©2005 prentice hall business publishing, introduction to management accounting 13/e,...

©2005 Prentice Hall Business Publishing, ©2005 Prentice Hall Business Publishing, Introduction to Management AccountingIntroduction to Management Accounting 13/e,13/e, Horngren/Sundem/Stratton Horngren/Sundem/Stratton 3 - 3 - 11

Measurement ofMeasurement of

Cost BehaviorCost Behavior

Chapter 3Chapter 3

©2005 Prentice Hall Business Publishing, Introduction to Management Accounting 13/e, Horngren/Sundem/Stratton 3 - 2

Learning Objective 1Learning Objective 1

Describe step- andDescribe step- and

mixed-cost behavior.mixed-cost behavior.


Step- and Mixed-CostStep- and Mixed-CostBehavior PatternsBehavior Patterns

Step costs change abruptly at intervalsStep costs change abruptly at intervalsof activity because the resources andof activity because the resources andtheir costs come in indivisible chunks.their costs come in indivisible chunks.



Lease cost exampleLease cost example

Oil and gas exploration activityOil and gas exploration activity

RelevantRelevantrangerange

Actual costActual costbehaviorbehavior

Fixed costFixed costapproximationapproximation

Leas

e co

stLe

ase

cost



Supermarket checker wage cost exampleSupermarket checker wage cost example

Shoppers per hourShoppers per hour

Relevant rangeRelevant range

VariableVariablecostcost

approximationapproximation

Actual costActual costbehaviorbehavior

40 440

Wag

e co

stW

age

cost



Mixed costsMixed costs contain elements of both contain elements of bothfixed- and variable-cost behavior.fixed- and variable-cost behavior.

The fixed-cost element is unchangedThe fixed-cost element is unchangedover a range of cost-driver activity.over a range of cost-driver activity.

The variable-cost element variesThe variable-cost element variesproportionately with cost-driver activity.proportionately with cost-driver activity.


Step- and Mixed-CostStep- and Mixed-CostBehavior PatternsBehavior PatternsF

acil

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ain

ten

ance

Fac

ilit

ies

mai

nte

nan

ced

epar

tmen

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epar

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Number of patient-days per monthNumber of patient-days per month

$10,000$10,000

1,0001,000 5,0005,000

TotalTotalvariablevariablecostcost

FixedFixedcostcost

Relevant rangeRelevant range

$5.00 per$5.00 perpatient daypatient day



Describe managementDescribe management

influences on cost behavior.influences on cost behavior.


Product and Service Product and Service Decisions and the Value Decisions and the Value ChainChain

Distribution channelsDistribution channels

Choice of process and product designChoice of process and product design

Quality levelsQuality levels

Product featuresProduct features


Capacity DecisionsCapacity Decisions

They are the fixed costs of being ableThey are the fixed costs of being ableto achieve a desired level of production orto achieve a desired level of production orto provide a desired level of service whileto provide a desired level of service whilemaintaining product or service attributes.maintaining product or service attributes.


Committed Fixed CostsCommitted Fixed Costs

Salaries of key personnelSalaries of key personnel

Committed fixed costsCommitted fixed costs usually arise usually arisefrom the possession of facilities,from the possession of facilities,

equipment, and a basic organization.equipment, and a basic organization.

Lease paymentsLease payments

Property taxesProperty taxes


Discretionary Fixed CostsDiscretionary Fixed Costs

Discretionary fixed costsDiscretionary fixed costs are costs fixed are costs fixedat certain levels only because managementat certain levels only because managementdecided that these levels of cost should bedecided that these levels of cost should beincurred to meet the organization’s goals.incurred to meet the organization’s goals.

These discretionary fixed costs have noThese discretionary fixed costs have noobvious relationship to levels of outputobvious relationship to levels of output

activity but are determined as partactivity but are determined as partof the periodic planning process.of the periodic planning process.


Discretionary Fixed CostsDiscretionary Fixed Costs

Each planning period, managementEach planning period, managementwill determine how much towill determine how much to

spend on discretionary items.spend on discretionary items.

These costs then become fixedThese costs then become fixeduntil the next planning period.until the next planning period.


Examples of DiscretionaryExamples of DiscretionaryFixed CostsFixed Costs

Advertising and promotionAdvertising and promotion

Research and developmentResearch and development

Management salariesManagement salaries

Employee trainingEmployee training


Technology DecisionsTechnology Decisions

Choice of technology (e-commerce versusChoice of technology (e-commerce versusin-store or mail-order sales) positions thein-store or mail-order sales) positions theorganization to meet its current goals andorganization to meet its current goals andto respond to changes in the environment.to respond to changes in the environment.


