Cost Behavior: Analysis and Use PDF

Cost Behavior: Analysis and Use Topic 2 (Chapter 2) © 2012 McGraw-Hill Education (Asia) Learning Objective 1 Identify and give examples of each of the three basic manufacturing cost categories. McGraw-Hill McGraw-Hill/Irwin Education (Asia) Garrison, Noreen, Brewer, Cheng & Yuen Slide 2 Man...

Cost Behavior: Analysis and Use Topic 2 (Chapter 2) © 2012 McGraw-Hill Education (Asia) Learning Objective 1 Identify and give examples of each of the three basic manufacturing cost categories. McGraw-Hill McGraw-Hill/Irwin Education (Asia) Garrison, Noreen, Brewer, Cheng & Yuen Slide 2 Manufacturing Costs Direct Materials Direct Labor Manufacturing Overhead The Product McGraw-Hill McGraw-Hill/Irwin Education (Asia) Garrison, Noreen, Brewer, Cheng & Yuen Slide 3 Direct Materials Raw materials that become an integral part of the product and that can be conveniently traced directly to it. Example: A radio installed in an automobile McGraw-Hill McGraw-Hill/Irwin Education (Asia) Garrison, Noreen, Brewer, Cheng & Yuen Slide 4 Direct Labor Those labor costs that can be easily traced to individual units of product. Example: Wages paid to automobile assembly workers McGraw-Hill McGraw-Hill/Irwin Education (Asia) Garrison, Noreen, Brewer, Cheng & Yuen Slide 5 Manufacturing Overhead Manufacturing costs that cannot be traced directly to specific units produced. Examples: Indirect materials and indirect labor Materials used to support the production process. Examples: lubricants and cleaning supplies used in the automobile assembly plant. McGraw-Hill McGraw-Hill/Irwin Education (Asia) Wages paid to employees who are not directly involved in production work. Examples: maintenance workers, janitors and security guards. Garrison, Noreen, Brewer, Cheng & Yuen Slide 6 Nonmanufacturing Costs Selling Costs Administrative Costs Costs necessary to secure the order and deliver the product. All executive, organizational, and clerical costs. McGraw-Hill McGraw-Hill/Irwin Education (Asia) Garrison, Noreen, Brewer, Cheng & Yuen Slide 7 Learning Objective 1 Understand how fixed and variable costs behave and how to use them to predict costs. McGraw-Hill McGraw-Hill/Irwin Education (Asia) Garrison, Noreen, Brewer, Cheng & Yuen Slide 8 Cost Classifications for Predicting Cost Behavior How a cost will react to changes in the level of activity within the relevant range. McGraw-Hill Education (Asia) McGraw-Hill/Irwin  Total variable costs change when activity changes.  Total fixed costs remain unchanged when activity changes. Garrison, Noreen, Brewer, Cheng & Yuen Slide 9 The Activity Base (also called a cost driver) Machine hours Units produced A measure of what causes the incurrence of a variable cost Miles driven McGraw-Hill McGraw-Hill/Irwin Education (Asia) Labor hours Garrison, Noreen, Brewer, Cheng & Yuen Slide 10 Variable Cost The activity base is the number of text sent. Total Texting Bill Your total texting bill is based on how many texts you send. Number of Texts Sent McGraw-Hill McGraw-Hill/Irwin Education (Asia) Garrison, Noreen, Brewer, Cheng & Yuen Slide 11 Variable Cost Per Unit Cost Per Text Sent The cost per text sent is constant at 5 cents per text. Number of Texts Sent McGraw-Hill McGraw-Hill/Irwin Education (Asia) Garrison, Noreen, Brewer, Cheng & Yuen Slide 12 Examples of Variable Costs 1. Merchandising companies – cost of goods sold. 2. Manufacturing companies – direct materials, direct labor, and variable overhead. 3. Merchandising and manufacturing companies – commissions, shipping costs, and clerical costs such as invoicing. 