1. 1 Cost Drivers and Cost Behavior CHAPTER 5 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. PowerPointPresentation by PowerPoint Presentation by LuAnn Bean Professor of Accounting Florida Institute of Technology Managerial Accounting 11E Maher/Stickney/Weil

2. 2 CHAPTER GOAL This chapter discusses classifying costs and 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 and by how much. ☼☼

3. 3 VARIABLE COSTS: Definition Are costs that change in total as the level of activity changes. LO 1 FIXED COSTS: Definition Are costs that do not change in total with changes in activity levels.

4. 4 RELEVANT RANGE: Definition Is the range of activity over which the firm expects a set of cost behaviors to be consistent. LO 1

5. 5 EXHIBIT 5.1 Estimates of variable and fixed costs apply only if level of activity lies within relevant range.

6. 6 FIXED COSTS Fixed (capacity) costs are divided between  Committed costs  Capacity costs that will continue to exist even if operations are temporarily reduced  Discretionary (programmed or managed) costs  Need not be incurred in the short run to operate the business LO 2

7. 7 VARIABLE and FIXED COSTS: A Reminder Variable costs change with the volume of activity. Fixed costs remain constant over the relevant range of activity. LO 3

8. 8 CURVILINEAR VARIABLE COSTS: Definition Are costs that vary with the volume of activity but not in constant proportion. LO 3

9. 9 What is an example of a curvilinear cost? Costs become curvilinear when volume discounts are offered. LO 3

10. 10 LO 3 EXHIBIT 5.5 Volume discounts.

11. 11 LO 3 EXHIBIT 5.6 A Production time decreases as volume increases due to learning from experience.

12. 12 LO 3 EXHIBIT 5.6 B & C Total labor time and cost will decrease with increases in volume. Time Cost

13. 13 SEMIVARIABLE COSTS: Definition Are costs that have both fixed and variable components. Also called Mixed Costs. LO 3

14. 14 LO 3 EXHIBIT 5.7 Semifixed costs change because of changes in long-term assets; semivariable costs do not. Semivariable Semifixed

15. 15 SIMPLIFYING COST ANALYSES Some costs do not vary in the short run over the relevant range (fixed costs). Some vary with volume (variable costs). Others are neither completely fixed or variable. Decision makers can simplify these variations by treating costs as either fixed or variable. LO 3

16. 16 EXERCISE 3 Press “Enter” or click left mouse button for answer. Name three methods of cost estimation. LO 4 Statistical regression, Account analysis, and Engineering estimation

17. 17 ANALYZING HISTORICAL COSTS Two steps to analyze historical cost data  Make an estimate of the past relation  Update for current, future periods  Adjust costs for inflation and other changes LO 5

18. 18 TOTAL COST EQUATION LO 5 Total costs = Fixed costs + (Variable costs × Activity) Independent Variables

19. 19 ANALYZING COSTS Steps in analyzing costs are:  Review alternative cost drivers (independent variables)  Plot the data  Examine the data and method of accumulation LO 5

20. 20 MULTIPLE REGRESSION: Definition Has more than one independent variable. LO 6 R

21. 21 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 and discretionary costs  Inflation  Mismatched time periods  Trade-offs in choosing time period LO 6

22. 22 LO 7 EXHIBIT 5.12 Every method of cost estimation has strengths and weaknesses.

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

24. 24 DERIVING LEARNING CURVES  Mathematically, the learning curve effect can be expressed by the equation: Y=aX b, where  Y = average number of labor hours required per unit for X units  a = number of labor hours required for the first unit  X = cumulative number of units produced  b = index of learning, equal to the log of the learning rate divided by the log of 2. LO 8

25. 25 STANDARD ERRORS OF THE COEFFICIENTS  The standard errors of the coefficients give an idea of the confidence we can have in the fixed and variable cost coefficients.  The smaller the standard error relative to its coefficient, the more precise the estimate.  Such computational precision does not necessarily indicate that the estimating procedure is theoretically correct, however. LO 9

26. 26 T-STATISTIC  The ratio between an estimated regression coefficient and its standard error is known as the t-value or t- statistic.  If the absolute value of the t-statistic is approximately 2 or larger, we can be relatively confident that the actual coefficient differs from zero. LO 9

27. 27 R-SQUARED  The R 2 attempts to measure how well the line fits the data (that is, how closely the data points cluster about the fitted line).  If all the data points were on the same straight line, the R 2 would be 1.00—a perfect fit. If the data points formed a circle or disk, the R 2 would be zero, indicating that no line passing through the center of the circle or disk fits the data better than any other. LO 9

28. 28 End of CHAPTER 5