2. PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 5 Cost Behavior

3. 5- 3 Cost Behavior Patterns Cost behavior describes the way total cost behaves, or changes, when some measure of activity changes. The range of activity within which assumptions about cost behavior hold true is the relevant range. Unit variable costs remain unchanged. Total fixed costs remain unchanged.

4. 5- 4 Cost Behavior Summary

5. 5- 5 Mixed Costs Mixed costs contain a fixed portion that is incurred even when the facility is unused, and a variable portion that increases with usage. Utilities typically behave in this manner. Activity (Kilowatt Hours) Total Utility Cost Fixed Monthly Utility Charge Variable Cost per KW Total mixed cost

6. 5- 6 y = total cost, which is plotted on the vertical axis, and is called the dependent variable. a = total fixed cost, an amount that will be incurred regardless of the activity level, and is called the intercept or the constant. b = the slope of the line, the unit variable cost, which tells us how much the total cost (y) will increase for each unit increase in activity (x). x = the activity that causes total cost (y) to change. Activity (x) is also called the cost driver, or the independent variable. Linear Approaches to Analyzing Mixed Costs y = Total Costs x = Activity b = Slope a = Intercept

7. 5- 7 Linear Approaches to Analyzing Mixed Costs There are three different methods to analyze mixed costs, all using the linear assumption as a base. 1.Scattergraph: A graph that provides a visual representation of the relationship between total cost (y) and activity level (x). A scattergraph is a useful first step in analyzing cost behavior because it helps determine the nature of the relationship and whether the linearity assumption is valid. 2.High-low method: A simple approach that uses the two most extreme data points to determine the slope of the line (variable cost per unit) and the intercept (total fixed cost). 3.Least-squares regression: A statistical technique for finding the best fitting line based on historical data. The slope of the line provides an estimate of the variable cost per unit, while the intercept provides an estimate of the total fixed cost.

8. 5- 8 Scattergraph A scattergraph is a graph with total cost plotted on the vertical (Y) axis and some measure of activity on the horizontal (X) axis.

9. 5- 9 High-Low Method

10. 5- 10 High-Low Method = Total Fixed Cost Variable Cost per Unit × Activity Total Cost _ $0.25 × 15,000 $15,750 _ $12,000 = February Estimate Total Fixed Cost = $0.25 × 5,000 $13,250 _ $12,000 = May Estimate Total Fixed Cost =

11. 5- 11 Least-Squares Regression Method  Software such as Excel can be used to fit a regression line through the data points.  The cost analysis objective is the same: y = a + bx The output from the regression analysis can be used to create an equation that enables you to estimate total costs at any activity level.

12. 5- 12 Least-Squares Regression Method

13. 5- 13 Summary of Linear Methods

14. 5- 14 Contribution Margin Ratio Contribution Margin Sales Revenue Variable Costs = ‒ Contribution Margin Formula Contribution Margin Ratio Contribution Margin Sales Revenue = Contribution Margin Ratio

15. 5- 15 Variable Versus Full Absorption Costing

16. 5- 16 End of Chapter 5