# Chapter 2 Managerial Accounting Answers

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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
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
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
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

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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
     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

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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