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Lecture Managerial accounting: Creating value in a dynamic business environment (9/e): Chapter 6 - Ronald W. Hilton

Chapter 6 - Activity analysis, cost behavior, and cost estimation. After completing this chapter, you should be able to: Explain the relationships between cost estimation, cost behavior, and cost prediction; define and describe the behavior of the following types of costs: variable, step-variable, fixed, step-fixed, semivariable (or mixed), and curvilinear; explain the importance of the relevant range in using a cost behavior pattern for cost prediction. | Chapter 6 Activity Analysis, Cost Behavior, and Cost Estimation Cost prediction Using knowledge of cost behavior to forecast level of cost at a particular activity. Focus is on the future. Introduction Cost behavior Relationship between cost and activity. Process of determining cost behavior, often focusing on historical data. Cost estimation Learning Objective 1 Total Variable Cost Example Your total Pay Per View bill is based on how many Pay Per View shows that you watch. Number of Pay Per View shows watched Total Pay Per View Bill Learning Objective 2 Variable Cost Per Unit Example Number of Pay Per View shows watched Cost per Pay Per View show The cost per Pay Per View show is constant. For example, $4.95 per show. Step-Variable Costs Activity Cost Total cost remains constant within a narrow range of activity. Total Fixed Cost Example Your monthly basic cable TV bill probably does not change no matter how many hours you watch. Number of hours watched Monthly Basic Cable Bill Fixed Cost Per Unit Example Number of hours watched Monthly Basic cable Bill per hour watched The average cost per hour decreases as more hours are spent watching cable television. Rent Cost in Thousands of Dollars 0 1,000 2,000 3,000 Rented Area (Square Feet) 30 60 90 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. Step-Fixed Costs Fixed Monthly Utility Charge Variable Utility Charge Activity (Kilowatt Hours) Total Utility Cost Total semivariable cost Semivariable Cost Slope is variable cost per unit of activity. Curvilinear Cost Curvilinear Cost Function Relevant Range Activity Total Cost Curvilinear Cost Function A straight-line (constant unit variable cost) closely approximates a curvilinear line within the relevant range. Curvilinear Cost Curvilinear Cost Function Relevant Range Activity Total Cost Curvilinear Cost Function A straight-Line (constant unit variable cost) closely approximates a curvilinear line within the relevant range. Learning Objective 3 Engineered, Committed and Discretionary Costs Discretionary May be altered in the short term by current managerial decisions. Committed Long-term, cannot be reduced in the short term. Engineered Physical relationship with activity measure. Depreciation on Buildings and equipment Advertising and Research and Development Direct Materials Learning Objective 4 Visual-Fit Method Vertical distance is total cost, approximately $16,000. 0 1 2 3 4 * Total Cost in 1,000’s of Dollars 10 20 0 * * * * * * * * * Activity, 1,000’s of Units Produced Estimated fixed cost = $10,000 A scatter diagram of past cost behavior may be helpful in analyzing mixed costs. Learning Objective 5 Account Classification Method Cost estimates are based on a review of each account making up the total cost being analyzed. OwlCo recorded the following production activity and maintenance costs for two months: Using these two levels of activity, compute: the variable cost per unit. the total fixed cost. The High-Low Method Unit variable cost = $3,600 ÷ 4,000 units = $.90 per unit Fixed cost = Total cost – Total variable cost Fixed cost = $9,700 – ($.90 per unit × 9,000 units) Fixed cost = $9,700 – $8,100 = $1,600 The High-Low Method Learning Objectives 5 cont., 6 and 7 can be found in the Text Book