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BA 512: Managerial Accounting 6. Activity Analysis, Cost Behavior & Estimation Schiller International University BA 512 Today’s Class Attendance Schedule Review last class Activity Analysis, Cost Behavior & Cost Estimation Schiller International University BA 512 2 Day Class Reading Subject 1-Fri 4 Sep Chapter 1 & 2 Introduction & Review 5 Sep Chapter 3 Traditional Managerial Accounting 1-Sat 5 Sep Activity-Based Costing Chapter 5 5 Sep Activity-Based Management 6 Sep Chapter 7 Cost/Volume/Profit Analysis 1-Sun 6 Sep Chapter 6 Activity Analysis, Cost Behavior & Estimation 6 Sep Chapter 8 Absorption & Variable Costing 2-Fri 9 Oct Mid-Term Exam 10 Oct Chapter 9 Profit-Planning & Activity-Based Budgeting 2-Sat 10 Oct Chapter 10 Standard Costing & Balanced Scorecard 10 Oct Chapter 12 Responsibility Accounting 11 Oct Chapter 13 Investment Centers & Transfer Pricing 2-Sun 11 Oct Chapter 14 Decision-Making: Relevant Costs & Benefits 11 Oct Chapter 15 Target Costing & Pricing Decisions; Review 3-Fri 4 Dec Final Exam 3-Sat- 5-6 Dec Case Study Presentations Sun Schiller International University BA 512 3 We have classified costs from one perspective so far - - - Direct Indirect Material Material Labor Labor But there is another way that every one of these same costs can be classified: Fixed Variable To do that, let’s examine cost behavior. Schiller International University BA 512 4 Confusing? It can be. Let’s summarize: Recall the summary of our cost behavior discussion from Day 4/Lecture 2. Note that it is total cost which defines the way the term is used. Schiller International University BA 512 5 Step-Fixed Costs 90 Thousands of Dollars Rent Cost in 60 30 00 1,000 2,000 3,000 Rented Area (Square Feet) Schiller International University BA 512 6 Step-Variable Costs 90 Thousands of Dollars Direct Labor Cost in 60 30 00 100 200 300 Cost Driver Schiller International University BA 512 7 Semi-variable Cost Slope is variable cost per unit of activity. Total Telephone Cost Variable Telephone Charge Fixed Monthly Telephone Charge Activity (Minutes Phone Use) Schiller International University BA 512 8 The Break-Even Point The break-even point is the sales volume where the organization’s revenues and expenses are equal. It answers the question: How Many Widgets Do We Need to Sell to Break-Even? To answer the question, the first step is to break your company’s costs into fixed and variable costs. Schiller International University BA 512 9 Important Term: Unit Contribution Margin In order to calculate the break-even point, we introduce a new term, the unit contribution margin. Unit Selling Price USP - Unit Variable Costs OR - UVC Unit Contribution Margin UCM How many units must we sell to cover our fixed costs? Schiller International University BA 512 10 Deriving the Break-Even Equation from the Income Statement I Revenues – Variable Costs – Fixed Costs = Operating Income* OR (USP x Q) – (UVC x Q) – FC = OI OR (UCM x Q) – FC = OI Where USP = unit selling price FC = fixed cost UVC = unit variable cost OI = operating income UCM = unit contribution margin Q = quantity * You can also think of operating income as profit, as we shall explain shortly. Schiller International University BA 512 11 Deriving the Break-Even Equation II (UCM x Q) – FC = OI But at Break-Even, Operating Income is zero (0). Therefore, UCM x QBE = FC OR QBE = FC/UCM Where UCM = unit contribution margin OI = operating income FC = fixed cost QBE = quantity Schiller International University BA 512 12 Finding the Break-Even Point Graphically 378 336 294 252 $(000) 210 168 126 Fixed Costs 84 42 0 0 1000 2000 3000 4000 5000 Units Schiller International University BA 512 13 Operating Leverage Lower Profits Above Break-Even Higher Profits Above Break-Even Lower Losses Below Break-Even Higher Losses Below Break-Even Low Fixed Costs High Fixed Costs $ $ # of Units # of Units Low Operating Leverage High Operating Leverage Schiller International University BA 512 14 Assumptions Underlying CVP Analysis Selling price is constant throughout the entire relevant range. Costs are linear over the relevant range. In multi-product companies, the sales mix is constant. In manufacturing firms, inventories do not change (units produced = units sold). 16 Schiller International University BA 512 Some New Terminology (to learn) Committed Cost Discretionary Cost Long-term, cannot be May be altered in the reduced in the short short term by current term. managerial decisions. Engineered Cost Physical relationship Fixed Variable with activity measure. Variable Depreciation on Advertising; Buildings and Direct Research & equipment Materials Development Schiller International University BA 512 25 In the New Manufacturing Environment (JIT & FMS) A trend toward more fixed costs because of Increased automation (more machines). Smaller & stable workforce. Implications Managers are more “locked-in” with fewer decision alternatives. Planning becomes more crucial because fixed costs are committed, i.e. difficult to change with current operating decisions. Schiller International University BA 512 26 Cost Behavior in Types of Companies Merchandisers Service Organizations Cost of Goods Sold Supplies and travel Examples of variable costs Manufacturers Merchandisers and Manufacturers Direct Material, Direct Labor, and Variable Sales commissions and Manufacturing Overhead shipping costs Schiller International University BA 512 27 Cost Behavior in Types of Companies Examples of fixed costs Merchandisers, manufacturers, and service organizations Real estate taxes Insurance Sales salaries Depreciation Advertising Schiller International University BA 512 28 29 Account Classification Method Cost estimates are based on a review of each account making up the total cost. Schiller International University BA 512 30 Account Classification Method Example NOTE: These costs are semi-variable. Schiller International University BA 512 31 Visual-Fit Method A scatter diagram of past cost behavior may be helpful in analyzing semi-variable costs. Schiller International University BA 512 32 Visual-Fit Method Total variable cost = Total cost – Total fixed cost Plot the – points on a about Draw a line through the plotted data $10,000so thatgraph Total variable cost = $16,000 data points= $6,000 Unit variable of points fall above and below equal numbers cost = $6,000(total cost vs. = $2the line. ÷ 3,000 units activity). Estimated fixed portion of cost = $10,000 20 1,000’s of Dollars * ** * Total Cost in * * * * Vertical distance at 10 * * any point is total cost, fixed plus variable. 