overhead. Other companies opt for the conceptually superior method of treating fringe benefit expenses of direct laborers as additional direct labor costs. Some companies include all of these costs in manufacturing overhead. Other companies treat fringe benefit expenses of direct laborers as additional direct labor costs. Fall 2010 Mugan

How to allocate indirect costs to products MOVH
Depends on the nature of products and production system Traditional- direct labor hours (DLH); number of units produced; Automation and computer technology have increased the indirect costs in many organizations Activity-Based Costing (ABC)- a procedure that attempts to provide a more precise indirect cost allocation Fall 2010 Mugan 14 14

Numerical Example- Unit Cost
THD Company produces 4,000 units of Product A and 20,000 units of Product B each year. Direct Material for Product A is TL 10; Product B 15 Total indirect product costs are TL 900,000, and total direct labor hours(DLH) are 50,000. Product A requires 2.5 DLH and Product B requires 2.0 DLH to produce. Direct labor cost per hour TL 30 Continue Fall 2010 Mugan

Numerical Example Management at THD believes that indirect costs
are actually caused by the following five activities: Fall 2010 Mugan

Unit Cost - Traditional
THD uses DLH as the basis 1.determine the allocation of MOVH per unit = predetermined overhead rate(PDOR) PDOR= Total Overhead/ Total DLH 2. determine MOVH per unit = PDOR x DL Cost per hour 3. add DM,DL and MOVH per unit Fall 2010 Mugan

PDOR and MOVH Fall 2010 Mugan

Unit Costs – Traditional
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The following activity data was supplied by
Numerical Example-MOVH by ABC The following activity data was supplied by the management of THD Fall 2010 Mugan

Numerical Example-MOVH by ABC
This activity data can be used to develop application rates for each of the five activities. Fall 2010 Mugan

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Now that we have calculated the application rates, we use the rates to assign indirect costs to Product A. Fall 2010 Mugan

MOVH costs for a unit of Product B Fall 2010 Mugan

Reconciliation check Fall 2010 Mugan

Unit Costs – Using ABC Fall 2010 Mugan

Comparison of Unit Costs
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percentage of indirect
Advantages of ABC Activity-based costing is very useful in firms . . . With multiple products and services. That have products and services that use indirect activities in different ways. That have a high percentage of indirect product costs. Fall 2010 Mugan

Proper identification
Problems With ABC Proper identification of cost drivers is difficult. ABC ignores the difference between the fixed and variable costs of an activity. ABC is more costly because additional measurements and observations must be made. Fall 2010 Mugan

Quality of Conformance
When the overwhelming majority of products produced conform to design specifications and are free from defects. The term quality has many meanings. Quality can mean that a product has many features not found in other products; it can mean that it is well-designed; or it can mean that it is defect-free. In this appendix, the focus is on the presence or absence of defects. Quality of conformance is the degree to which the actual product or service meets its design specifications. Anything that does not meet design specifications is a defect and is indicative of low quality of conformance. Fall 2010 Mugan

Prevention and Appraisal Costs
Prevention Costs Support activities whose purpose is to reduce the number of defects There are four broad categories of quality costs: prevention costs, appraisal costs, internal failure costs, and external failure costs. Prevention costs are incurred to support activities whose purpose is to reduce the number of defects. Appraisal costs are incurred to identify defective products before the products are shipped to customers. Appraisal Costs Incurred to identify defective products before the products are shipped Fall 2010 Mugan

Internal and External Failure Costs
Internal Failure Costs Incurred as a result of identifying defects before they are shipped External Failure Costs Incurred as a result of defective products being delivered to customers Internal failure costs are incurred as a result of identifying defects before they are shipped to customers. External failure costs are incurred as a result of defective products being delivered to customers. Fall 2010 Mugan

Examples of Quality Costs
Prevention Costs Quality training Quality circles Statistical process control activities Appraisal Costs Testing & inspecting incoming materials Final product testing Depreciation of testing equipment Internal Failure Costs Scrap Spoilage Rework External Failure Costs Cost of field servicing & handling complaints Warranty repairs Lost sales Here are some examples of each type of quality cost. Prevention costs include quality training, quality circles, and statistical process control activities. Appraisal costs include testing and inspection of incoming materials, final product testing, and depreciation of testing equipment. Internal failure costs include scrap, spoilage, and rework. External failure costs include the cost of field servicing and handling customer complaints, warranty repairs, and lost sales arising from reputation of poor quality. Fall 2010 Mugan