Cost-Control IncentivesCost-Control Incentives

Managers use their knowledge of costManagers use their knowledge of costbehavior to set cost expectations.behavior to set cost expectations.

Employees may receive rewards thatEmployees may receive rewards thatare tied to meeting these expectations.are tied to meeting these expectations.



Measure and mathematicallyMeasure and mathematically

express cost functions andexpress cost functions and

use them to predict costs.use them to predict costs.


Cost FunctionsCost Functions

Planning and controlling the activitiesPlanning and controlling the activitiesof an organization require accurateof an organization require accurate

and useful estimates of futureand useful estimates of futurefixed and variable costs.fixed and variable costs.



Understanding relationships between costsUnderstanding relationships between costsand their cost drivers allows managers to...and their cost drivers allows managers to...

evaluate strategic plans andevaluate strategic plans andoperational improvement programs.operational improvement programs.

make short- and long-run decisions.make short- and long-run decisions.

plan or budget the effects of future activities.plan or budget the effects of future activities.



TheThe first stepfirst step in estimating or predicting in estimating or predictingcosts is measuring cost behavior as acosts is measuring cost behavior as afunction of appropriate cost drivers.function of appropriate cost drivers.

TheThe second stepsecond step is to use these cost is to use these costmeasures to estimate future costs atmeasures to estimate future costs atexpected levels of cost-driver activity.expected levels of cost-driver activity.


Cost Function EquationCost Function Equation

Y = Total costY = Total cost

F = Fixed costF = Fixed cost

V = Variable cost per unitV = Variable cost per unit

X = Cost-driver activity in number of unitsX = Cost-driver activity in number of units


Cost Function EquationCost Function Equation

Mixed-cost function:Mixed-cost function:Y = F + VXY = F + VX

The mixed-cost function isThe mixed-cost function iscalled a linear-cost function.called a linear-cost function.

Y = $10,000 + $5.00XY = $10,000 + $5.00X


Developing Cost FunctionsDeveloping Cost Functions

A cost function’s estimates of costsA cost function’s estimates of costsat actual levels of activity must reliablyat actual levels of activity must reliablyconform with actually observed costs.conform with actually observed costs.

The cost function must be believable.The cost function must be believable.



Describe the importanceDescribe the importance

of activity analysis forof activity analysis for

measuring cost functions.measuring cost functions.


Choice of Cost Drivers:Choice of Cost Drivers:Activity AnalysisActivity Analysis

Choosing a cost function startsChoosing a cost function startswith choosing cost drivers.with choosing cost drivers.

Managers use activity analysis toManagers use activity analysis toidentify appropriate cost drivers.identify appropriate cost drivers.

Activity analysis directs managementActivity analysis directs managementaccountants to the appropriateaccountants to the appropriate

cost drivers for each cost.cost drivers for each cost.



Northwestern Computers makes twoNorthwestern Computers makes twoproducts: Mozart-Plus and Powerdriveproducts: Mozart-Plus and Powerdrive

In the past, most of the support costsIn the past, most of the support costswere twice as much as labor costs.were twice as much as labor costs.

Northwest has upgraded the productionNorthwest has upgraded the productionfunction, which has increased supportfunction, which has increased support

costs and reduced labor cost.costs and reduced labor cost.



Using the old cost driver, labor cost, theUsing the old cost driver, labor cost, theprediction of support costs would be:prediction of support costs would be:

Labor costLabor cost $ 8.50$ 8.50 $130.00$130.00Support cost:Support cost:2 × Direct labor cost2 × Direct labor cost $17.00$17.00 $260.00$260.00

Mozart-PlusMozart-Plus PowerdrivePowerdrive



Using the more appropriate cost driver,Using the more appropriate cost driver,the number of components added tothe number of components added to

products, the predicted support costs are:products, the predicted support costs are:



Support costSupport cost at $20/componentat $20/component $20 × 5 components$20 × 5 components $100.00$100.00 $20 × 9 components$20 × 9 components $180.00$180.00Difference in predictedDifference in predicted support costsupport cost $ 83.00$ 83.00 $ 80.00$ 80.00

higherhigher lower lower

Mozart-PlusMozart-Plus PowerdrivePowerdrive



Measure cost behavior usingMeasure cost behavior using

the account analysis, high-low,the account analysis, high-low,

visual-fit, and least-squaresvisual-fit, and least-squares

regression methods.regression methods.


Methods of MeasuringMethods of MeasuringCost FunctionsCost Functions

1. Engineering analysis1. Engineering analysis 2. Account analysis2. Account analysis 3. High-low analysis3. High-low analysis 4. Visual-fit analysis4. Visual-fit analysis 5. Least-squares regression analysis5. Least-squares regression analysis


Engineering AnalysisEngineering Analysis

It measures cost behavior according to what It measures cost behavior according to what costs should be, not by what costs have been.costs should be, not by what costs have been.