0 0 1 2 3 4 Activity, 1,000’s of Units Produced Schiller International University BA 512 33 We can also do the calculation shown on the previous slide mathematically: TC = F + VX Total Cost is the The number of units dependent variable. (X) is the independent variable. The y-intercept term (F) is The X term coefficient (V) the estimate of fixed costs. is the estimate of variable cost per unit of activity, the slope of the cost line. Schiller International University BA 512 34 Finding F and V 1,000’s of Dollars) * * TC (Total Cost in for our example: * 16 * * * * * * * 10 TC = F + VX 0 1 2 3 4 X (1,000’s of Units Produced) To find F, solve equation for x = 0: F = TC or in other words, F = $10,000. Now, solve for V at any point on the line, e.g. X = 3,000: $16,000 = $10,000 + V(3,000) V = ($16,000 – $10,000)/$3,000 = $2.00 per unit So our fixed costs are $10,000 and our unit variable costs are $2.00. Schiller International University BA 512 35 BUT-- This still requires us to pull points from a chart that we have drawn by hand. This is not very precise. There is a more precise way to do this, if we have access to a computer. It is called the: Least-Squares Regression Method Schiller International University BA 512 36 Review: Least Squares Regression Method When we have data points that we think are related, we can plot them on a graph. The vertical axis is known as y; the horizontal as x. We then want to know if we can draw a straight line through the points in such a way that the distance from the points to the line is minimized. This line is called a regression line and is defined as: Y = mx + b Where m is the slope of the line And b is the y-intercept: where the line crosses the y-axis. MS Excel makes it easy to calculate m (slope) and b (y- intercept) Schiller International University BA 512 38 Review: Least-Squares Regression Method Use Excel to solve following equation for us. TC = F + VX Total Cost is the The number of units dependent variable, y. (x) is the independent variable. The y-intercept term (F) is The X term coefficient (V) the estimate of fixed costs. is the estimate of variable cost per unit of activity, the slope of the cost line. Schiller International University BA 512 39 Schiller International University BA 512 40 41 One More Thing: Multiple Regression Multiple regression includes two or more independent variables: TC = F + V1X1 + V2X2 Terms in this equation have the same meaning as in simple regression with only one independent variable. Schiller International University BA 512 42 The High-Low Method Schiller International University BA 512 43 Example: Owl Company recorded the following production activity and maintenance costs for five months. Month Units Cost 1 6,000 $7,200 2 5,000 $6,100 3 8,000 $8,500 4 9,000 $9,700 5 8,000 $8,700 Compute: the variable cost per unit. the total fixed cost. Schiller International University BA 512 44 We could plot the results and use the Visual Fit method shown earlier. Month Units Cost 1 6,000 $7,200 2 5,000 $6,100 3 8,000 $8,500 4 9,000 $9,700 5 8,000 $8,700 Or we can use the High-Low method. First, we identify the high and low production months. Schiller International University BA 512 45 46 47 48 A High-Low Method Question for You If sales commissions are $10,000 when 80,000 units are sold (low month) and $14,000 when 120,000 units are sold (high month), what is the variable portion of sales commission per unit sold? a. $.08 per unit b. $.10 per unit c. $.12 per unit d. Schiller International University $.125 per unit BA 512 49 50 A High-Low Method Question for You If sales commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the fixed portion of the sales commission? a. $ 2,000 b. $ 4,000 c. $10,000 d. $12,000 Schiller International University BA 512 51 Another High-Low Method Question If sales commissions are $10,000 when 80,000 units are sold and $14,000 when 120,000 units are sold, what is the fixed portion of the sales commission? a. $ 2,000 b. $ 4,000 c. $10,000 d. $12,000 Schiller International University BA 512 52 Engineering Method of Cost Estimation Instead of asking for historical data to estimate costs (needed for the other four methods), this method asks not what costs were but what they should have been. These are called engineering cost studies. Schiller International University BA 512 53 54 Let’s Take a Break - - - Schiller International University BA 512 55 But it is not usually so easy. The available historic data is plagued with: Missing data. Outlier data points. Mismatched time periods costs. Trade-offs in choosing the time period. Committed and discretionary costs. Inflation. Schiller International University BA 512 56 Obviously, there is lots of room for judgment when estimating costs but that is the nature of – MANAGERIAL ACCOUNTING Schiller International University BA 512 57 Let’s try some problems: 6-24 6-33 Schiller International University BA 512 58 End of Today’s Lecture Thanks again for your case study presentations. Schiller International University BA 512 59

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