Demonstration Problem

Chapter 12 – Exercise 4

Estimating Costs Based on

Behavior Patterns

AccountingWhat the Numbers Mean 9e

Problem Definition

• The following table shows the amount of cost incurred in May for the cost items indicated. During May 16,000 units of the firm’s single product were manufactured.

Raw materials $83,200Factory depreciation expense 81,000Direct labor 198,400Production supervisor’s salary 12,200Computer rental expense 8,400Maintenance supplies used 1,600

Problem Requirements

a. How much cost would you expect to be incurred for each of the above items during June when 19,200 units of product are planned for production?

b. Calculate the average total cost per unit for the 16,000 units manufactured in May. Explain why this figure would not be useful to a manager interested in predicting the cost of producing 19,200 units in June.

Problem Solution

• Step 1 – Determine the cost behavior pattern for each cost item:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s salaryComputer rental expenseMaintenance supplies used

Cost Behavior

Problem Solution

• Step 1 – Determine the cost behavior pattern for each cost item:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s salaryComputer rental expenseMaintenance supplies used

Cost Behavior

Is the cost item a variable cost or a fixed cost?

Problem Solution

• Step 1 – Determine the cost behavior pattern for each cost item:

Raw materials VariableFactory depreciation expenseDirect laborProduction supervisor’s salaryComputer rental expenseMaintenance supplies used

Cost Behavior

Variable costs change

as activity changes.

Problem Solution

• Step 1 – Determine the cost behavior pattern for each cost item:

Raw materials VariableFactory depreciation expense FixedDirect laborProduction supervisor’s salaryComputer rental expenseMaintenance supplies used

Cost Behavior

Fixed costs remain

constant as activity changes.

Problem Solution

• Step 1 – Determine the cost behavior pattern for each cost item:

Raw materials VariableFactory depreciation expense FixedDirect labor VariableProduction supervisor’s salaryComputer rental expenseMaintenance supplies used

Cost Behavior

Problem Solution

• Step 1 – Determine the cost behavior pattern for each cost item:

Raw materials VariableFactory depreciation expense FixedDirect labor VariableProduction supervisor’s salary FixedComputer rental expenseMaintenance supplies used

Cost Behavior

Problem Solution

• Step 1 – Determine the cost behavior pattern for each cost item:

Raw materials VariableFactory depreciation expense FixedDirect labor VariableProduction supervisor’s salary FixedComputer rental expense FixedMaintenance supplies used

Cost Behavior

Problem Solution

• Step 1 – Determine the cost behavior pattern for each cost item:

Raw materials VariableFactory depreciation expense FixedDirect labor VariableProduction supervisor’s salary FixedComputer rental expense FixedMaintenance supplies used Variable

Cost Behavior

Problem Solution

• Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s

salary Computer rental expenseMaintenance supplies used Total Cost

Cost Behavior

Cost @ 16,000 units

$ 83,20081,000

198,40012,200

8,400 1,600

$384,800

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

Problem Solution

• Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s

salary Computer rental expenseMaintenance supplies used Total Cost

Cost Behavior

Cost @ 16,000 units

$ 83,20081,000

198,40012,200

8,400 1,600

$384,800

$ 5.20

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

Variable rate calculation:

$83,200 / 16,000 units = $ 5.20/unit

Problem Solution

• Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s

salary Computer rental expenseMaintenance supplies used Total Cost

Cost Behavior

$ 83,20081,000

198,40012,200

8,400 1,600

$384,800

$ 5.20

Fixed Amount

Variable Rate/Unit

81,000

VariableFixed

VariableFixedFixed

Variable

Fixed costs items will remain constant regardless of the level of activity (within the relevant range).

Cost @ 16,000 units

Problem Solution

• Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s

salary Computer rental expenseMaintenance supplies used Total Cost

Cost Behavior

$ 83,20081,000

198,40012,200

8,400 1,600

$384,800

$ 5.20

12.40

Fixed Amount

Variable Rate/Unit

40,500

VariableFixed

VariableFixedFixed

Variable

Variable rate calculation:

$198,400 / 16,000 units = $12.40/unit

Cost @ 16,000 units

Problem Solution

• Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s

salary Computer rental expenseMaintenance supplies used Total Cost

Cost Behavior

$ 83,20081,000

198,40012,200

8,400 1,600

$384,800

$ 5.20

12.40

Fixed Amount

Variable Rate/Unit

40,500

12,200

VariableFixed

VariableFixedFixed

Variable

Cost @ 16,000 units

Problem Solution

• Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s

salary Computer rental expenseMaintenance supplies used Total Cost

Cost Behavior

$ 83,20081,000

198,40012,200

8,400 1,600

$384,800

$ 5.20

12.40

Fixed Amount

Variable Rate/Unit

40,500

6,1008,400

VariableFixed

VariableFixedFixed

Variable

Cost @ 16,000 units

Problem Solution

• Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s

salary Computer rental expenseMaintenance supplies used Total Cost

Cost Behavior

$ 83,20081,000

198,40012,200

8,400 1,600

$384,800

$ 5.20

12.40

0.10

Fixed Amount

Variable Rate/Unit

40,500

6,1004,200

VariableFixed

VariableFixedFixed

Variable

Variable rate calculation:

