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PPT 3 -1
Don R. Hansen
Maryanne M. Mowen
COST MANAGEMENT
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PPT 3 -2
Activity CostBehavior
Chapter Three
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PPT 3 -3
Learning Objectives
Define and describe fixed, variable, and mixed costs.
Explain the use of resources and activities and their relationship to cost behavior.
Separate mixed costs into their fixed and variable components using the high-low method, the scatterplot method, and the method of least squares.
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PPT 3 -4
Learning Objectives (continued)
Evaluate the reliability of the cost formula. Explain how multiple regression can be used to
assess cost behavior Discuss the use of managerial judgment in
determining cost behavior.
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PPT 3 -5
Fixed Cost Behavior Variable Cost Behavior
$ $Relevant Range
Activity Activity
Cost Behavior
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PPT 3 -6
Total Costs
$Cost
Number of Units Produced
Fixed Costs Variable Costs
Linearity Assumption
Y = F + VX
The Behavior of a Mixed Cost
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PPT 3 -7
Basic Terms
Activity capacity is the ability to perform activities.
Practical capacity is the efficient level of activity performance.
Resources are economic inputs that are consumed in performing activities.
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PPT 3 -8
Types of Fixed Resources
Flexible Resources Committed Resources Discretionary Fixed Costs
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PPT 3 -9
Flexible Resources
Flexible resources are supplied as used and needed.They are acquired from outside sources, where the terms of acquisition do not require any long-term commitment for any given amount of the resource.
Example: Materials and energy
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PPT 3 -10
Committed Resources
Committed resources are supplied in advance of usage.
They are acquired by the use of either an explicit or implicit contract to obtain a given quantity of resource, regardless of whether the amount of the resource available is fully used or not. Committed resources may have unused capacity.
Example: Buying or leasing a building or equipment
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PPT 3 -11
Committed Resources (continued)
Committed fixed expenses are costs incurred for the acquisition of long-term capacity.
Example: Plant, equipment, warehouses, vehicles, and salaries of top employees
Discretionary fixed expenses are shorter-term committed resources.
Example: The hiring of new receiving clerks
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PPT 3 -12
Resource Relationships
The relationship between resources supplied and resources used is expressed by the following equation:
Resources available = Resources used + Unused capacity
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PPT 3 -13
Available orders = Orders used + Orders unused
7,500 orders = 6,000 orders + 1,500 orders
Fixed engineering rate = $150,000/7,500
= $20 per change order
Variable engineering rate = $90,000/6,000
= $15 per change order
Example
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PPT 3 -14
Cost of orders supplied = Cost of orders used + Cost of unused orders
= [($20 + $15) x 6,000] + ($20 x 1,500)
= $240,000
Of course, the $240,000 is precisely equal to the $150,000 spent on engineers and the $90,000 spent on supplies.
The $30,000 of excess engineering capacity means that a new product could be introduced without increasing current spending on engineering.
Example (continued)
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PPT 3 -15
$Cost
Number of Units Produced
Linearity Assumption
Narrow Width
Step-Variable Costs
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PPT 3 -16
$Cost
Number of Units Produced
Linearity Assumption
Wider Width
Step-Fixed Costs
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PPT 3 -17
Methods for Measuring the Fixed and Variable Components of a Mixed Cost
The High-Low Method Scatterplot Method The Method of Least Squares
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PPT 3 -18
Month Utility Costs Units ProducedJanuary $2,000 200February 2,500 400March 4,500 600April 5,000 800May 7,500 1,000
High-Low Method: An Example
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PPT 3 -19
Y = F + VX
Variable Cost Rate (V)= (Y2 - Y1)/(X2 - X1) V = ($7,500-$2,000)/(1,000-200) V = $5,500/800 V = $6.875 per unit
The High-Low Method (continued)
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PPT 3 -20
Y = F + VX$7,500 = F + $6.875 (1,000)
F = $7,500 - $6,875 F = $625
The cost formula using the high-low method is:
Y = $625 + $6.875 (X)
The High-Low Method (continued)
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PPT 3 -21
Units Produced
UtilityCost
$8,000
6,000
4,000
2,000
0200 400 600 800 1,000
..
. ..
Analyst can fit linebased on his or herexperience
Important: Cost function is onlyrelevant within relevant range
Scatterplot Method
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PPT 3 -22
Nonlinear Relationship
ActivityCost
0 Activity Output
**
***
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PPT 3 -23
Upward Shift in Cost Relationship
ActivityCost
0 Activity Output
* **
**
*
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PPT 3 -24
Presence of Outliers
ActivityCost
0 Activity Output
* **
**
*
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PPT 3 -25
Least Squares
Constant 250
Std Err of Y Est 299.304749934466
R squared 0.944300518134715
No. of Observations 5
Degrees of Freedom 3
X Coefficient(s) 6.75
Std Err of Coef. 0.9464847243
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PPT 3 -26
Least Squares (continued)
The results gives rise to the following equation:
Utility Costs = $250 + ($6.75 x # of units produced)
R2 = .944, or 94.4 percent of the variation in setup costs is explained by the number of setup hours variable.
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PPT 3 -27
Using Confidence Intervals:
Given:*T-value for sample size of 5 at 95% confidence level is 3.182 (two-tale
test and 3 degrees of freedom)*Standard error of estimate for this sample at the 95% confidence level
is 598.6
The confidence interval for 300 units is: TC = $250 + 6.75 (300) + (3.192 x $598.6) = $2275 + $1911
Least Squares (continued)
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PPT 3 -28
TC = b0 + b1X1 + b2X2 + . . .
b0 = the fixed cost or intercept
bi = the variable rate for the ith independent variable
Xi = the ith independent variable
Multiple Regression
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PPT 3 -29
Utility MonthMHrs SummerCostJanuary 1,3400 $1,688February 1,2980 1,636March 1,3760 1,734April 1,4050 1,770May1,500 12,390June 1,4321 2,304July 1,322 12,166August 1,4161 2,284September 1,3701 1,730October 1,5800 1,991November 1,4600 1,840December 1,4550 1,833
Multiple Regression (continued)
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PPT 3 -30
Constant 243.1115
Std Err of Y Est 55.5083
R squared 0.9672
No. of Observations 12
Degrees of Freedom 9
X Coefficient(s) 1.0972 510.4907
Std Err of Coef. 0.2102 32.5490
Multiple Regression (continued)
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PPT 3 -31
Multiple Regression (continued)
The results gives rise to the following equation:
Utilities cost = $243.11 + $1.097(MH) + $510.49(Summer)
R2 = 0.967, or 96.7 percent of the variation in utilities cost is explained by the machine hours and summer variables.
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PPT 3 -32
Use past experience Try to confirm results with operating personal Use common sense to confirm statistical studies
Some Tips
Cost Behavior and Managerial Judgment
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PPT 3 -33
End of Chapter 3