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Chapter 6
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Activity Analysis, Cost Behavior, and Cost Estimation
Terms in this set (28)
Cost Behavior
Refers to the relationship between cost and activity
Cost Estimation
The process of determining how a particular cost behaves, often relying on historical cost data
Cost Prediction
Using our knowledge of cost behavior to forecast the cost to be incurred at a particular level of activity
Cost Behavior Patterns
Cost Functions
Variable Cost
-Changes in total in direct proportion to a change in the activity level (or cost driver)
-Variable cost per unit remains the same as activity changes
Step-Variable Costs
-Costs that are nearly variable, but they increase in small steps instead of continuously
-Usually include inputs that are purchased and used in relatively small increments
-Remains constant within an activity range--when monthly activity increases beyond this narrow range
-Approximating a Step-Variable Cost: if the steps in a step-variable cost behavior pattern are small, the step-variable cost function may be approximated by a variable cost function without much loss in accuracy
Fixed Costs
-Remains unchanged in total as the activity level (or cost driver) varies
-Facilities costs are an example
-The fixed cost per unit does change as activity varies
-In any cost analysis it is preferable to work with total fixed cost rather than fixed cost per unit
Step-Fixed Costs
-Remain fixed over a wide range of activity but jump to a different amount for activity levels outside that range
Semivariable Cost (Mixed Cost)
-Has both fixed and variable component to it
-The distance between the fixed-cost line and the total-cost line in a graph is the amount of variable cost
-The slope of the total-cost line is the variable cost per unit of activity
Curvilinear Cost
-Behavior pattern has a curved graph
-Illustrates increasing/decreasing marginal costs
Relevant Range
-The range on activity within which management expects the company to operate
-A semivariable cost behavior pattern is often used to approximate a curvilinear cost--important to limit this approximation to the range of activity in which its accuracy is acceptable
Approximating a Curvilinear Cost Within the Relevant Range
-Semivariable cost behavior patterns can be used to estimate curvilinear costs within the relevant range
-Accuracy declines as the activity level gets further away from the boundary of the relevant range
-The straight line used to approximate cost within the relevant range represents a semivariable cost behavior pattern
-Slope of the line represents a unit variable-cost component
-The point at which the line intersects the graph represents a fixed-cost component
Engineered Cost
-Bears a definitive physical relationship to the activity measure
-Example: direct material cost
Committed Cost
-Results from an organization's ownership or use of facilities and its basic organization structure
-Example: property taxes, depreciation on buildings/equipments, rent costs, and management salaries are committed fixed costs
Discretionary Cost
-Arises as a result of a management decision to spend a particular amount of money for some purpose
-Examples: amounts spent on research and development, advertising and promotion, management development programs, and contributions to charitable organizations
Committed vs. Discretionary Costs
-Management can change committed costs only through relatively major decisions that have long-term implications such as building a new production facility, leasing a fleet of vehicles, or adding more management personnel to oversee a new division (generally influence costs incurred over a long period of time)
-Discretionary costs can be changed in the short run more easily
Cost Behaviors in Different Industries
Conclusions drawn about cost behavior in one industry are not necessarily transferrable to another industry
Account-Classification Method (Account Analysis)
-Involves careful examination of the organization's ledger accounts
-Each cost classified in the ledger as a variable, fixed, or semivariable cost
-Then, cost amounts are estimated by examining job-cost records, paid bills, labor times cards, and other source documents
-Examination of historical source documents is combined with other knowledge that may affect costs in the future
Visual-Fit Method
-When a cost has been classified as semivariable or when the analyst has no clear idea about the behavior of a cost item, it is helpful to use the visual-fit method to plot recent observations of the cost at various activity levels in a scatter diagram
-The scatter diagram helps visualize the relationship between cost and the level of activity (or cost driver)
-Used for cost of activities WITHIN RELEVANT RANGE
-Allows users to spot outliers in the data (if due to an error or very unusual circumstances, it should be ignored in the cost analysis)
-Drawback: lack of objectivity--two cost analysts may draw two different visually fit cost lines--not a serious problem if this method is combined with other, more serious methods
High-Low Method
-The semivariable-cost approximation is computed using exactly two data points
-The high and low activity levels are chosen from the available data set and are used together with their associated cost levels to compute the variable and fixed cost components as follows:
Variable cost per unit = (difference between the COSTS corresponding to the highest and lowest activity levels)/(difference between the highest and lowest ACTIVITY levels)
-Restricted to relevant range
-More objective than the visual-fit method since it leaves no room for the cost analyst's judgment
-Major weakness: only two data points are used to estimate the cost behavior pattern
Least-Squares Regression Method
-The cost line is positioned so as to minimize the sum of the squared deviations between the cost line and data points--the deviations are measured vertically on the graph rather than perpendicular to the line
-The cost line fit to the data using least-squares regression is called a least-squares regression line
-Restricted to relevant range
Equation Form of Least-Squares Regression Line (Simple Regression)
-Represented by the equation of a straight line
Y = a + bX
-"a" is the fixed cost component; "b" is the slope of the line; X is the units
-X is the independent variable, since it is the variable upon which the estimate is based
-Y is the dependent variable, sine its estimate depends on the independent variable
-Objective method that makes use of all data
-How does a cost analyst evaluate a particular regerssion line based on a specific set of data? Economic plausibility and goodness of fit
-Regression line should always be evaluated from the perspective of economic plausibility: Does the regression line make sense? Is it intuitively plausible to the cost analyst?
-Goodness of fit: determine objectively how well a regression line fits the data upon which it is based
Multiple Regression
-There may be two or more independent variables that are important predictors of cost behavior
-Statistical method that estimates a linear relationship between one dependent variable and two or more independent variables
Y = a + b1X1 + b2X2
where Y denotes the dependent variable, X1 denotes the first independent variable, and X2 denotes the second independent variable
-"a" denotes the regression estimate of the fixed-cost component
Data Collection Problems
1. Missing Data
2. Outliers
3. Mismatched time periods
4. Trade-offs in choosing the time period
5. Allocated and discretionary costs
6. Inflation
Engineering Method
-Study the process that results in cost incurrence
-Rather than looking at how much a material cost last period, you ask how much material should be needed and how much it should cost
-Time and motion studies: determine the steps required for people to perform the manual tasks that are part of the production process
-Very useful in rapidly evolving, high-technology industries
Learning Curve
-In many production processes production efficiency increases with experience.
-As cumulative output increases, the average labor time per unit declines, declining labor costs as well
Experience Curve
-Broadened version of the learning curve
-Includes costs other than direct labor
Learning/Experience Curves
-Have been applied primarily to complex, labor-intensive manufacturing operations
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