Chapter 7 Cost Drivers and Cost Behavior IDIS 364 – Spring 2007.
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Transcript of Chapter 7 Cost Drivers and Cost Behavior IDIS 364 – Spring 2007.
Chapter 7Cost Drivers and Cost
Behavior
IDIS 364 – Spring 2007
Nature of Fixed & Variable Costs
Variable costs - change in total as the level of activity changes Also known as an engineered cost There is a definitive physical
relationship to the activity measure Fixed costs - do not change in total
with changes in activity levels
Nature of Fixed & Variable Costs
Accounting concepts of variable and fixed costs are short run concepts Apply to a particular period of time Relate to a particular level of production
Relevant range is the range of activity over which the firm expects cost behavior to be consistent Outside the relevant range, estimates of
fixed and variable costs may not be valid
Types of Fixed Costs Capacity costs- fixed costs that provide
a firm with the capacity to produce and/or sell its goods and services Also know as committed costs and typically
relate to a firm’s ownership of facilities and its basic organizational structure
Capacity costs may cease if operations shut down, but continue in fixed amounts at any level of operations
Examples: property taxes, executive salaries
Types of Fixed Costs Discretionary costs - need not be
incurred in the short run to operate the business, however, usually they are essential for achieving long-run goals Also referred to as programmed or
managed costs Examples: research and development
costs, advertising
Other Cost Behavior Patterns
Curvilinear variable costs - costs may vary with the volume of activity, but not in constant proportion For example, as volume increases, the
cost of materials may decrease per unit (perhaps due to quantity discounts), exhibiting decreasing marginal costs
Marginal cost - the cost of producing the next unit
Other Cost Behavior Patterns
Learning curves - shows how the time required to perform a task goes down, per unit, as the number of units increases Some companies experience learning
effects on costs Compete by learning quickly so they
become low-cost leaders and capture market share
Semivariable Costs Refers to costs that have both
variable and fixed components Examples: repair and maintenance
costs, utility costs
Semifixed Costs Refers to costs that increase in steps
Example: A quality-control inspector can examine 1,000 units per day. Inspection costs are semifixed with a step up for every 1,000 units per day
Distinction between fixed and semifixed is subtle
Change in fixed costs usually involves a change in long-term assets: a change in semifixed costs often does not
Cost Estimation Methods Cost estimates are used in various
business decisions, planning exercises, and performance evaluations
Three methods discussed Statistical regression analysis Account analysis Engineering estimation
Estimating Costs Using Historical Data
Trying to estimate fixed and variable costs using the following formula
TC=F + VX
Where: TC = Total CostsF = Fixed CostsV = Variable CostsX = Activity Variable
Estimating Costs Using Historical Data
The following steps should be taken in analyzing cost data: Review alternative cost drivers Plot the data Examine the data and method of
accumulation
Statistical Regression Analysis
Used to estimate the relationship between costs and the activity that caused, or is closely associated with, those costs Costs are the dependent variable(s) Activity level is the independent variable
Fits the data points to a line using least-squares criterion
Statistical Regression Analysis
Results of this analysis yield an estimate of both the fixed component and the cost driver rates (variable component)
Account Analysis Analysts review each cost account and
classifies it according to its relation to a cost driver The sum of costs for each activity are
divided by the sum of the cost driver volumes to determine the cost driver rates
These cost driver rates correspond to the coefficients calculated using regression analysis
Engineering Method of Estimating Costs
The engineering method indicates what costs should be Analysts study the physical relation
between the quantity of inputs and outputs Determine the steps required to perform the
task, the time needed to complete each step, the number and type of employees required, and the materials and other inputs needed
The accountant assigns costs to each of the inputs to estimate the cost of the outputs
Data Problems Missing Data Outliers Allocated and discretionary costs Inflation Mismatched time periods Trade-offs in choosing the time
period
Interpreting Regression Analysis Output
Standard errors of the coefficients indicate the degree of confidence we can have in the fixed and variable cost coefficients The smaller the standard error, the more precise
the estimate The t-statistic is the ratio between an
estimated coefficient and its standard error If about 2 or larger, we can be relatively
confident that the actual coefficient differs from 0
Interpreting Regression Analysis Output
If a variable cost coefficient has a small t-statistic, it may indicate that little relation exists between the activity and changes in costs
If a fixed cost coefficient has a small t-statistic, it may indicate that these costs have little, if any, fixed cost component
R2
R2 measures how well the line fits the data An R2 of 1 means that the regression
explains all of the variance An R2 of 0 means that the regression
explains none of the variance Many believe that a low R2 indicates
a weak relationship between total costs and the activity base
Cautions When Using Regression
Users of regression analysis should be cautious in drawing inferences from regression results unless they are familiar with statistical estimation problems such as: Multicollinearity Autocorrelation, and Heteroscedasticity
End of Chapter 7