Distribution of Quality Costs
When quality of conformance is low, total quality cost is high and consists mostly of internal and external failure. Companies can reduce their total quality cost by focusing on prevention and appraisal. The cost savings from reduced defects usually swamps the costs of the additional prevention and appraisal efforts. Here are four key concepts about the relationship between the four types of quality costs. When the quality of conformance is low, total quality cost is high and most of this cost consists of internal and external failure costs. Total quality costs drop rapidly as the quality of conformance increases. Companies reduce their total quality costs by focusing their efforts on prevention and appraisal because the cost savings from reduced defects usually overwhelm the costs of additional prevention and appraisal. Total quality costs are minimized when the quality of conformance is slightly less than one hundred percent. This is a debatable point in the sense that some experts believe that total quality costs are not minimized until the quality of conformance is one hundred percent. Fall 2010 Mugan

Quality cost reports provide an estimate of the financial consequences of the company’s current defect rate. A quality cost report details the prevention, appraisal, internal failure, and external failure costs that arise from a company’s current quality control efforts. When interpreting a cost of quality report managers should look for two trends. First, increases in prevention and appraisal costs should be more than offset by decreases in internal and external failure costs. Second, the total quality costs as a percent of sales should decrease. Fall 2010 Mugan

Quality Cost Reports: Graphic Form
Quality reports can also be prepared in graphic form. Quality cost reports can also be prepared in graphic form. Managers should still look for the same two trends whether the data is presented in a graphic or table format. Fall 2010 Mugan

Uses of Quality Cost Information
Help managers see the financial significance of defects. Help managers identify the relative importance of the quality problems. Uses of quality cost information include the following. It helps managers see the financial significance of defects. It helps managers identify the relative importance of the quality problems faced by the company. It helps managers see whether their quality costs are poorly distributed. In general, costs should be distributed more toward prevention and to a lesser extent appraisal than toward failures. Limitations of quality cost information include the following. Simply measuring and reporting quality cost problems does not solve quality problems. Results usually lag behind quality improvement programs. Initially, prevention and appraisal cost increases may not be offset by decreases in failure costs. The most important quality cost, lost sales arising from customer ill-will, is often omitted from quality cost reports because it is difficult to estimate. Help managers see whether their quality costs are poorly distributed. Fall 2010 Mugan

ISO 9000 Standards ISO 9000 standards have become an international measure of quality. To become ISO 9000 certified, a company must demonstrate: A quality control system is in use, and the system clearly defines an expected level of quality. The system is fully operational and is backed up with detailed documentation of quality control procedures. The intended level of quality is being achieved on a sustained basis. The International Organization for Standardization, based in Geneva Switzerland, has established quality control guidelines known as the ISO nine thousand standards. For a company to become ISO nine thousand certified by a certifying agency it must demonstrate that: A quality control system is in use, and the system clearly defines an expected level of quality, The system is fully operational and is backed up with detailed documentation of quality control procedures, and The intended level of quality is being achieved on a sustained basis. Although the ISO nine thousand standards were developed in Europe they have become widely accepted elsewhere throughout the world including the United States. Fall 2010 Mugan

Product Life Cycle Fall 2010 Mugan

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Introduction Growth Maturity Decline
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http://www. ee. unb. ca/powereng/courses/EE2703/EE2703_DetailedDesign2
Fall 2010 Mugan

Least-Squares Regression Using Microsoft Excel.
Appendix Least-Squares Regression Using Microsoft Excel. In this appendix we will show you how to use Microsoft Excel to determine the key variable necessary for least-squares regression. As you have seen, we need three pieces of information: the estimated variable cost per unit (the slope of the line), the estimated fixed cost (the intercept), and R squared. Let’s get started. I think you will find that using Microsoft Excel is quite easy. Fall 2010 Mugan

Simple Regression Analysis Example
Matrix, Inc. wants to know its average fixed cost and variable cost per unit. Using the data to the right, let’s see how to do a regression using Microsoft Excel. Matrix, Inc. has gathered fifteen month’s of information concerning the number of meals prepared and the total cost of preparing them each month. We will use this data in our least-squares regression model. Fall 2010 Mugan

