1. Cost Behavior Analysis Chapter 3

2. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Recall the summary of our cost behavior discussion from Chapter 2. Types of Cost Behavior Patterns

3. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion The Activity Base A measure of the event that causes the incurrence of a variable cost – a cost driver Units produce d Miles driven Labor hours Machine hours

4. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Minutes Talked Total Long Distance Telephone Bill True Variable Cost Example Your total long distance telephone bill is based on how many minutes you talk.

5. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Minutes Talked Per Minute Telephone Charge Variable Cost Per Unit Example The cost per minute talked is constant. For example, 10 cents per minute.

6. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Step-Variable Costs Activity Cost Total cost remains constant within a narrow range of activity.

7. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Step-Variable Costs Activity Cost Total cost increases to a new higher cost for the next higher range of activity.

8. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Relevant Range A straight line closely approximates a curvilinear variable cost line within the relevant range. Activity Total Cost Economist’s Curvilinear Cost Function The Linearity Assumption and the Relevant Range Accountant’s Straight-Line Approximation (constant unit variable cost)

9. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Number of Local Calls Monthly Basic Telephone Bill Total Fixed Cost Example Your monthly basic telephone bill is probably fixed and does not change when you make more local calls.

10. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Number of Local Calls Monthly Basic Telephone Bill per Local Call Fixed Cost Per Unit Example The fixed cost per local call decreases as more local calls are made.

11. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Cost Behavior Merchandisers Cost of Goods Sold Merchandisers Cost of Goods Sold Manufacturers Direct Material, Direct Labor, and Variable Manufacturing Overhead Manufacturers Direct Material, Direct Labor, and Variable Manufacturing Overhead Merchandisers and Manufacturers Sales commissions and shipping costs Merchandisers and Manufacturers Sales commissions and shipping costs Service Organizations Supplies and travel Service Organizations Supplies and travel Examples of normally variable costs Examples of normally fixed costs Merchandisers, manufacturers, and service organizations PBB taxes, Insurance, Sales salaries Depreciation, Advertising Merchandisers, manufacturers, and service organizations PBB taxes, Insurance, Sales salaries Depreciation, Advertising

12. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Examples Advertising and Research and Development Examples Advertising and Research and Development Examples Depreciation on Buildings and Equipment Examples Depreciation on Buildings and Equipment Types of Fixed Costs Discretionary May be altered in the short-term by current managerial decisions Discretionary May be altered in the short-term by current managerial decisions Committed Long-term, cannot be reduced in the short term. Committed Long-term, cannot be reduced in the short term.

13. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Example: Office space is available at a rental rate of $30,000 per year in increments of 1,000 square feet. As the business grows more space is rented, increasing the total cost. Fixed Costs and Relevant Range Continue

14. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Rent Cost in Thousands of Dollars 0 1,000 2,000 3,000 Rented Area (Square Feet) 0 30 60 Fixed Costs and Relevant Range 90 Relevant Range Total cost doesn’t change for a wide range of activity, and then jumps to a new higher cost for the next higher range of activity.

15. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion How does this type of fixed cost differ from a step-variable cost? Step-variable costs can be adjusted more quickly and... The width of the activity steps is much wider for the fixed cost. Fixed Costs and Relevant Range

16. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Fixed Monthly Utility Charge Variable Cost per KW Activity (Kilowatt Hours) Total Utility Cost X Y A semivariable cost has both fixed and variable components. Consider the example of utility cost. Semivariable Costs Total semivariable cost

17. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Fixed Monthly Utility Charge Variable Cost per KW Activity (Kilowatt Hours) Total Utility Cost X Y Semivariable Costs Total semivariable cost Y = a + bX

18. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion The Analysis of Semivariable Costs 1. High-Low Method 3. Least-Square Regression Method 2. Scattergraph Method

19. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Plot the data points on a graph (total cost vs. activity). 0 1 2 3 4 * Total Cost in 1,000’s of Dollars 10 20 0 * * * * * * * * * Activity, 1,000’s of Units Produced X Y The Scattergraph Method

20. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion 0 1 2 3 4 * Total Cost in 1,000’s of Dollars 10 20 0 * * * * * * * * * Activity, 1,000’s of Units Produced X Y The Scattergraph Method (2) Intercept is the estimated fixed cost (a) = $10,000 Draw a line through the data points with about an equal numbers of points above and below the line.

21. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion 0 1 2 3 4 * Total Cost in 1,000’s of Dollars 10 20 0 * * * * * * * * * Activity, 1,000’s of Units Produced X Y The Scattergraph Method (3) The slope is the estimated variable cost per unit. Slope = Change in cost ÷ Change in units The slope is the estimated variable cost per unit. Slope = Change in cost ÷ Change in units Vertical distance is the change in cost. Horizontal distance is the change in activity.

22. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion WiseCo recorded the following production activity and maintenance costs for two months: Using these two levels of activity, compute: the variable cost per unit; the fixed cost; and then express the costs in equation form Y = a + bX. The High-Low Method

23. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Change  in cost Change in units The High-Low Method  Variable cost per unit = Change in cost ÷ change in units

24. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion The High-Low Method  Variable cost per unit = $2,400 ÷ 3,000 units = $0.80 per unit

25. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion The High-Low Method  Variable cost = $2,400 ÷ 3,000 units = $0.80 per unit  Fixed cost = Total cost – Total variable cost Fixed cost = $9,800 – ($0.80 per unit × 8,000 units) Fixed cost = $9,800 – $6,400 = $3,400

26. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion  Variable cost = $2,400 ÷ 3,000 units = $0.80 per unit  Fixed cost = Total cost – Total variable cost Fixed cost = $9,800 – ($0.80 per unit × 8,000 units) Fixed cost = $9,800 – $6,400 = $3,400  Total cost = Fixed cost + Variable cost (Y = a + bX) Y = $3,400 + $0.80X The High-Low Method

27. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Software can be used to fit a regression line through the data points. The cost analysis objective is the same: Y = a + bx Least-Squares Regression Method Least-squares regression also provides a statistic, called the R 2, that is a measure of the goodness of fit of the regression line to the data points.

28. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion 0 1 2 3 4 Total Cost 10 20 0 Activity * * * * * * * * * * Least-Squares Regression Method R 2 is the percentage of the variation in total cost explained by the activity. R 2 for this relationship is near 100% since the data points are very close to the regression line. X Y

29. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Cost Estimation Methods Regression Analysis A statistical method used to create an equation relating independent (or X ) variables to dependent (or Y ) variables. Past data is used to estimate relationships between costs and activities. A statistical method used to create an equation relating independent (or X ) variables to dependent (or Y ) variables. Past data is used to estimate relationships between costs and activities. Dependent variables are caused by the independent variables. Independent variables are the cost drivers that are correlated with the dependent variables.

30. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Caution: Before doing the analysis, take time to determine if a logical relationship between the variables exists. Cost Estimation Methods Regression Analysis The simple cost model is actually a regression model: TC = F + V X The simple cost model is actually a regression model: TC = F + V X This model will only be useful within a relevant range of activity.

31. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Cost Estimation Methods Regression Analysis A set of data can be regressed using several techniques: Manual computations SPSS or SAS Statistical Software Excel or other spreadsheet A set of data can be regressed using several techniques: Manual computations SPSS or SAS Statistical Software Excel or other spreadsheet The result of the regression process is a regression model: TC = F + V X The result of the regression process is a regression model: TC = F + V X Each regression model has an R-square (R 2 ) measure of how good the model is. Range of R 2 = 0 to 1.0 Each regression model has an R-square (R 2 ) measure of how good the model is. Range of R 2 = 0 to 1.0

32. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Simple Regression Analysis Example Fasco 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 Excel. Fasco 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 Excel.

33. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Simple Regression Analysis Example You will need three pieces of information from your regression analysis: 1.Estimated Variable Cost per Unit (line slope) 2.Estimated Fixed Costs (line intercept) 3.Goodness of fit, or R 2 You will need three pieces of information from your regression analysis: 1.Estimated Variable Cost per Unit (line slope) 2.Estimated Fixed Costs (line intercept) 3.Goodness of fit, or R 2 To get these three pieces of information we will need to use THREE different excel functions. LINEST, INTERCEPT, & RSQ To get these three pieces of information we will need to use THREE different excel functions. LINEST, INTERCEPT, & RSQ

34. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion Let’s put our knowledge of cost behavior to work by preparing a contribution format income statement.

35. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion The Contribution Format The contribution margin format emphasizes cost behavior. Contribution margin covers fixed costs and provides for income.

36. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion The Contribution Format Used primarily for external reporting. Used primarily by management.

37. I Made R. Natawidnyana, Ak., CPMA Cost Accounting – Third Sesion End of Session 3