1. A&MIS 5251W. F. Bentz A&MIS 212 Session 10 January 17, 2002 William F. Bentz

2. A&MIS 5252W. F. Bentz Key Issues Cost Behavior  Terminology  Understanding the concepts  Total versus units costs  Computing the fixed and variable components of a semi-variable cost  Points of potential confusion

3. A&MIS 5253W. F. Bentz Cost Drivers  There are seven primary cost drivers at the macro level. The one considered most often in accounting is the time-rate of activity. Think of this as the volume of activity experienced during a time period. The driver volume is considered next.

4. A&MIS 5254W. F. Bentz Cost Drivers - Volume  The issue is: How should we expect costs to behave (vary) with respect to changes in the time-rate of activity all else being equal. In traditional accounting terms: “How do costs behave with respect to changes in volume?” First, we consider the effects of volume changes on total costs.

5. A&MIS 5255W. F. Bentz Total variable cost Activity Volume Total cost Slope is the rate of change

6. A&MIS 5256W. F. Bentz Total variable cost Variable costs are those costs that vary in direct proportion to changes in activity volume. Such costs are normally rep- resented by a simple affine linear equation, Y = vX, where Y represents the total variable cost, v represents the variable cost per unit of activity and X represents the volume of activity during a period.

7. A&MIS 5257W. F. Bentz Total step-variable cost Step-variable costs are those costs that vary in small increments with respect to changes in activity volume. Such costs are also normally represented by a simple affine linear equation, Y = vX, where Y represents the total variable cost, v represents the variable cost per unit of activity and X represents the volume of activity during a period.

8. A&MIS 5258W. F. Bentz Total step-variable cost However, at a micro level, the increments may be relatively large and a local manager might treat the cost like a semi-fixed cost ( slide 28). It is a matter of perspective and required level of precision. Manager’s salaries effectively are variable from McDonald’s corporate perspective, but not from the perspective of a local franchisee with two restaurants.

9. A&MIS 5259W. F. Bentz Total fixed cost Activity Volume Total cost

10. A&MIS 52510W. F. Bentz Total fixed cost Fixed costs are those costs that do not vary in total with respect to modest changes in activity volume. Such costs are represented by Y = F, where Y represents total cost, and F represents total fixed cost. Fixed costs do change over time, due to price changes and as a result of decisions, but they are relatively constant with respect to changes in activity volume, all else being equal.

11. A&MIS 52511W. F. Bentz Total mixed cost Activity Volume Total cost Total cost curve

12. A&MIS 52512W. F. Bentz Total mixed cost Activity Volume Total cost Total cost curve Fixed component Variable component

13. A&MIS 52513W. F. Bentz Total mixed cost Semivariable or mixed costs are those costs that contain both a fixed and a variable component. Such costs are normally represented by a simple linear equation of the form Y = F + vX, where Y represents total cost, F represents total fixed cost, and v represents the variable cost per unit of activity, and X is the volume of activity during a period.

14. A&MIS 52514W. F. Bentz Total semi-fixed cost Activity Volume Total cost Total cost curve

15. A&MIS 52515W. F. Bentz Total cost (microeconomics) Activity Volume Total cost Total cost curve Relevant range

16. A&MIS 52516W. F. Bentz Average cost (microeconomics) Volume Average Unit Cost Total cost curve Relevant range

17. A&MIS 52517W. F. Bentz OSU Bumper Sticker I am not lost, I am exploring

18. A&MIS 52518W. F. Bentz Assumptions for 212 Purposes  Assume direct labor is a variable cost unless you are given information to the contrary.  Assume total fixed cost does not change unless you are given information to the contrary.

19. A&MIS 52519W. F. Bentz Assumptions for 212 Purposes  In the absence of information to the contrary, expect Selling and Administrative Expense and Manufacturing Overhead to include both fixed and variable components.

20. A&MIS 52520W. F. Bentz