Engineering analysis entails a systematicEngineering analysis entails a systematicreview of materials, supplies, labor,review of materials, supplies, labor,

support services, and facilitiessupport services, and facilitiesneeded for products and services.needed for products and services.


Account AnalysisAccount Analysis

The simplest method of accountThe simplest method of accountanalysis selects a plausibleanalysis selects a plausible

cost driver and classifies eachcost driver and classifies eachaccount as a variable or fixed cost.account as a variable or fixed cost.


Account Analysis ExampleAccount Analysis Example

Supervisor’s salary and benefitsSupervisor’s salary and benefits $ 3,800$ 3,800 $3,800$3,800

Hourly workers’ wages and benefitsHourly workers’ wages and benefits 14,674 14,674 $14,674$14,674

Equipment depreciation and rentalsEquipment depreciation and rentals 5,873 5,873 5,873 5,873

Equipment repairsEquipment repairs 5,604 5,604 5,604 5,604

Cleaning suppliesCleaning supplies 7,472 7,472 7,472 7,472

Total maintenance costsTotal maintenance costs $37,423$37,423 $9,673$9,673 $27,750$27,750

Monthly costMonthly cost AmountAmount FixedFixed VariableVariable


Account Analysis ExampleAccount Analysis Example

Fixed cost per month = $9,673Fixed cost per month = $9,673

Variable cost per patient-dayVariable cost per patient-day= $27,750 ÷ 3,700= $27,750 ÷ 3,700

= $7.50 per patient-day= $7.50 per patient-day

3,700 patient-days3,700 patient-days

Y = $9,673 + ($7.50 × patient-days)Y = $9,673 + ($7.50 × patient-days)


High-Low MethodHigh-Low Method

The focus of this method is normally onThe focus of this method is normally onthe highest- and lowest-activity points.the highest- and lowest-activity points.

The first step if to plot the historicalThe first step if to plot the historicaldata points on a graph.data points on a graph.


High-Low Method ExampleHigh-Low Method Example

High month: AprilHigh month: AprilMaintenance cost: $47,000Maintenance cost: $47,000

Number of patient-days: 4,900Number of patient-days: 4,900

Low month: SeptemberLow month: SeptemberMaintenance cost: $17,000Maintenance cost: $17,000

Number of patient-days: 1,200Number of patient-days: 1,200

What is the variable cost?What is the variable cost?



($47,000 – $17,000) ÷ (4,900 – 1,200)($47,000 – $17,000) ÷ (4,900 – 1,200)= $30,000 ÷ 3,700 = $8.1081= $30,000 ÷ 3,700 = $8.1081

What is the fixed cost?What is the fixed cost?



$47,000 = Fixed cost + ($8.1081× 4,900)$47,000 = Fixed cost + ($8.1081× 4,900)$47,000 – $39,730 = $7,270$47,000 – $39,730 = $7,270

$17,000 = Fixed cost + ($8.1081× 1,200)$17,000 = Fixed cost + ($8.1081× 1,200)$17,000 – $9,730 = $7,270$17,000 – $9,730 = $7,270


Visual-Fit MethodVisual-Fit Method

In the In the visual-fit methodvisual-fit method,, the cost analyst the cost analystvisually fits a straight line through a plotvisually fits a straight line through a plot

of all of the available data, not justof all of the available data, not justbetween the high point and thebetween the high point and the

low point, making it more reliablelow point, making it more reliablethan the high-low method.than the high-low method.


Least-Squares Regression Least-Squares Regression MethodMethod

Regression analysis measuresRegression analysis measuresa cost function more objectivelya cost function more objectivelyby using statistics to fit a costby using statistics to fit a cost

function to all the data.function to all the data.

Regression analysis measuresRegression analysis measurescost behavior more reliably thancost behavior more reliably than

other cost measurement methods.other cost measurement methods.


Coefficient of Coefficient of DeterminationDetermination

One measure of reliability,One measure of reliability,or goodness of fit, is theor goodness of fit, is the

coefficient of determination,coefficient of determination,R² (or R-squared).R² (or R-squared).

The coefficient of determinationThe coefficient of determinationmeasures how much of themeasures how much of the

fluctuation of a cost is explainedfluctuation of a cost is explainedby changes in the cost driver.by changes in the cost driver.

©2005 Prentice Hall Business Publishing, ©2005 Prentice Hall Business Publishing, Introduction to Management AccountingIntroduction to Management Accounting 13/e,13/e, Horngren/Sundem/Stratton Horngren/Sundem/Stratton 3 - 3 - 4343

End of Chapter 3End of Chapter 3

©2005 prentice hall business publishing, introduction to management accounting 13/e,...

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