Managerial Accounting Chapter 3 PDF

Managerial Accounting Fifth Canadian Edition Chapter 3 Cost Behaviour Copyright © 2024 Pearson Canada Inc. 3-1 Chapter 3 Learning Objectives (1 of 2) 1. Describe key characteristic...

Managerial Accounting Fifth Canadian Edition Chapter 3 Cost Behaviour Copyright © 2024 Pearson Canada Inc. 3-1 Chapter 3 Learning Objectives (1 of 2) 1. Describe key characteristics and graphs of various cost behaviours. 2. Use cost equations to express and predict costs. 3. Use account analysis and scatter plots to analyze cost behaviour. 4. Use the high-low method to analyze cost behaviour. 5. Use regression analysis to analyze cost behaviour. 6. Analyze cost behaviour and make predictions using data analytics tools. 7. Prepare contribution margin income statements for service firms and merchandising firms Copyright © 2024 Pearson Canada Inc. 3-2 Chapter 3 Learning Objectives (2 of 2) 8. Use variable costing to prepare contribution margin income statements for manufacturers. (Appendix 3A) 9. Compare operating income approaches: variable versus absorption costing. (Appendix 3A) 10. Use segment reporting to utilize the contribution margin income statement format in an organization with two or more divisions. 11. (Appendix 3B) Copyright © 2024 Pearson Canada Inc. 3-3 Objective 1 Describe key characteristics and graphs of various cost behaviours. Copyright © 2024 Pearson Canada Inc. 3-4 Cost Behaviours Exhibit 3-1 Variable Costs increase with volume. Example: Costs of Toiletries and snacks in a hotel increases with the number of guests. Fixed Costs remain constant, Exhibit 3-3 regardless of changes in volume. Example: Cost of a lease on a hotel remains the same, regardless of the number of guests. Copyright © 2024 Pearson Canada Inc. 3-5 Relevant Range (1 of 2) The range of operations within which the total fixed costs and the variable cost per unit remain constant Most commonly this is an issue of organizational capacity For example, if the hotel has a capacity of 500 guests, and the demand for rooms is consistently higher, they might decide to lease another hotel; therefore, the fixed lease costs has now increased. If the volume of toiletries increases to the point that the company is eligible for a volume discount, the variable cost per hotel guest would decrease. Copyright © 2024 Pearson Canada Inc. 3-6 Mixed Costs Exhibit 3-5 Mixed Costs consist of a fixed component and a variable portion. For example: if a hotel were completely empty, the utilities would cost $2,000 per week. These costs increase by $8 per guest. Copyright © 2024 Pearson Canada Inc. 3-7 Quick Check: Cost Behaviour (1 of 4) 1. Which of the following costs is an example of a fixed cost? a. Salary of plant manager b. Sales commissions c. Direct materials d. Delivery costs Copyright © 2024 Pearson Canada Inc. 3-8 Quick Check: Cost Behaviour (2 of 4) 2. Which of the following is a characteristic of a variable cost? a. Variable costs fluctuate in total with production and sales. b. Variable costs are fixed in total. c. Variable costs do not change in total over any range. d. Variable costs per unit change with changes in volume Copyright © 2024 Pearson Canada Inc. 3-9 Quick Check: Cost Behaviour (3 of 4) 3. Renting a car and paying $35 per day plus $.20 per kilometre driven is an example of what type of cost? a. Conversion cost b. Fixed cost c. Mixed cost d. Variable cost Copyright © 2024 Pearson Canada Inc. 3 - 10 Quick Check: Cost Behaviour (4 of 4) 4. For most businesses, annual straight-line depreciation expense on the company's building is what type of cost? a. Variable b. Fixed c. Mixed d. Step Copyright © 2024 Pearson Canada Inc. 3 - 11 Objective 2 Use cost equations to express and predict costs. Copyright © 2024 Pearson Canada Inc. 3 - 12 Cost Equation: An Example A company is manufacturing desks in a space that costs $10,000 per month to rent. The cost of the direct material is $30 per desk and $20 of direct labour per desk. What are the total cost if we produce zero desks? What are the total cost if we produce 100 desks? What are the total cost if we produce 1,000 desks? How do we determine total cost? y=f+vx Total Cost = Fixed Cost + (Variable