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TRANSCRIPT
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2010 The McGraw-Hill Companies, Inc.
Cost Behavior: Analysis and Use
Chapter 5
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McGraw-Hill/Irwin Slide 2
Learning Objective 1
Understand how fixed andvariable costs behave and
how to use them to predictcosts.
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McGraw-Hill/Irwin Slide 3
The Activity Base (also called a cost driver)
A measure of whatcauses the
incurrence of avariable cost
Unitsproduced
Milesdriven
Machinehours
Laborhours
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McGraw-Hill/Irwin Slide 4
Cost In Total Per Unit
Variable Total variable cost is Variable cost per unit remains
proportional to the activity the same over wide ranges
level within the relevant range. of activity.
Total fixed costs remain the
same even when the activity Average fixed costs per unitFixed level changes within the decrease as the activity
relevant range. level increases.
Average fixed costs per unit decrease as theactivity level increases.
Types of Cost Behavior Patterns Fixed
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McGraw-Hill/Irwin Slide 5
Volume
Cost
True Variable Costs
The amount of a true variable cost used during theperiod varies in direct proportion to the activity level.The overage charge on a cell phone bill was oneexample of a true variable cost.
Direct material isanother exampleof a cost thatbehaves in a truevariable pattern.
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McGraw-Hill/Irwin Slide 6
Step-Variable Costs
A step-variable costis a resource that is obtainable onlyin large chunks (such as maintenance workers) andwhose costs change only in response to fairly wide
changes in activity.
Volume
C
ost
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Step-Variable Costs
Volume
Cost
Only fairly wide changesin the activity level willcause a change in the
number of maintenanceworkers employed.
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Number of Minutes Usedwithin Monthly Plan
M
onthlyBasic
CellP
honeBill
Total Fixed Cost An Example
For example, your cell phone bill probably includes afixed amount related to the total minutes allowed inyour calling plan. The amount does not change when
you use more or less allowed minutes.
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ExamplesAdvertising and
Research andDevelopment
ExamplesDepreciation on Buildingsand Equipment and Real
Estate Taxes
Types of Fixed Costs
Discretionary
May be altered in the
short-term by currentmanagerial decisions
Committed
Long-term, cannot be
significantly reduced inthe short term.
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Rent
CostinThousands
ofDollars
0 1,000 2,000 3,000Rented Area (Square Feet)
0
30
60
Fixed Costs and the Relevant Range
90
RelevantRange
The relevant rangeof activity for a fixedcost is the range ofactivity over which
the graph of thecost is flat.
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Fixed Monthly
Utility Charge
VariableCost per KW
Activity (Kilowatt Hours)
TotalUtilityCost
X
Y
A mixed cost contains both variable and fixed
elements. Consider the example of utility cost.
Mixed Costs (also called semivariable costs)
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Mixed Costs
The total mixed cost line can be expressedas an equation: Y= a+ bX
Where: Y = The total mixed cost.
a = The total fixed cost (the
vertical intercept of the line).
b = The variable cost per unit of
activity (the slope of the line).
X = The level of activity.
Fixed Monthly
Utility Charge
VariableCost per KW
Activity (Kilowatt Hours)
Total
UtilityCost
X
Y
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Analysis of Mixed Costs
In account analysis, each account isclassified as either variable or fixed based
on the analysts knowledge of howthe account behaves.
The engineering approach classifies
costs based upon an industrialengineers evaluation of production
methods, and material, labor andoverhead requirements.
Account Analysis and the Engineering Approach
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Learning Objective 3
Analyze a mixed cost
using the high-lowmethod.
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The High-Low Method An Example
The variable costper hourof
maintenance isequal to the change
in cost divided bythe change in hours.
= $6.00/hour$2,400400
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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
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The High-Low Method An Example
Y = $4,700 + $6.00X
The Cost Equation for Maintenance
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Quick Check
Sales salaries and commissions are $10,000 when80,000 units are sold, and $14,000 when 120,000units are sold. Using the high-low method, what is thevariable 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
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Sales salaries and commissions are $10,000 when80,000 units are sold, and $14,000 when 120,000units are sold. Using the high-low method, what is thevariable 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
Quick Check
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Quick Check
Sales salaries and commissions are $10,000 when80,000 units are sold, and $14,000 when 120,000units are sold. Using the high-low method, what isthe fixed portion of sales salaries and commissions?
a. $ 2,000
b. $ 4,000
c. $10,000
d. $12,000
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Sales salaries and commissions are $10,000 when80,000 units are sold, and $14,000 when 120,000units are sold. Using the high-low method, what isthe fixed portion of sales salaries and commissions?
a. $ 2,000
b. $ 4,000
c. $10,000
d. $12,000
Quick Check
Total cost = Total fixed cost +
Total variable cost
$14,000 = Total fixed cost +
($0.10 120,000 units)
Total fixed cost = $14,000 - $12,000
Total fixed cost = $2,000
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Least-Squares Regression Method
A method used to analyze mixed costs if ascattergraph plot reveals an approximately linear
relationship between theXand Yvariables.
