Cost Accounting Horngreen, Datar, Foster Determining How Costs Behave Session 10.
10 - 1 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster...
-
date post
21-Dec-2015 -
Category
Documents
-
view
222 -
download
0
Transcript of 10 - 1 ©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster...
10 - 1©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Determining HowCosts Behave
Determining HowCosts Behave
Chapter 102/07/05
10 - 2©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 1Learning Objective 1
Explain the two assumptions
frequently used in
cost-behavior estimation.
Costs are driven by activities called cost drivers and are linear within the relevant range
10 - 3©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Assumptions in Cost-BehaviorEstimation
Assumptions in Cost-BehaviorEstimation
Changes in total costs can be explained bychanges in the level of a single activity,
i.e., a cost driver.Cost behavior can adequately be
approximated by a linear function of theactivity level within the relevant range.For example, fixed costs are fixed and
variable costs are constant per unit of activity.
10 - 4©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 2Learning Objective 2
Describe linear cost functions
and three common ways in
which they behave.(Variable, Fixed and Mixed)
10 - 5©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost FunctionCost Function
What is a cost function?
It is a mathematical expressiondescribing how costs change
with changes in the levelof an activity.
10 - 6©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost FunctionCost Function
La Playa Hotel offers an airlinethree alternative cost structures toaccommodate its crew overnight:
1. $60 per night per room usage
y = $60x
The slope of the cost function is $60,because all costs are variable in this case.
10 - 7©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost FunctionCost Function
$0
$5,000
$10,000
$15,000
$20,000
0 100 200 300
x = Number of rooms
y =
Cos
t
10 - 8©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost FunctionCost Function
2. $8,000 per month
y = $8,000
$8,000 is called a constant or intercept.
The slope of the cost function is zero,because fixed costs don’t change
with the level of activity.
10 - 9©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost FunctionCost Function
$0
$5,000
$10,000
$15,000
$20,000
0 100 200 300
x = Number of rooms
y =
Cos
t
10 - 10©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost FunctionCost Function
3. $3,000 per month plus $24 per room
This is an example of a mixed cost. Partof the total cost is fixed, and part of the cost varies with the level of activity (x).
y = $3,000 + $24xy = a + bx
10 - 11©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost FunctionCost Function
$0
$5,000
$10,000
$15,000
$20,000
0 100 200 300
x = Number of rooms
y =
Cos
t
10 - 12©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Classification (fixed or variable) determined by:
Cost Classification (fixed or variable) determined by:
Choice of cost object(Fleet of Vans vs. one Van)
Time span (the longer the timethe more likely the cost will vary)
Relevant range of activity(Within which cost behavior
patterns hold true)
10 - 13©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Choice of Cost Object ExampleChoice of Cost Object Example
If the number of taxis owned by a taxi companyis the cost object, annual taxi registration and
license fees would be variable costs.
If miles driven during a year on a particular taxiis the cost object, registration and license fees
for that taxi are fixed costs.
10 - 14©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Time SpanTime Span
Whether a cost is variable or fixed with respectto a particular activity depends on the time span.
More costs are variable with longer time spans.
10 - 15©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Relevant RangeRelevant Range
Variable and fixed cost behavior patterns arevalid for linear cost functions only within
the given relevant range.
Costs may behave nonlinear outside the range.
10 - 16©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost EstimationCost Estimation
What is cost estimation?
It is the attempt to measure a pastcost relationship between costs
and the level of an activity.
Past cost-behavior functions can helpmanagers make more accurate
cost predictions.
10 - 17©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
The Cause-and-Effect CriterionIn Choosing Cost Drivers
The Cause-and-Effect CriterionIn Choosing Cost Drivers
Physical relationship(between the cost and the driver)
Contractual agreements(x amount of cost per unit of activity)
Implicitly established by logic(the more the units, the more the cost)
10 - 18©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 3Learning Objective 3
Understand various approaches
to cost estimation.
10 - 19©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Cost Estimation ApproachesCost Estimation Approaches
Industrial engineering method
Conference method
Account analysis method
Quantitative analysis methods
10 - 20©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Account Analysis ExampleAccount Analysis Example
The cost analyst uses experience andjudgment to separate total costs into
fixed and variable.
Avisha & Co. sells software programs.
Total sales = $390,000
The company sold 1,000 programs.
10 - 21©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Account Analysis ExampleAccount Analysis Example
Cost of goods sold = $130,000
Manager’s salary = $60,000
Secretary’s salary = $29,000
Commissions = 12% of sales
What is the total fixed cost?
$60,000 + $29,000 = $89,000
What is the fixed cost per unit sold?
10 - 22©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Account Analysis ExampleAccount Analysis Example
$89,000 ÷ 1,000 = $89.00
What is the variable cost per unit sold?
Cost of goods sold: $130,000
Commissions: $390,000 × .12 = $46,800
($130,000 + $46,800) ÷ 1,000 = $176.80
10 - 23©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 4Learning Objective 4
Outline steps in estimatinga cost function on the basisof past cost relationships.
10 - 24©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Steps In EstimatingA Cost Function
Steps In EstimatingA Cost Function
Step 1:Choose the dependent variable
(the cost to be estimated).Step 2:
Identify the independent variable (cost driver).
Step 3:Collect data on the dependent variable
and the cost driver(s).
