16_behavior of costs

8/8/2019 16_Behavior of Costs

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Determine relation of costs to volume; Illustrate relationship of costs to volume

through profitgraph; and

Application of cost behavior to the assignedcase Bill French


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What is cost behavior?

It is how costs work as the level ofactivity changes.


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Variable costs

are items of cost that vary, in total, directlyand proportionately with volume.

Fixed costsare items of cost that, in total, do not vary

at all with volume.

Semi-variable costs

are those costs that include a combination ofvariable-cost and fixed-cost items.


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TOTAL COST COST PER UNIT

Variable Cost Increases as volumeincreases;

Decreases as volume

decreases

Constant

Fixed cost Constant Increases as volumedecreases;

Decreases as volumeincreases.


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Graphical illustration:


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Mathematical equation:

TC = TFC + (UVC * X)

where:

TC = Total cost

TFC = Total fixed cost (per time period)

UVC = Unit variable cost (per unit of volume)

X = Volume


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Inherent conditions

Range of volume;

Length of time period;Stickiness of costs;and

Environment.


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Relevant Range

F

ixedCo

sts Volume in Units

$16,000

$12,000

$8,000

$4,000

0 500 1,000 1,500 2,000 2,500

Relevant Range


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Relevant Time Period

The amount of variable cost depends on the

time period over which cost behavior is beingestimated.


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Sticky Costs

Costs that are generally considered to be

100% variable, are in actuality, not 100%variable on the downside.


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Environment

Costs in a period that may change as a resultof many influences in the economic

environment such as:

Changes in wage rates, fringe benefits, andmaterial prices;

Changes arising from technological changesin production processes.


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JUDGMENT

HIGH-LOW METHODSCATTER DIAGRAM

LINEAR REGRESSION


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JUDGMENT

used in deciding how each item, or category,

of cost will vary with volume and what theamount of fixed costs will be; and

also known as account-by-account method.


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HIGH-LOW METHOD

used in estimating total costs at each of two

volume levels, which establishes two pointson the line; and

most accurate when the high and low levels

of activity are representation of the majorityof the other points.


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HIGH-LOW METHOD

UVC= Upper limit-lower limit of cost

Upper limit-lower limit of volume

Total Fixed Cost =

Upper or lower limit of cost - (UVC x Upperor lower limit of volume)


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SCATTER DIAGRAM

A chart of points in which actual costs

recorded in past periods are plotted againstthe volume levels in those periods.


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SCATTER DIAGRAM ILLUSTRATION


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LINEAR REGRESSION

Fit a line to the observations by the

statistical technique;Give the total fixed cost and unit variable

cost values directly


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General Rule:

use as much as relevant information as is

available, subject to limitation of time andcost in performing analysis


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Input versus Output MeasuresInput versus Output Measures

Monetary versus Nonmonetary MeasuresMonetaryversus Nonmonetary Measures

Choice of a MeasureChoice of a Measure


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Cost-Volume-Profit (CVP) Analysis

Shows the expected relationship between totalcosts and revenue at various volumes.

Revenue is assumed to be constant

All units produced are sold

TC= TFC+ (UVC x Volume)


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Sales= FC+VC

Zero profit

Point at which no profit nor loss is incurred.

Sale below BEP will mean loss

Sale above BEP will mean profit


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Break even point in peso- the total amount ofsales to recover costs

Or simply BEP in units x the SP


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0

2000

4000

6000

8000

10000

12000

14000

16000

0 0.2 0.4 0.6 0.8 1 1.2

Total Cost Profit Region

Break-even Point

Volume

Loss Region


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As volume increases, average per unit costdecreases because the average fixed cost ofeach unit decreases. This phenomenon is

referred to as spreading the fixed costs overhigher volume.


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Contribution Margin= SP-VC

CM ratio = Contribution margin/ SP

Contribution margin is the excess of Selling

price over variable cost.Contribution margin is equal to total Fixed Costs

at BEP.


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The Amount by which the current volumeexceeds the break-even volume.

The ratio or percentage decrease in sales before

a loss is incurred.


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Increase Selling price per unit

Decrease Variable cost per unit

Decrease Fixed Costs

Increase volume


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Changes in input prices- materials, wages,inflation

The rate of change in volume- rapid change involume will likely to increase cost

The direction in change in volume

The duration of change in volume

Prior knowledge of the changeProductivity

Management Discretion


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Product mix- uses weighted averagecontribution margin

CVP- single productLearning Curves- reduction in unitproduction cost associated with

increased productivity


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THANK YOU!

16_behavior of costs

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