This method uses allof thedata points to estimatethe fixed and variablecost components of a
mixed cost.The goal of this method isto fit a straight line to thedata that minimizes the
sum of the squared errors.
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McGraw-Hill/Irwin Slide 23
Least-Squares Regression Method
Software can be used to fita regression line throughthe data points.
The cost analysis objectiveis the same: Y= a+ bX
Least-squares regression also provides a statistic, calledthe R2, which is a measure of the goodness
of fit of the regression line to the data points.
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McGraw-Hill/Irwin Slide 24
0 1 2 3 4
T
otalCost
10
20
0
Activity
****
**
****
Least-Squares Regression Method
R2is the percentage of the variation in the dependentvariable (total cost) that is explained by variation in the
independent variable (activity).
R2varies from 0% to 100%, andthe higher the percentage the better.
X
Y
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McGraw-Hill/Irwin Slide 25
Learning Objective 4
Prepare an incomestatement using the
contribution format.
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McGraw-Hill/Irwin Slide 26
Lets put our
knowledge of cost
behavior to work
by preparing acontribution
format income
statement.
The Contribution Format
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McGraw-Hill/Irwin Slide 27
The Contribution Format
Total UnitSales Revenue 100,000$ 50$
Less: Variable costs 60,000 30
Contribution margin 40,000$ 20$Less: Fixed costs 30,000
Net operating income 10,000$
The contribution margin format emphasizes costbehavior. Contribution margin covers fixed costs
and provides for income.
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McGraw-Hill/Irwin Slide 28
Uses of the Contribution Format
The contribution income statement format is usedas an internal planning and decision-making tool.
We will use this approach for:
1.Cost-volume-profit analysis (Chapter 6).
2.Budgeting (Chapter 9).
3.Segmented reporting of profit data (Chapter 12).
4.Special decisions such as pricing and make-or-buy analysis (Chapter 13).
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McGraw-Hill/Irwin Slide 29
The Contribution Format
Used primarily forexternal reporting.
Used primarily bymanagement.
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2010 The McGraw-Hill Companies, Inc.
Least-Squares RegressionComputations
Appendix 5A
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McGraw-Hill/Irwin Slide 31
Learning Objective 5
Analyze a mixed costusing the least-squares
regression method.
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McGraw-Hill/Irwin Slide 32
Simple Regression Analysis An Example
Matrix, Inc. wants toknow its average
fixed cost and
variable cost per unit.
Using the data to theright, lets see how todo a regression using
Microsoft Excel.
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McGraw-Hill/Irwin Slide 33
Simple Regression Using Excel An Example
You will need three pieces ofinformation from yourregression analysis:
1. Estimated Variable Cost PerUnit (line slope)
2. Estimated Fixed Costs (lineintercept)
3. Goodness of fit, or R2
To get these three piecesinformation we will need touse three Excel functions.
SLOPE, INTERCEPT, and RSQ
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McGraw-Hill/Irwin Slide 34
Simple Regression Using Excel An Example
Place your cursor in
cell F4 and press the= key. Click on the
pull down menu andscroll down to More
Functions . . .
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McGraw-Hill/Irwin Slide 35
Scroll down to theStatistical,
functions. Now
scroll down thestatistical
functions until youhighlightSLOPE
Simple Regression Using Excel An Example
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McGraw-Hill/Irwin Slide 36
1. In the Known_ys box, enter C4:C19 for the range.
2. In the Known_xs box, enter D4:D19 for the range.
Simple Regression Using Excel An Example
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McGraw-Hill/Irwin Slide 37
Here is theestimate of the
slope of the line.
Simple Regression Using Excel An Example
1. In the Known_ys box, enter C4:C19 for the range.
2. In the Known_xs box, enter D4:D19 for the range.
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McGraw-Hill/Irwin Slide 38
With your cursor in
cell F5, press the =key and go to the pull
down menu forSpecial Functions.Select Statistical and
scroll down tohighlight the
INTERCEPT function.
Simple Regression Using Excel An Example
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McGraw-Hill/Irwin Slide 39
1. In the Known_ys box, enter C4:C19 for the range.
2. In the Known_xs box, enter D4:D19 for the range.
Here is theestimate of the
fixed costs.
Simple Regression Using Excel An Example
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McGraw-Hill/Irwin Slide 40
Finally, we willdetermine thegoodness of
fit, orR2, by
using the RSQfunction.
Simple Regression Using Excel An Example
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McGraw-Hill/Irwin Slide 41
1. In the Known_ys box, enter C4:C19 for the range.
2. In the Known_xs box, enter D4:D19 for the range.
Here is theestimate ofR2.
Simple Regression Using Excel An Example
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End of Chapter 5