10 - 25©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Steps In Estimating A Cost Function
Steps In Estimating A Cost Function
Step 5:Estimate the cost function,
(using High-Low or Regression analysis).
Step 6:Evaluate the estimated cost function.
Step 4:Plot the data on a graph.
10 - 26©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
High-Low Method ExampleHigh-Low Method Example
High capacity December: 55,000 machine-hours
Cost of electricity: $80,450
Low capacity September: 30,000 machine-hours
Cost of electricity: $64,200
What is the variable rate? Solving for b in general formula Y = a + b (X), Where Y is total cost,
a is fixed cost, and b is variable cost per activity (X)
10 - 27©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
High-Low Method ExampleHigh-Low Method Example
($80,450 – $64,200) ÷ (55,000 – 30,000)
$16,250 ÷ 25,000 = $0.65Variable cost per unit of activity (b)
What is the fixed cost (a)?
10 - 28©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
High-Low Method ExampleHigh-Low Method ExampleUsing the high level of activity,
$80,450 = Fixed cost + (55,000 × $0.65)Fixed cost = $80,450 – $35,750 = $44,700
Or, using the low level of activity,$64,200 = Fixed cost + (30,000 × $0.65)
Fixed cost = $64,200 – $19,500 = $44,700
General Formula: y = a + bx
y = $44,700 + $0.65 × (X) Machine-hours
10 - 29©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Regression AnalysisRegression Analysis
It is used to measure the average amount ofchange in a dependent variable, such as
Electricity cost, that is associated with unitincreases in the amounts of one or
more independent variables,such as machine-hours.
Regression analysis uses all availabledata to estimate the cost function.
10 - 30©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Regression AnalysisRegression Analysis
Simple regression analysis estimates therelationship between the dependent
variable and one independent variable.
Regression analysis also provides R2,which is an indication of the ‘goodness
of fit’ of the general formula for estimatingpurposes.
10 - 31©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Regression AnalysisRegression Analysis
The regression equation and regression lineare derived using the least-squares technique.
See appendix : Regression Analysis
The objective of least-squares is to developestimates of the parameters a and b.
10 - 32©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Regression AnalysisRegression Analysis
The regression method is more accurate thanthe high-low method, because it uses
information from all observations.A possible downside would be “outliers”
which are non-representative observations.
10 - 33©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 5Learning Objective 5
Describe criteria used toevaluate and choose cost drivers.
10 - 34©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Goodness of FitGoodness of Fit
The coefficient of determination (r2)expresses the extent to which the changes
in (x) explain the variation in (y).
An (r2) of 0.80 indicates that more than80% of the change in the dependent
variable can be explained by thechange in the independent variable.
10 - 35©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Slope of Regression LineSlope of Regression Line
A relatively steep slope indicates a strongrelationship between the cost driver and costs.
(Good for accurately estimating costs)
A relatively flat regression line indicates a weakrelationship between the cost driver and costs.
10 - 36©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Slope of Regression LineSlope of Regression Line
The closer the value of the correlationcoefficient (r) to ±1, the stronger the
statistical relation between the variables.
As (r) approaches +1, a positive relationshipis implied, meaning the dependent variable (y)
increases as the independent variable (x) increases.
10 - 37©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 6Learning Objective 6
Explain and give examples
of nonlinear cost functions.(These would negate the linear
assumption we make for Cost Behavior
within the Relevant range)
10 - 38©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Nonlinearity and Cost FunctionsNonlinearity and Cost Functions
A nonlinear cost function is a cost function inwhich the graph of total costs versus the levelof a single activity is not a straight line within
the relevant range.
Economies of scale
Quantity discounts
Step cost functions
10 - 39©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Nonlinearity and Cost FunctionsNonlinearity and Cost Functions
Economies of scale in advertising may enablean advertising agency to double the number
of advertisements for less than double the cost.
Quantity discounts on direct materialspurchases produce a lower cost perunit purchased with larger orders.
10 - 40©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Nonlinearity and Cost FunctionsNonlinearity and Cost Functions
A step function is a cost function in which thecost is constant over various ranges of the level
of activity, but the cost increases by discreteamounts as the level of activity changes
from one range to the next.
10 - 41©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning CurvesLearning Curves
A learning curve is a function that showshow labor-hours per unit decline as units
of output increase.
10 - 42©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Experience CurveExperience Curve
This is a function that shows how the costsper unit in various value chain areas decline
as units produced and sold increase.
10 - 43©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Learning Objective 8Learning Objective 8
Be aware of data problemsencountered in estimating
cost functions.
10 - 44©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Data Collection andAdjustment Issues
Data Collection andAdjustment Issues
Time periods do not match between recording dependent variable cost and cost driver activity.
Fixed costs are allocated as if they were variable.i.e., rent cost allocated to products
Data are either not available or not reliable.
Inflation may change relationship between cost and driver.
10 - 45©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Data Collection andAdjustment Issues
Data Collection andAdjustment Issues
Extreme values of observations occur frommechanical errors in recording costs.
Analysts should adjust or eliminate unusualobservations before estimating a cost relationship.
There is no homogeneous relationship.
The relationship between the cost driverand the cost is not stationary.
10 - 46©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster
Data Collection andAdjustment Issues
Data Collection andAdjustment Issues
The most difficult task in cost estimationis collecting high-quality, reliablymeasured data on the dependentvariable and the cost driver(s).