BMGT221 G Pfeiffer Chapter 6 1 A Cost Behavior How do Changes in Volume Affect Cost o Cost Behavior how costs change as volume changes o 3 most common cost behaviors a Variable Costs b Fixed Costs c Mixed Costs Variable Costs o Costs that change in total in direct proportion to changes in volume o Total Variable Cost Graph a Always begins at the origin Origin represents zero volume and zero cost b Slope is the variable cost per unit of activity c The Higher the Variable Cost per Unit of Activity v the steeper the slope of the line v remains constant in each graph o Cost Equations can be used to express how a cost behaves o Total Variable Cost y Variable Cost per Unit of Activity v x Volume of Activity x a y vx Fixed Costs o Costs that do not change in total despite wide ranges in volume a Fixed Costs per unit of activity vary inversely with changes in volume o Committed Fixed Costs costs that are locked in because of previous o Discretionary Fixed Costs costs that are a result of annual management management decisions decisions a Companies have more control over discretionary fixed costs because they can be adjusted in the short run o Total Fixed Cost Graph a Always flat lines b No slope that intersects the y axis at a level equal to total fixed costs o Total Fixed Cost y Fixed Amount Over a Period of Time f Mixed Costs o Costs that change in total but NOT in direct proportion to changes in volume o Total Fixed Cost y Total Variable Cost vx Total Fixed Costs f a y vx f o Total Fixed Cost Graph costs Relevant Range unit remain constant Increase as volume increases a b Slope upward c Line doesn t begin at the origin intersect the y axis at the level of fixed o Relevant Range band of volume where total fixed costs and variable cost per BMGT221 G Pfeiffer Chapter 6 2 o Change in cost behavior means change to a different relevant range Other Cost Behaviors o Step Costs costs that are fixed over a small range of activity and then jump up to a new fixed level with moderate changes in volume o Curvilinear Costs cost behaviors that are not linear a Estimate as a mixed cost if necessary B How do Managers Determine Cost Behavior Account Analysis o Account Analysis managers use their judgment to classify each general ledger account as variable fixed or mixed costs o Subjective o 3 Common Method to Analyze Cost Behavior a Scatter Plots b High Low Method c Regression Analysis Scatter Plots o Graphs the historical cost data on the y axis and volume data on the x axis o Helps managers visualize the relationship between the cost and the volume of activity a b High Low Method If there is a strong relationship the points will resemble a straight line If there is no relationship data points will appear random o Fits a mixed cost line through the highest and lowest volume data points a Produces the cost equation describing the mixed cost line o Step 1 Find the Variable cost per unit a Slope of the mixed cost line o Step 2 Find the Fixed Costs a Vertical Intercept o Step 3 Create the Cost Equation o Drawback Uses only 2 data points highest and lowest Regression Analysis o Regression Analysis statistical procedure for determining the line and cost equation that best fits the data a R Square a statistic generated by Regression Analysis that tells us how well the line fits the data points Ranges from 0 to 1 0 no relationship 1 perfect relationship Goodness of Fit o Uses ALL OF THE DATA POINTS o 3 Components Needed a R Square value b Intercept c X Variable 1 a Usually more accurate than the High Low Method BMGT221 G Pfeiffer Chapter 6 3 Predicting Costs volumes o Use results of High Low and Regression Analysis to plan for costs at different a Managers should only make predictions for volume that fall in the same relevant range b Both methods provide estimates Data Concerns o Only valid within relevant range o Seasonal Variations o Inflation o Outliers C What is a Contribution Margin Income Statement Traditional Income Statements are Organized by Cost Function AAA FITNESS EQUIPMENT Income Statement Month Ended July 31 Sales Revenue 52 500 Less Cost of Goods Sold 27 300 Gross Profit 25 200 Less Operating Expenses 14 600 Operating Income 10 600 o Provide little information on cost behavior o Don t distinguish Fixed Costs from Variable Costs Contribution Margin Income Statements are Organized by Cost Behavior AAA FITNESS EQUIPMENT Contribution Margin Income Statement Month Ended July 31 Sales Revenue 52 500 Less Variable Expenses 30 900 Contribution Margin 21 600 Less Fixed Expenses 11 000 Operating Income 10 600 o Can only be used internally o Statement can be used to predict how changes in volume will affect Operating Income D Appendix How Does Variable Costing Differ from Absorption Costing BMGT221 G Pfeiffer Chapter 6 4 o Variable Costing assigns only variable manufacturing costs direct materials o Absorption Costing products absorb fixed manufacturing costs as well as direct labor and variable MOH to products a Only used internally b Fixed MOH period costs variable manufacturing costs a Required by GAAP for external reporting b Traditional Income Statement Absorption Costing and Manager Incentives o When inventories increase absorption costing income is higher than variable o When inventories decrease absorption costing income is lower than variable costing income costing income o Therefore Managers may increase production to build up inventory to maximize income and therefore their own bonus
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