4. Service companies – supplies, travel, and clerical. McGraw-Hill Education (Asia) McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 13 Fixed Cost Monthly Cell Phone Contract Fee Your monthly contract fee for your cell phone is fixed for the number of monthly minutes in your contract. The monthly contract fee does not change based on the number of calls you make. Number of Minutes Used Within Monthly Plan McGraw-Hill McGraw-Hill/Irwin Education (Asia) Garrison, Noreen, Brewer, Cheng & Yuen Slide 14 Fixed Cost Per Unit Monthly Cell Phone Contract Fee Within the monthly contract allotment, the average fixed cost per cell phone call made decreases as more calls are made. Number of Minutes Used Within Monthly Plan McGraw-Hill McGraw-Hill/Irwin Education (Asia) Garrison, Noreen, Brewer, Cheng & Yuen Slide 15 Cost Classifications for Predicting Cost Behavior Behavior of Cost (within the relevant range) Cost In Total Per Unit Variable Total variable cost changes as activity level changes. Variable cost per unit remains the same over wide ranges of activity. Fixed Total fixed cost remains the same even when the activity level changes. Average fixed cost per unit goes down as activity level goes up. McGraw-Hill Education (Asia) McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 16 Quick Check  Which of the following costs would be variable with respect to the number of cones sold at a Baskins & Robbins shop? (There may be more than one correct answer.) A. The cost of lighting the store. B. The wages of the store manager. C. The cost of ice cream. D. The cost of napkins for customers. McGraw-Hill McGraw-Hill/Irwin Education (Asia) Garrison, Noreen, Brewer, Cheng & Yuen Slide 17 Quick Check  Which of the following costs would be variable with respect to the number of cones sold at a Baskins & Robbins shop? (There may be more than one correct answer.) A. The cost of lighting the store. B. The wages of the store manager. C. The cost of ice cream. D. The cost of napkins for customers. McGraw-Hill McGraw-Hill/Irwin Education (Asia) Garrison, Noreen, Brewer, Cheng & Yuen Slide 18 Fixed Costs and the Relevant Range For example, assume office space is available at a rental rate of $30,000 per year in increments of 1,000 square feet. Fixed costs would increase in a step fashion at a rate of $30,000 for each additional 1,000 square feet. McGraw-Hill Education (Asia) McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 19 Rent Cost in Thousands of Dollars Fixed Costs and the Relevant Range McGraw-Hill Education (Asia) McGraw-Hill/Irwin 90 Relevant 60 Range 30 0 0 The relevant range of activity for a fixed cost is the range of activity over which the graph of the cost is flat. 1,000 2,000 3,000 Rented Area (Square Feet) Garrison, Noreen, Brewer, Cheng & Yuen Slide 20 Quick Check  Which of the following statements about cost behavior are true? a. Fixed costs per unit vary with the level of activity. b. Variable costs per unit are constant within the relevant range. c. Total fixed costs are constant within the relevant range. d. Total variable costs are constant within the relevant range. McGraw-Hill Education (Asia) McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 21 Quick Check  Which of the following statements about cost behavior are true? a. Fixed costs per unit vary with the level of activity. b. Variable costs per unit are constant within the relevant range. c. Total fixed costs are constant within the relevant range. d. Total variable costs are constant within the relevant range. McGraw-Hill Education (Asia) McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 22 Mixed Costs (also called semivariable costs) A mixed cost contains both variable and fixed elements. Consider the example of utility cost. Total Utility Cost Y Variable Cost per KW Activity (Kilowatt Hours) McGraw-Hill Education (Asia) McGraw-Hill/Irwin X Garrison, Noreen, Brewer, Cheng & Yuen Fixed Monthly Utility Charge Slide 23 Mixed Costs The total mixed cost line can be expressed as an equation: Y = a + bX Where: Y Y a Total Utility Cost b X = The total mixed cost. = The total fixed cost (the vertical intercept of the line). = The variable cost per unit of activity (the slope of the line). = The level of activity. Variable Cost per KW Activity (Kilowatt Hours) McGraw-Hill Education (Asia) McGraw-Hill/Irwin X Garrison, Noreen, Brewer, Cheng & Yuen Fixed Monthly Utility Charge Slide 24 Mixed Costs – An Example If your fixed monthly utility charge is $40, your variable cost is $0.03 per kilowatt hour, and your monthly activity level is 2,000 kilowatt hours, what is the amount of your