Cost per unit X # of units) y=total costs v=variable cost per unit f=fixed costs X-number of units Copyright © 2024 Pearson Canada Inc. 3 - 13 Relevant Range (2 of 2) Band of volume where total fixed costs remain constant The hotel expansion, if carried out, will increase the hotel’s fixed costs to a new level. Band of volume where variable costs per unit remain constant With more capacity, negotiate greater volume discounts on the toiletries, lowering variable toiletries cost per guest Exhibit 3-7 Exhibit 3-8 Copyright © 2024 Pearson Canada Inc. 3 - 14 Other Cost Behaviours Step Costs Exhibit 3-10 Curvilinear costs are not linear – they do not fit into any neat pattern Approximate this type of cost as a mixed cost Exhibit 3-11 Copyright © 2024 Pearson Canada Inc. 3 - 15 Summary Problem 1 (1 of 3) Fitness-for-Life’s fixed operating costs were $10,000 per month Variable operating costs were $1 per member per month Club’s existing facilities serve up to 750 members per month Complete the following schedule for different levels Copyright © 2024 Pearson Canada Inc. 3 - 16 Summary Problem 1 (2 of 3) Monthly Operating Cost 100 Members 500 Members 750 Members Total variable costs Total fixed costs __________ ___________ __________ Total operating costs __________ ___________ __________ Variable cost per member Fixed cost per member __________ ___________ __________ Average cost per member ‗‗‗‗‗‗‗‗‗‗‗ ‗‗‗‗‗‗‗‗‗‗‗ ‗‗‗‗‗‗‗‗‗‗‗ Copyright © 2024 Pearson Canada Inc. 3 - 17 Summary Problem 1 (3 of 3) Why should the manager not use the average cost per member to predict total costs at different levels? 100 Members 500 Members 750 Members Total variable costs $ 100 $ 500 $ 750 Total fixed costs 10,000 10,000 10,000 Total operating costs $ 10,100 $ 10,500 $ 10,750 Variable cost per member $ 1.00 $ 1.00 $ 1.00 Fixed cost per member 100.00 20.00 13.33 Average cost per member $ 101.00 $ 21.00 $ 14.33 Copyright © 2024 Pearson Canada Inc. 3 - 18 Sustainability and Cost Behaviour E-banking and e-billing serves to reduce variable costs for both the bank and society at large: – reduced demand for printed bills reduces both the demand for paper, ink/toner, shipping and disposal – resulting is a reduction in the harvesting of trees, production of dyes, use of fuel for transportation and landfill space required – costs are reduced to business and savings trickle down to the customer Copyright © 2024 Pearson Canada Inc. 3 - 19 Objective 3 Use account analysis and scatter plots to analyze cost behaviour. Copyright © 2024 Pearson Canada Inc. 3 - 20 Cost Behaviour Analysis Four methods to analyze cost behaviour – Account Analysis – Scatter Plots – High-Low Method – Regression Analysis Copyright © 2024 Pearson Canada Inc. 3 - 21 Account Analysis Use of judgment to classify each general ledger account as variable, fixed, or mixed Requires knowledge of the business and the nature of its operations Subjective Copyright © 2024 Pearson Canada Inc. 3 - 22 Scatter Plots Use historical data to determine a cost’s behaviour Scatter plot is the graph of historical cost data on the y-axis and volume data on the x-axis Helps managers visually determine how strong the relationship is between the cost and the volume of the chosen activity base Exhibit 3-13 Copyright © 2024 Pearson Canada Inc. 3 - 23 Objective 4 Use the high-low method to analyze cost behaviour. Copyright © 2024 Pearson Canada Inc. 3 - 24 High-Low Method Step 1: Find variable cost per unit (slope) of cost line Step 2: Find the fixed costs (vertical intercept) Step 3: Create the cost equation Advantage: Easy to use Disadvantage: Only uses 2 data points Exhibit 3-14 Copyright © 2024 Pearson Canada Inc. 3 - 25 High-Low Method: An Example (1 of 2) Exhibit 3-12 Formula Find the variable cost per unit Rise Change in cost y (high)  y (low) Slope  Variable cost per unit of activity(v )    Run Change in volume x (high)  x (low) ($209,600  $114,000) $8 per guest (25,200 guests  13,250 guests) Copyright © 2024 Pearson Canada Inc. 3 - 26 High-Low Method: Example (2 of 2) Step 2: Find the fixed costs (vertical intercept) = Total mixed cost – Total variable cost Total mixed costs  Variable cost component  Fixed cost component