Simple Regression Using Excel
You will need three pieces of information from your regression analysis: Estimated Variable Cost per Unit (line slope) Estimated Fixed Costs (line intercept) Goodness of fit, or R2 To gather the three pieces of information we need, we will use three special functions in Excel. These functions are named LINEST, INTERCEPT, and RSQ. LINEST provides us with the slope of the line, INTERCEPT gives us the fixed cost intercept, and RSQ yields the R squared value. Load Excel on your computer and enter the data shown in the table on the right side of your screen. Start with the headings in cell B3, C3, and D3. Enter the months in column B, the total cost in column C, and the number of meals in column D. When finished entering this data, go to the next screen. To get these three pieces information we will need to use three different Excel functions. LINEST, INTERCEPT, & RSQ Fall 2010 Mugan

Place your cursor in cell F4 and press the = key. Click on the pull down menu and scroll down to “More Functions . . .” We will place the slope of the line in cell F4, so place your cursor in cell F4 and press the equal key. Look to the left of your screen and you will see the special functions drop-down menu. Click on the down arrow to the right of the special functions tab and scroll down to select more functions. Fall 2010 Mugan

Scroll down to the “Statistical”, functions. Now scroll down the statistical functions until you highlight “LINEST” Use the Or select a category option to select statistical. Once statistical is selected, move to the select a function window and scroll down until you find LINEST. Click on LINEST. Fall 2010 Mugan

The Function Arguments window will pop-up for LINEST. The first blank space is for Known underscore y’s. We want to enter the total cost for each month in this space. To do this, click on cell C4, hold down the mouse button and drag down to cell C19. Now, release the mouse button and C4 colon C19 will appear in the first space. We have now entered the total cost. Move your cursor down to the second space named Known underscore x’s. We want to enter the number of meals prepared in this space. Click on cell D4, hold down the mouse button and drag down to cell D19. Release the mouse button and you have entered the number of meals. 1. In the Known_y’s box enter C4:C19 for the range. 2. In the Known_x’s box enter D4:D19 for the range. Fall 2010 Mugan

Here is the estimate of the slope of the line. Look at the bottom of your screen to locate the two point seven, seven. This is the estimate of the slope of the line. Now look at your cell F4 and make sure it looks just like the cell contents on this screen. If you have two point seven, seven and cell F4 looks good, press the enter key. You have calculated the slope of the line, which is the first piece of vital information. 1. In the Known_y’s box enter C4:C19 for the range. 2. In the Known_x’s box enter D4:D19 for the range. Fall 2010 Mugan

With you cursor in cell F5, press the = key and go to the pull down menu for special functions. Select Statistical and scroll down to highlight the INTERCEPT function. Move your cursor to cell F5 and press the equal key. Return to the special functions area and click on the down arrow. The statistical function should now be selected. Scroll the select a function window until you find INTERCEPT. Click on INTERCEPT to select this function. Fall 2010 Mugan

Here is the estimate of the fixed costs. Part I Once again we are asked to enter the Known underscore y’s and x’s. Follow the same procedures we used earlier to enter the total cost values in the Known underscore y’s and the number of meals in the Known underscore x’s spaces. Part II Notice that Excel has already calculated the estimated fixed costs at two thousand six hundred eighteen dollars and seventy-two cents. If you find this amount and your cell F5 looks like the one on the screen, press the enter key. You have just determined the fixed cost intercept, which is the second piece of information needed. 1. In the Known_y’s box enter C4:C19 for the range. 2. In the Known_x’s box enter D4:D19 for the range. Fall 2010 Mugan

Finally, we will determine the “goodness of fit”, or R2, by using the RSQ function. Move your cursor to cell F6, press the equal key, and select the special functions section of Excel. You are already in statistical, so scroll until you find the special function RSQ (or R squared). Click on RSQ and you are ready to enter the necessary data. Fall 2010 Mugan

Here is the estimate of R2. Part I Once again, the function arguments window asks you to enter the Known underscore y’s and x’s. Follow the same procedure to enter total cost in the Known underscore y’s and the number of meals in the Known underscore x’s. Part II Look in the arguments window and notice that the R squared is equal to ninety-three point three percent. That is an excellent R squared. If you calculated this value for R squared and your cell F6 looks like the one on your screen, press the enter key. You have now completed gathering all the information necessary. Using Excel to solve a least-squares regression problem is very easy. It is very important that you understand the output from these special functions. 1. In the Known_y’s box enter C4:C19 for the range. 2. In the Known_x’s box enter D4:D19 for the range. Fall 2010 Mugan

Cost Classification and Cost Behavior

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