utility bill? Y = a + bX Y = $40 + ($0.03 × 2,000) Y = $100 McGraw-Hill Education (Asia) McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 25 Learning Objective 2 Analyze a mixed cost using the high-low method. McGraw-Hill McGraw-Hill/Irwin Education (Asia) Garrison, Noreen, Brewer, Cheng & Yuen Slide 26 The High-Low Method – An Example Assume the following hours of maintenance work and the total maintenance costs for six months. McGraw-Hill Education (Asia) McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 27 The High-Low Method – An Example The variable cost per hour of maintenance is equal to the change in cost divided by the change in hours. $2,400 = $6.00/hour 400 McGraw-Hill Education (Asia) McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 28 The High-Low Method – An Example Total Fixed Cost = Total Cost – Total Variable Cost Total Fixed Cost = $9,800 – ($6/hour × 850 hours) Total Fixed Cost = $9,800 – $5,100 Total Fixed Cost = $4,700 McGraw-Hill Education (Asia) McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 29 The High-Low Method – An Example The Cost Equation for Maintenance Y = $4,700 + $6.00X McGraw-Hill Education (Asia) McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 30 Quick Check  Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the variable portion of sales salaries and commission? a. $0.08 per unit b. $0.10 per unit c. $0.12 per unit d. $0.125 per unit McGraw-Hill Education (Asia) McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 31 Quick Check  Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the variable portion of sales salaries and commission? a. $0.08 per unit Units Cost b. $0.10 per unit High level 120,000 $ 14,000 c. $0.12 per unit Low level 80,000 10,000 40,000 $ 4,000 d. $0.125 per unit Change $4,000 ÷ 40,000 units = $0.10 per unit McGraw-Hill Education (Asia) McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 32 Quick Check  Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the fixed portion of sales salaries and commissions? a. $ 2,000 b. $ 4,000 c. $10,000 d. $12,000 McGraw-Hill Education (Asia) McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 33 Quick Check  Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the fixed portion of sales salaries and commissions? a. $ 2,000 Total cost = Total fixed cost + Total variable cost b. $ 4,000 $14,000 = Total fixed cost + c. $10,000 ($0.10 × 120,000 units) d. $12,000 McGraw-Hill Education (Asia) McGraw-Hill/Irwin Total fixed cost = $14,000 - $12,000 Total fixed cost = $2,000 Garrison, Noreen, Brewer, Cheng & Yuen Slide 34 Learning Objective 3 Prepare an income statement using the contribution format. McGraw-Hill McGraw-Hill/Irwin Education (Asia) Garrison, Noreen, Brewer, Cheng & Yuen Slide 35 The Contribution Format Let’s put our knowledge of cost behavior to work by preparing a contribution format income statement. McGraw-Hill Education (Asia) McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 36 The Contribution Format Sales Revenue Less: Variable costs Contribution margin Total $ 100,000 60,000 $ 40,000 Less: Fixed costs Net operating income 30,000 $ 10,000 Unit $ 50 30 $ 20 The contribution margin format emphasizes cost behavior. Contribution margin covers fixed costs and provides for income. McGraw-Hill Education (Asia) McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 37 Uses of the Contribution Format The contribution income statement format is used as an internal planning and decision-making tool. We will use this approach for: 1.Cost-volume-profit analysis (Chapter 4). 2.Budgeting (Chapter 10). 3.Segmented reporting of profit data (Chapter 13). 4.Special decisions such as pricing and make-orbuy analysis (Chapter 14). McGraw-Hill Education (Asia) McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 38 The Contribution Format Used primarily for external reporting. McGraw-Hill Education (Asia) McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Used primarily by management. Slide 39 End of Topic 2 McGraw-Hill Education (Asia) McGraw-Hill/Irwin Garrison, Noreen, Brewer, Cheng & Yuen Slide 40