y  vx  f $209,600 ($8 per guest  25,200 guests)  f f $8,000 Step 3: Create and use an equation to show the behaviour of a mixed cost y = total monthly utilities cost x = number of guests y = $8x + $8,000 Copyright © 2024 Pearson Canada Inc. 3 - 27 Objective 5 Use regression analysis to analyze cost behaviour. Copyright © 2024 Pearson Canada Inc. 3 - 28 Regression Analysis: Example (1 of 4) Add Data Analytics Tools In Excel – In File Click on ‘More’, then options Copyright © 2024 Pearson Canada Inc. 3 - 29 Regression Analysis: Example (2 of 4) Click on ‘Add Ins’ Then click on Analysis Toolpack Then click Go Copyright © 2024 Pearson Canada Inc. 3 - 30 Regression Analysis: Example (3 of 4) Click On Analysis Toolpack Then on ‘OK’ Copyright © 2024 Pearson Canada Inc. 3 - 31 Regression Analysis: Example (4 of 4) In ‘Data’ tab in Excel Click on Data Analysis Copyright © 2024 Pearson Canada Inc. 3 - 32 Regression Analaysis – Example (1 of 3) Click on Regression Click ‘OK’ Copyright © 2024 Pearson Canada Inc. 3 - 33 Regression Analaysis – Example (2 of 3) In the input ‘Y’ Range Highlight total costs range In the input ‘X’ Range highlight total volume range Then click ‘OK’ Copyright © 2024 Pearson Canada Inc. 3 - 34 Regression Analysis – Example (3 of 3) The Summary Output is produced Note: Intercept = Fixed Costs and x-variable 1 = variable cost per unit Copyright © 2024 Pearson Canada Inc. 3 - 35 R-Square Value “Goodness of fit” of the data to the calculated line How well does the line fit the data points? Ranges from 0 to 1; want R-square >= 0.80 Exhibit 3-16 Copyright © 2024 Pearson Canada Inc. 3 - 36 Objective 6 Analyze cost behaviour and make predictions using data analytics tools. Copyright © 2024 Pearson Canada Inc. 3 - 37 Data Analytics as a Predictive Tool Data analytics is often used to make predictions by identifying patterns in large data sets. Regression analysis is one tool that is often used for building predictive models. We can use more than one 'X' variable to predict 'y', by analyzing large data sets with multiple regression analysis. Copyright © 2024 Pearson Canada Inc. 3 - 38 Objective 7 Prepare contribution margin income statements for service firms and merchandising firms. Copyright © 2024 Pearson Canada Inc. 3 - 39 Traditional Income Statement Organized by function – Product costs comprised of Direct Material, Direct Labour and Manufacturing Overhead – Period costs comprised of Selling, General and Administrative expenses AAA FITNESS EQUIPMENT Income Statement Month Ended July 31 Sales revenue $ 52,500 Less: Cost of goods sold (27,300) Gross profit 25,200 Less: Operating expenses (14,600) Operating income $ 10,600 Copyright © 2024 Pearson Canada Inc. 3 - 40 Contribution Margin Income Statement Organized by behaviour – Variable Costs – Fixed Costs Contribution Margin = Sales – Variable Costs AAA FITNESS EQUIPMENT Contribution Margin Income Statement Month Ended July 31 Sales revenue $ 52,500 Less: Variable expenses (30,900) Contribution margin 21,600 Less: Fixed expenses (11,000) Operating income $ 10,600 Copyright © 2024 Pearson Canada Inc. 3 - 41 Objective 8 (Appendix 3A) Use variable costing to prepare contribution margin income statements for manufacturers. Copyright © 2024 Pearson Canada Inc. 3 - 42 Variable Costing vs. Absorption Costing (1 of 2) Variable Costing Assigns only variable manufacturing costs to products (DM, DL, Variable MOH) Fixed manufacturing overhead = period cost For internal management decisions Required by financial reporting standards (ASPE and IFRS) for external reporting Copyright © 2024 Pearson Canada Inc. 3 - 43 Variable Costing vs. Absorption Costing (2 of 2) Absorption Costing Assign all manufacturing costs to products (DM, DL, Variable MOH and Fixed MOH) Products “absorb” Fixed MOH Product costs include ALL inventoriable costs Traditional income statement Copyright © 2024 Pearson Canada Inc. 3 - 44 Absorption Costing vs Variable Costing Absorption Costing Variable Costing Product Costs Direct materials Direct materials (Capitalized as Inventory of Direct labour Direct labour until expensed as Cost Variable manufacturing overhead Variable manufacturing overhead Goods Sold) Fixed