$1,600 / 16,000 units = $ 0.10/unit

Cost @ 16,000 units

Problem Solution

• Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s

salary Computer rental expenseMaintenance supplies used Total Cost

Cost Behavior

$ 83,20081,000

198,40012,200

8,400 1,600

$384,800

$ 5.20

12.40

0.10$17.70

Fixed Amount

Variable Rate/Unit

81,000

12,2008,400

$ 101,600

VariableFixed

VariableFixedFixed

Variable

Cost @ 16,000 units

Problem Solution

• Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s

salary Computer rental expenseMaintenance supplies used Total Cost

Cost Behavior

$ 83,20081,000

198,40012,200

8,400 1,600

$384,800

$ 5.20

12.40

0.10$17.70

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

Cost formula = $101,600 fixed cost + $17.70 per unit variable cost

Cost @ 16,000 units

81,000

12,2008,400

$ 101,600

Problem Solution

• Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determined in Step 2:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s

salary Computer rental expenseMaintenance supplies used Total Cost

Cost Behavior

Cost @ 19,200 units

$ 5.20

12.40

0.10$17.70

Fixed Amount

Variable Rate/Unit

81,000

12,2008,400

$ 101,600

VariableFixed

VariableFixedFixed

Variable

Problem Solution

• Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determined in Step 2:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s

salary Computer rental expenseMaintenance supplies used Total Cost

Cost Behavior

$ 5.20

12.40

0.10$17.70

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

$ 99,840

Calculation:

19,200 units * $5.20 per unit

81,000

12,2008,400

$ 101,600

Cost @ 19,200 units

Problem Solution

• Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determined in Step 2:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s

salary Computer rental expenseMaintenance supplies used Total Cost

Cost Behavior

$ 5.20

12.40

0.10$17.70

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

$ 99,84081,000

Fixed costs do not change at 19,200 units.

81,000

12,2008,400

$ 101,600

Cost @ 19,200 units

Problem Solution

• Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determined in Step 2:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s

salary Computer rental expenseMaintenance supplies used Total Cost

Cost Behavior

$ 5.20

12.40

0.10$17.70

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

$ 99,84081,000

238,080

Calculation:

19,200 units * $12.40 per unit

81,000

12,2008,400

$ 101,600

Cost @ 19,200 units

Problem Solution

• Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determined in Step 2:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s

salary Computer rental expenseMaintenance supplies used Total Cost

Cost Behavior

$ 5.20

12.40

0.10$17.70

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

$ 99,84081,000

238,08012,200

81,000

12,2008,400

$ 101,600

Cost @ 19,200 units

Problem Solution

• Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determined in Step 2:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s

salary Computer rental expenseMaintenance supplies used Total Cost

Cost Behavior

$ 5.20

12.40

0.10$17.70

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

$ 99,84081,000

238,08012,200

8,400

81,000

12,2008,400

$ 101,600

Cost @ 19,200 units

Problem Solution

• Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determined in Step 2:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s

salary Computer rental expenseMaintenance supplies used Total Cost

Cost Behavior

$ 5.20

12.40

0.10$17.70

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

$ 99,84081,000

238,08012,200

8,4001,920

Calculation:

19,200 units * $0.10 per unit

81,000

12,2008,400

$ 101,600

Cost @ 19,200 units

Problem Solution

• Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determined in Step 2:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s

salary Computer rental expenseMaintenance supplies used Total Cost

Cost Behavior

$ 5.20

12.40

0.10$17.20

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

$ 99,84081,000

238,08012,200

8,4001,920

$441,440

81,000

12,2008,400

$ 101,600

Cost @ 19,200 units

Problem Requirements

a. How much cost would you expect to be incurred for each of the above items during June when 19,200 units of product are planned for production?

b. Calculate the average total cost per unit for the 16,000 units manufactured in May. Explain why this figure would not be useful to a manager interested in predicting the cost of producing 19,200 units in June.

Problem Solution

• Average total cost for May:

• It would not be meaningful to use this average total cost figure to predict costs in the subsequent months; that would involve unitizing the fixed expenses – and they do not behave on a per unit basis.

$384,800 / 16,000 = $24.05 per unit

Problem Solution

• Average total cost calculations are only valid for the number of units used in the calculation. Average total cost for any other number of units produced would be different because the fixed expenses per unit would decrease for each additional unit produced.

• Using the average total cost of $24.05 to estimate the cost of producing 19,200 units would give an estimate of $461,760, which is significantly higher than the $441,440 calculated in part a using the cost formula:

Total Cost = $101,600 fixed cost + $17.70 per unit variable cost

AccountingWhat the Numbers Mean 9e

David H. MarshallWayne W. McManus

Daniel F. Viele

You should now have a better understandingof using cost behavior information.

Remember that there is a demonstration problem for each chapter that is here for your learning benefit.