1. 1 PowerPointPresentation by PowerPoint Presentation by Gail B. Wright Professor Emeritus of Accounting Bryant University MANAGERIAL ACCOUNTING 10 TH EDITION BY MAHER, STICKNEY & WEIL COST DRIVERS & COST BEHAVIOR CHAPTER 5 © Copyright 2008 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star Logo, and South- Western are trademarks used herein under license.

2. Managerial Decision Making 2 1.Distinguish between variable & fixed costs & between short run & long run; define relevant range. 2.Identify capacity costs, committed costs, & discretionary costs. 3.Describe the nature of various cost behavior patterns. 4.Describe how managers use cost behavior patterns. LEARNING OBJECTIVES Continued

3. Managerial Decision Making 3 5.Explain how to use historical data to estimate costs. 6.Describe how analysts estimate cost behavior using regression, account analysis, & engineering methods. 7.Explain costs, benefits, & weaknesses of various cost estimation methods. LEARNING OBJECTIVES Continued

4. Managerial Decision Making 4 8.Identify derivation of learning curves. (Appendix 5.1). 9.Interpret the results of regression analyses. (Appendix 5.2). LEARNING OBJECTIVES

5. Managerial Decision Making 5 CHAPTER GOAL This chapter discusses classifying costs & methods for estimating cost behavior.  Fixed costs  Variable costs All managerial decisions deal with choices among different activity levels. Managers must estimate which costs will vary with the activity & by how much. ☼☼

6. Managerial Decision Making 6 VARIABLE COSTS: Definition Are costs that change in total as the level of activity changes. LO 1

7. Managerial Decision Making 7 SHORT RUN, LONG RUN In the short run, a firm has only the capacity of the existing plant. Management can change production only in the long run. LO 1

8. Managerial Decision Making 8 RELEVANT RANGE: Definition Is the range of activity over which the firm expects a set of cost behaviors to be consistent. LO 1

9. Managerial Decision Making 9 VARIABLE & FIXED COSTS: A Reminder Variable costs change with the volume of activity. Fixed costs remain constant over the relevant range of activity. LO 3

10. Managerial Decision Making 10 CURVILINEAR VARIABLE COSTS: Definition Are costs that vary with the volume of activity but not in constant proportion. LO 3

11. Managerial Decision Making 11 What is an example of a curvilinear cost? Costs become curvilinear when volume discounts are offered. LO 3

12. Managerial Decision Making 12 SEMIVARIABLE COSTS: Definition Are costs that have both fixed and variable components. Also called Mixed Costs. LO 3

13. Managerial Decision Making 13 ANALYZING HISTORICAL COSTS 2 steps to analyze historical cost data  Make an estimate of the past relation  Update for current, future periods  Adjust costs for inflation & other changes LO 5

14. Managerial Decision Making 14 TOTAL COST EQUATION LO 5 Total costs = Fixed costs + (Variable costs * Activity) Independent Variables

15. Managerial Decision Making 15 ANALYZING COSTS Steps in analyzing costs are:  Review alternative cost drivers (independent variables)  Plot the data  Examine the data & method of accumulation LO 5

16. Managerial Decision Making 16 CHICAGO HOSPITAL 1 The Chicago Hospital operating room suite has 12 operating rooms. Can we estimate the overhead costs that can be directly traced to a particular surgery? Continued LO 6 R

17. Managerial Decision Making 17 TOTAL OVERHEAD COST ESTIMATE LO 6 A computer program using least squares fits a straight line to observed data points to minimize the sum of squares of vertical distances between observed points & the regression line. The line will depict the best fit of projected costs. Total overhead costs (estimated) = Fixed costs + (Variable costs * Activity) = $18,600 + ($908 * Operating room hours) R

18. Managerial Decision Making 18 MULTIPLE REGRESSION: Definition Has more than 1 independent variable. LO 6 R

19. Managerial Decision Making 19 TOTAL OVERHEAD COST ESTIMATE 2 LO 6 A computer program using least squares fits a straight line to observed data points to minimize the sum of squares of vertical distances between observed points & the regression line. Total overhead costs (estimated) = Fixed costs + (Hours + Setup + VIP + # rooms used + Special surgeries) = $90,592 + ($175*Hours + $257*Setup + $3,839*VIP + $2,043*# rooms used + $6,050*Special surgeries) R

20. Managerial Decision Making 20 CHICAGO HOSPITAL: Account Analysis Step 1: Using account analysis, the Chicago Hospital administrator will classify each overhead cost related to surgery to a cost driver. For example, staff wages for operating room clean up between surgeries will be classified as “Operating room setup.” Continued LO 6 A

21. Managerial Decision Making 21 CHICAGO HOSPITAL: Engineering Estimation Engineering method of cost estimation indicates what costs should be. This is a very costly method to put into practice because it requires experts to make the estimates, especially for indirect costs. LO 6 E

22. Managerial Decision Making 22 DATA PROBLEMS Regardless of method used, results will only be as good as the quality of the data used. Problems include  Missing data  Outliers  Allocated & discretionary costs  Inflation  Mismatched time periods  Trade-offs in choosing time period LO 6

23. Managerial Decision Making 23 COMMON SIMPLIFICATIONS In general, more sophisticated methods provide more accurate cost estimates than simpler ones. Methods of simplification are  Using only 1 cost driver  Assuming cost behavior patterns are linear within the relevant range  Assume cost decreases are not “sticky” LO 7

24. Managerial Decision Making 24 What are sticky costs? Sticky costs do not decrease when activity decreases. Example: keeping (not firing) workers when activity levels decrease. LO 7

25. Managerial Decision Making 25 CHAPTER 5 THE END