manufacturing overhead Period Costs Fixed manufacturing overhead (Expensed in periods Variable nonmanufacturing costs Variable nonmanufacturing costs incurred) Fixed nonmanufacturing costs Fixed nonmanufacturing costs Focus External reporting— Internal reporting only required by IFRS/ASPE Income Statement Conventional income statement Contribution margin statement Format Copyright © 2024 Pearson Canada Inc. 3 - 45 Objective 8 (Appendix 3B) Use segmented reporting to utilize the contribution margin income statement format in an organization with two or more divisions. Copyright © 2024 Pearson Canada Inc. 3 - 46 Traceable Costs vs. Common Fixed Costs While fixed costs are often allocated to sub-units in a traditional income statement, they can lead to false assumptions such as the belief that elimination of a segment will result in greater profits. Common fixed costs—which would not be eliminated in the event of dropping a segment—should not be included in evaluating segment performance. Only traceable fixed costs will be eliminate if a segment is dropped. Copyright © 2024 Pearson Canada Inc. 3 - 47 Segmented Income Statement – Exhibit 3-26 MAPLEWOOD EQUESTRIAN CENTRE Segmented Income Statement for the Year Ended December 31, 2020 Boarding Lessons Totals Sales $115,500 $248,500 $364,000 Variable costs (36,000) (47,000) (83,000) Contribution margin 79,500 201,500 281,000 Traceable fixed costs (27,000) (45,000) (72,000) Segment margin $ 52,500 $156,500 209,000 Common costs (167,000) $ 42,000 Copyright © 2024 Pearson Canada Inc. 3 - 48 Quick Check Copyright © 2024 Pearson Canada Inc. 3 - 49 Quick Check (1 of 8) 1. (Learning Objectives 1, 9) If a per-unit cost remains constant over a wide range of volume, the cost is most likely a a. variable cost b. fixed cost c. mixed cost d. step cost Copyright © 2024 Pearson Canada Inc. 3 - 50 Quick Check (2 of 8) 2. (Learning Objectives 1, 9) The cost per unit decreases as volume increases for which of the following cost behaviours? a. Variable costs and fixed costs b. Variable costs and mixed costs c. Fixed costs and mixed costs d. Only fixed costs Copyright © 2024 Pearson Canada Inc. 3 - 51 Quick Check (3 of 8) 3. (Learning Objective 2) In the mixed cost equation y v = +x f, which amount represents the total variable cost component? a. Y b. V c. F d. vx Copyright © 2024 Pearson Canada Inc. 3 - 52 Quick Check (4 of 8) 4. (Learning Objective 2) Which of the following would generally be considered committed fixed cost for a retailing firm? a. Cost of a trip to Cancun given to the employee who is Employee of the Year b. Lease payments made on the store building c. Cost of sponsoring the local golf tournament for charity d. Cost of the annual sales meeting for all employees Copyright © 2024 Pearson Canada Inc. 3 - 53 Quick Check (5 of 8) 5. (Learning Objective 3) Which method is used to see if a relationship between the cost driver and total cost exists? a. Scatter plot b. Variance analysis c. Outlier d. Account analysis Copyright © 2024 Pearson Canada Inc. 3 - 54 Quick Check (6 of 8) 6. (Learning Objective 4) How is the high point selected for the high-low method? a. The point with the highest total cost is chosen. b. The point with the highest volume of activity is chosen. c. The point that has the highest cost and highest volume of activity is always chosen. d. Both the high point and the low point are selected at random. Copyright © 2024 Pearson Canada Inc. 3 - 55 Quick Check (7 of 8) 7. (Learning Objective 5) What is the advantage of using regression analysis to determine the cost equation? a. The method is objective. b. All data points are used to calculate the cost equation. c. It is generally more accurate than the high-low method. d. All of the above statements are true about regression analysis. Copyright © 2024 Pearson Canada Inc. 3 - 56 Quick Check (8 of 8) 8. (Learning Objective 10) The contribution margin income statement a. a. provides owners with cash flow information. b. is required for external reporting. c. is useful to managers in decision making and planning. d. arrives at operating income by subtracting operating expenses from gross profit. Copyright © 2024 Pearson Canada Inc. 3 - 57