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					Introduction to Management Accounting
Introduction to Management Accounting

             Chapter 3



    Measurement of Cost Behavior
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 AmericaWest was a low-cost/full-service airline
   (Contrast to Southwest)
 Decided to expand service which required
   additional costs
 Most of these new costs would be fixed but
   revenues in the industry fluctuate with the
   economy
 Flexibility was accomplished via leasing
          Linear-cost Behavior

Costs are assumed to be fixed or variable
within the relevant range of activity
 Learning
Objective 1
                     Step Cost Behavior Patterns

              Step costs change abruptly at intervals
               of activity because the resources and
              their costs come in indivisible chunks.
Step Cost Behavior Patterns
Mixed-Cost Behavior Patterns

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


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


   The variable-cost element varies
proportionately with cost-driver activity.
    Mixed-Cost Behavior Patterns
             Parkview Medical Center
Predicted costs = fixed + variable costs (patient-days)
       Predicted costs = $10,000 + $5(4,000)
             Predicted costs = $30,000
 Learning
Objective 2
              Management’s Influence on Cost Behavior


               Choice of process and product design


                          Quality levels


                         Product features


                      Distribution channels
         Capacity Decisions




They are the fixed costs of being able
to achieve a desired level of production or
to provide a desired level of service while
maintaining product or service attributes.
   Committed Fixed Costs


    Committed fixed costs arise
  from the possession of facilities,
equipment, and a basic organization.

          Lease payments

          Property taxes

     Salaries of key personnel
          Discretionary Fixed Costs

 Discretionary fixed costs are costs fixed at certain levels
only because management decided that these levels of cost
   should be incurred to meet the organization’s goals.


     These discretionary fixed costs have no obvious
        relationship to levels of output activity but
 are determined as part of the periodic planning process.

   Each planning period, management will determine
 how much to spend on discretionary items. These costs
    then become fixed until the next planning period.
          Examples of Discretionary
               Fixed Costs
                Research and
                development

 Advertising
and promotion



Management
  salaries
       Technology Decisions

Choice of technology (e-commerce versus
 in-store or mail-order sales) positions the
 organization to meet its current goals and
to respond to changes in the environment.
           Cost-Control Incentives


Managers use their        Employees may
knowledge of cost       Receive rewards that
 behavior to set        are tied to meeting
cost expectations.       these expectations.
 Learning
Objective 3
                            Cost Functions


              Planning and controlling the activities
               of an organization require accurate
                  and useful estimates of future
                     fixed and variable costs.
          Cost Functions

Understanding relationships between costs
and their cost drivers allows managers to...


    Make better operating, marketing,
       And production decisions


         Plan and evaluate actions


    Determine appropriate costs for
    short-run and long-run decisions.
           Cost Functions


The first step in estimating or predicting
 costs is measuring cost behavior as a
 function of appropriate cost drivers.



  The second step is to use these cost
  measures to estimate future costs at
 expected levels of cost-driver activity.
               Cost Function Equation
      Let:
      Y = Total cost
      F = Fixed cost
      V = Variable cost per unit
      X = Cost-driver activity in number of units

The mixed-cost function is called a linear-cost function.

                     Mixed-cost function:
                          Y = F + VX
                     Y = $10,000 + $5.00X
  Developing Cost Functions




The cost function must be believable.



  A cost function’s estimates of costs
at actual levels of activity must reliably
conform with actually observed costs.
 Learning
Objective 4   Choice of Cost Drivers: Activity Analysis


                  Choosing a cost function starts
                   with choosing cost drivers.


                 Managers use activity analysis to
                 identify appropriate cost drivers.

               Activity analysis directs management
                 accountants to the appropriate
                     cost drivers for each cost.
Choice of Cost Drivers: Activity Analysis

        Northwestern Computers makes two
       products: Mozart-Plus and Powerdrive


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

       Northwest has upgraded the production
        function, which has increased support
            costs and reduced labor cost.
Choice of Cost Drivers: Activity Analysis


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


                        Mozart-Plus        Powerdrive
Labor cost                $ 8.50            $130.00
Support cost:
2 × Direct labor cost      $17.00           $260.00
   Choice of Cost Drivers: Activity Analysis

Using the more appropriate cost driver, the number of components
        added to products, the predicted support costs are:

                                 Mozart-Plus      Powerdrive
 Support cost at $20/component
  $20 × 5 components                 $100.00
  $20 × 9 components                                $180.00
 Difference in predicted
  support cost                       $ 83.00        $ 80.00
                                     higher           lower
 Learning
Objective 5   Methods of Measuring Cost Functions



               1. Engineering analysis
               2. Account analysis
               3. High-low analysis
               4. Visual-fit analysis
               5. Least-squares regression analysis
         Engineering Analysis

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



  Engineering analysis entails a systematic
    review of materials, supplies, labor,
       support services, and facilities
     needed for products and services.
                          Account Analysis

     The simplest method of account analysis selects a plausible
   cost driver and classifies each account as a variable or fixed cost.

                          Parkview Medical Center
           Monthly cost              Amount      Fixed      Variable

Supervisor’s salary and benefits     $ 3,800     $3,800
Hourly workers’ wages and benefits    14,674                 $14,674
Equipment depreciation and rentals     5,873      5,873
Equipment repairs                      5,604                   5,604
Cleaning supplies                      7,472                   7,472
Total maintenance costs              $37,423     $9,673      $27,750
Account Analysis Example

        3,700 patient-days

  Fixed cost per month = $9,673

   Variable cost per patient-day
        = $27,750 ÷ 3,700
     = $7.50 per patient-day

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

     Plot historical data points on a graph.


Focus on the highest- and lowest-activity points.


            High month: April
         Maintenance cost: $47,000
        Number of patient-days: 4,900

          Low month: September
         Maintenance cost: $17,000
        Number of patient-days: 1,200
              High-Low Method Example




The point at which the line intersects the Y axis is the intercept, F, or
estimate of Fixed Costs, and the slope of the line measures the variable cost.
     High-Low Method Example

          What is the variable cost (V)?
Using algebra to solve for variable and fixed costs.



         Variable costs = Change in costs
                          change in activity

    V = ($47,000 – $17,000) ÷ (4,900 – 1,200)
           = $30,000 ÷ 3,700 = $8.1081
       High-Low Method Example
              What is the fixed cost (F)?

       F = Total mixed cost – total variable cost
At X (high) F = $47,000 - ($8.1081× 4,900 patient days)
                 = $47,000 – $39,730
                   = $7,270 a month

At X (low) F = $17,000 = ($8.1081× 1,200 patient days)
                 = $17,000 – $9,730
                  = $7,270 a month

    Cost function measured by high-low method:
   Y = $7,270 per month + ($8.1081 × patient-days)
         Visual-Fit Method


In the visual-fit method, the cost analyst
visually fits a straight line through a plot
   of all of the available data, not just
     between the high point and the
   low point, making it more reliable
       than the high-low method.
           Example of Visual Fit

Cost
                                 .
            .    .
       .             .       .
            .            .
Least-Squares Regression Method


     Regression analysis measures
    a cost function more objectively
      by using statistics to fit a cost
        function to all the data.

     Regression analysis measures
    cost behavior more reliably than
   other cost measurement methods.
Coefficient of Determination

    One measure of reliability,
     or goodness of fit, is the
   coefficient of determination,
        R² (or R-squared).


 The coefficient of determination
    measures how much of the
 fluctuation of a cost is explained
   by changes in the cost driver.
   The End




End of Chapter 3

				
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