The most common cost behaviors Variable costs Fixed costs Mixed costs Absorption costing the costing method where products absorb both fixed and variable manufacturing costs Required by GAAP for external reporting Product Costs DM DL V Moh FMOHPeriod Costs VSA FSA The only difference between absorption and variable costing is that fixed manufacturing overhead is a product cost under absorption costing but a period cost under variable costing Account Analysis a method for determining cost behavior that is based on a manager s judgment in classifying each general ledger account as a variable fixed or mixed cost The analysis is not based entirely on facts the estimates are subjective Committed Fixed Costs Fixed costs that are locked in because of previous management decisions management has little or no control over these costs in the short run Ex a long term lease these costs cannot be changed in the short term Contribution Margin Sales revenue minus variable expenses Contribution Margin Income Statement Income statement that organizes costs by behavior variable or fixed costs rather than by function Cost Behavior Describes how costs change as volume changes Cost Equation A mathematical equation for a straight line that expresses how a cost behaves Total variable cost y Variable cost per If volume is zero total variable costs are zero Cost graphs always begin at the origin which is zero Curvilinear Costs A cost behavior that is x Volume of activity x or y vx unit of activity v not linear Discretionary Fixed Costs Fixed costs that are a result of annual management decisions fixed costs that are controllable in the short run Fixed Costs Costs that do not change in total despite wide changes in volume Fixed cost per unit of activity decreases when volume increases Fixed cost per unit of activity increases when volume decreases Fixed cost per garment Total fixed costs of garments High Low Method A method for determining cost behavior that is based on two historical data points the highest and lowest volume of activity Easy to use it uses only two data points Highest and lowest 1 Find the slope Variable cost per unit in cost y in volume x 2 f Fixed costs y Total mixed cost vx total variable cost rearranged y vx f Mixed Cost Costs that change but not in direct proportion to changes in volume Mixed costs have both variable cost and fixed cost components Total mixed costs increase as volume increases because of the variable cost component Regression Analysis A statistical procedure for determining the line that best fits the data by using all of the historical data points not just the high and low data points R square Goodness of fit Intercept Fixed cost X Variable 1 variable cost per activity Utilities monthly cost equation y 7 85x 14 538 The R square value ranges from 0 to 1 with 0 being no relationship between cost and volume meaning the activity is not a cost driver and 1 describing a perfect relationship where the activity is a cost driver Over 0 80 very reliable between 0 50 and 0 80 use with caution less than 0 50 Weak Relevant Range The band of volume where total fixed costs remain constant at a certain level and where the variable cost per unit remains constant at a certain level Scatter Plot A graph that plots historical cost y axis and volume data x axis Helps managers visually determine how strong the relationship is between the cost and the volume of the chosen activity base Step Costs A cost behavior that is fixed over a small range of activity and then jumps to a different fixed level with moderate changes in volume Outliers Abnormal data points data points that do not fall in the same general pattern as the other data points Variable Costs Costs incurred for every unit of activity As a result total variable costs change n direct proportion to changes in volume although Variable cost per unit remains constant and it s the slope of cost graph Variable Costing The costing method that assigns only variable manufacturing costs to products All fixed manufacturing costs Fixed MOH are expensed as period costs Breakeven point The sales level at which operating income is zero Sales below the breakeven point result in a loss Sales above the breakeven point provide a profit fixed expenses total contribution margin total revenues Total Expenses Contribution Margin Per Unit The excess of the unit sales price over the variable cost per unit also called unit contribution margin Contribution Margin Ration Ration of contribution margin to sales revenue Cost Volume Profit CVP Analysis Expresses the relationships among costs volume and profit or loss Indifference Point The volume of sales which a company would be indifferent between cost structures because they would result in the same total cost Margin of Safety Excess of expected sales over breakeven sales the drop in sales a company can absorb without incurring an operating loss Operating Leverage The relative amount of fixed and variable costs that make up a firm s total costs Operating Leverage Factor At a given level of sales the contribution margin divided by operating income the operating leverage factor indicates the percentage change in operating income that will occur from a 1 change in sales volume Sales Mix The combination of products that make up total sales Sensitivity Analysis A what if technique that asks what results will be if actual prices or costs change or if an underlying assumption changes Avoidable Fixed Costs Fixed costs that can be eliminated as a result of taking a particular course of action Constraint A factor that restricts production or sale of a product Contract Manufacturers Manufacturers who make products for other companies Cost Plus Pricing An approach to pricing used by price setters cost plus pricing begins with the product s total costs and adds the company s desired profit to determine a cost plus price Offshoring Having work performed overseas Offshored work can either be performed by the company itself or by outsourcing the work to another company Opportunity Cost The benefit foregone by choosing a particular alternative course of action Outsourcing A make or buy decision Managers decide whether to buy a product or service or produce it in house Product Line Income Statement An income statement that shows the operating income of each product line as well as the company as a whole Relevant Information Expected future data differs among alternatives Segment Margin The income resulting from