How does a managerial accountant determine the cost behavior pattern for a particular cost item?

The determination of cost behavior, which is often called cost estimation, can be accomplished in a number of ways.

One way is to analyze historical data concerning costs and activity levels.

The relationship between cost and activity, called cost behavior, is relevant to the management functions of planning, control, and decision making.

In order to plan operations and prepare a budget, managers need to predict the costs that will be incurred at different levels of activity.

Knowledge of cost behavior will help the manager to make the desired cost prediction.

A cost prediction is a forecast of cost at a particular level of activity. (LO1)

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Activity Analysis, Cost Behavior, and CostEstimationChapter 6Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.CostpredictionUsing knowledgeof cost behaviorto forecastlevel of cost ata particularactivity. Focusis on the future.IntroductionCostbehaviorRelationshipbetweencost andactivity.Process ofdeterminingcost behavior,often focuseson historicaldata.Costestimation6-2Total Variable Cost Example Your total Pay Per View bill is based on how many Pay Per View shows that you watch.Number of Pay Per View shows watchedTotal Pay Per View Bill6-3Variable Cost Per Unit ExampleThe cost per Pay Per View show is constant. For example, $4.95 per show.Number of Pay Per View shows watchedCost per Pay Per View show6-4Step-Variable CostsActivityCostTotal cost remainsconstant within anarrow range ofactivity.6-5Step-Variable CostsActivityCostTotal cost increases to a new higher cost for the next higher range of activity. 6-6Total Fixed Cost ExampleYour monthly basic cable TV bill probably does not change no matter how many hours you watch. Number of hours watchedMonthly Basic Cable Bill6-7Fixed Cost Per Unit ExampleThe average cost per hour decreases as more hours are spent watching cable television.Number of hours watched Monthly Basic cable Bill per hour watched6-8Rent Cost in Thousands of Dollars 0 1,000 2,000 3,000 Rented Area (Square Feet)306090Total cost doesn’t change for a wide range of activity, and then jumps to a new higher cost for the next higher range of activity.Step-Fixed Costs6-9Semivariable Cost A semivariable cost is partly fixed and partly variable.Consider thefollowing example:.6-10Fixed MonthlyRental ChargeVariable Lease Charge Per HourRental Charge Per Hour Total Lease CostTotal semivariable costSemivariable Cost The slope isthe variable cost per unitof activity.6-11Curvilinear CostCurvilinearCost FunctionRelevant RangeActivityTotal CostCurvilinearCost FunctionA straight-line(constant unit variable cost) closely approximates a curvilinear line withinthe relevant range.6-12Curvilinear CostCurvilinearCost FunctionRelevant RangeActivityTotal CostCurvilinearCost FunctionA straight-Line(constant unit variable cost) closely approximates a curvilinear line withinthe relevant range.6-13Engineered, Committed, and Discretionary CostsDiscretionaryMay be altered in the short term by current managerial decisions.CommittedLong-term, cannot be reduced in the short term.EngineeredPhysical relationship with activity measure.Depreciation on Buildings and equipmentAdvertising and Research and DevelopmentDirect Materials6-14Visual-Fit Method A scatter diagram of past cost behavior may be helpful in analyzing mixed costs.6-15Plot the data points on a graph (total cost vs. activity).0 1 2 3 4*Total Cost in1,000’s of Dollars10200*********Activity, 1,000’s of Units ProducedVisual-Fit Method6-16Draw a line through the plotted data points so that about equal numbers of points fall above and below the line. Visual-Fit Method0 1 2 3 4*Total Cost in1,000’s of Dollars10200*********Activity, 1,000’s of Units Produced6-17Visual-Fit MethodVertical distance is total cost, approximately $16,000.0 1 2 3 4*Total Cost in1,000’s of Dollars10200*********Activity, 1,000’s of Units ProducedEstimated fixed cost = $10,0006-18The High-Low MethodOwl Co recorded the following production activity & maintenance costs for two months: Using these two levels of activity, compute: the variable cost per unit. the total fixed cost.6-19The High-Low Method6-20 Unit variable cost =in costin unitsThe High-Low Method6-21 Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unitThe High-Low Method6-22 Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit Fixed cost = Total cost – Total variable costThe High-Low Method6-23 Unit variable cost = $3,600 ÷ 4,000 units = $0.90 per unit Fixed cost = Total cost – Total variable cost Fixed cost = $9,700 – ($0.90 per unit × 9,000 units)The High-Low Method6-24 Unit variable cost = $3,600 ÷ 4,000 units = $.90 per unit Fixed cost = Total cost – Total variable cost Fixed cost = $9,700 – ($.90 per unit × 9,000 units) Fixed cost = $9,700 – $8,100 = $1,600The High-Low Method6-25Least-Squares Regression Method Regression is a statistical procedure usedto determine the relationship between variables such as activity and cost.ActivityTotal CostThe objective ofthe regressionmethod is thegeneral cost equation:Y = a + bX6-26Y = a + bXTotal Cost is thedependent variable.The activity (X) is theindependent variable.The X term coefficient (b)is the estimate of variablecost per unit of activity,the slope of the cost line.The intercept term (a) isthe estimate of fixed costs. Equation Form of Least-Squares Regression Line6-27Least-Squares Regression MethodStatistics courses and computer courses deal with detailed regression computations using Microsoft Excel.Accountants and managers must be able to interpret and use regression estimates.6-28Terms in the equation have the samemeaning as in simple regression withonly one independent variable.Multiple Regression Multiple regression includes two or more independent variables: Y = a + b1X1 + b2X2 6-29Engineering Methodof Cost EstimationCost estimates are based on measurement and pricing of the work involved.6-30Effect of Learningon Cost BehaviorAs I make more of thesethings it takes me lesstime for each one. It mustbe the learning curve effectthat the boss wastalking about.I’ve noticed the same thing. And if you include all the variable overhead costs that are also declining, that must be the experience curve.6-31Learning CurveCumulative Production Output Average LaborTime per UnitLearning effectsare large initially.Learning effectsbecome smaller, eventually reaching steady state.6-32Data Collection ProblemsMissing data.Outlier data points.Mismatched time periods costs. Trade-offs in choosing the time period.Allocated and discretionary costs.Inflation.6-33

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