COST BEHAVIOR CHAPTER © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use CHAPTER OBJECTIVES Define and describe fixed, variable, and mixed costs Explain the use of resources and activities and their relationship to cost behavior Explain how several methods of cost estimation can be used Separate mixed costs into their fixed and variable components using the high-low method, the scatterplot method, and the method of least squares © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use CHAPTER OBJECTIVES Evaluate the reliability of the cost formula Explain how multiple regression can be used to assess cost behavior Define the learning curve, and discuss its impact on cost behavior Discuss the use of managerial judgment in determining cost behavior © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use BASICS OF COST BEHAVIOR Cost Behavior • The term used to describe whether a cost changes when the level of output changes • Fixed costs not change as output changes • Variable costs increase in total with an increase in output and decrease in total with a decrease in output LO-1 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use BASICS OF COST BEHAVIOR Cost Objects • An item for which managers want cost information • For manufacturing or merchandising firms, it is usually the tangible product • For service firms, it is usually the service provided LO-1 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use BASICS OF COST BEHAVIOR Measures of Output • Activity drivers explain changes in activity costs by measuring changes in activity output (usage) • The two general categories of activity drivers • Unit-level drivers • Non-unit-level drivers LO-1 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use BASICS OF COST BEHAVIOR Fixed FixedCosts Costs • Fixed costs are costs that in total are constant within the relevant range as the level of the activity driver varies LO-1 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use BASICS OF COST BEHAVIOR Fixed FixedCosts Costs JCM Audio Systems, Inc produces speakers for home audio systems One department produces voice coils There are two production lines that can each make up to 100,000 voice coils per year The production-line manager is paid $60,000 per year For production up to 100,000 units only one manager is needed; above that (to 200,000 units) two managers are needed LO-1 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use BASICS OF COST BEHAVIOR Fixed FixedCosts Costs JCM Audio Systems, Inc The total cost of supervision remains the same within the relevant range, but the unit cost decreases as production increases LO-1 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use BASICS OF COST BEHAVIOR Fixed FixedCosts Costs JCM Audio Systems, Inc The total cost of supervision remains the same within the relevant range, but the unit cost decreases as production increases LO-1 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use RELIABILITY OF COST FORMULAS • Confidence Intervals Yf ± tSe • This is the formula for calculating the desired level of confidence • Yf is the predicted cost for a given level of activity • t is the t distribution (get this from the table in your book • Se is the standard error shown in the regression output LO-5 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use EXHIBIT 3.14—TABLE OF SELECTED VALUES: T DISTRIBUTION LO-5 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use MULTIPLE REGRESSION • Whenever least squares is used to fit an equation involving two or more independent variables, the method is called multiple regression • In the case of two explanatory variables, the linear equation is expanded to include the additional variable Y = F + V1X1 + V2X2 where X1 = Number of moves X2 = Number of pounds moved LO-6 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use MULTIPLE REGRESSION • Adding another independent variable might increase the explanatory power of our model • Performing the regression is very similar to simple regression • Input the data – make sure the two independent variables are side by side • Follow the same directions, but select both independent variable columns for the “input X range” LO-6 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use MULTIPLE REGRESSION Month Materials Handling Cost Number of Moves Pounds Moved January $2,000 100 6,000 February 3,090 125 15,000 March 2,780 175 7,800 April 1,990 200 600 May 7,500 500 29,000 June 5,300 300 23,000 July 4,300 250 17,000 August 6,300 400 25,000 September 5,600 475 12,000 October 6,240 425 22,400 LO-6 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use EXHIBIT 3.15—MULTIPLE REGRESSION RESULTS FOR ANDERSON COMPANY’S MATERIALS HANDLING COST LO-6 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use MULTIPLE REGRESSION • Interpreting the results • Under “coefficients” in the bottom left of the output find the intercept and the slope • Write the equation • Y = $507.31 + $7.84X1 + $0.11X2 • Examine reliability of the new model • Adjusted R2 is 99% - a significant improvement • The p-values are all very good as well • the t statistic drops to degrees of freedom because another independent variable is used LO-6 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use THE LEARNING CURVE AND NONLINEAR COST BEHAVIOR • The learning curve shows how labor hours per unit decreases as units produced increases • The experience curve relates cost to increased efficiency – the more you perform a task the lower the cost is of doing it LO-7 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use THE LEARNING CURVE AND NONLINEAR COST BEHAVIOR Cumulative Average-Time Learning Curve •States that the cumulative average time per unit decreases by a constant percentage •The learning rate is expressed as a percent LO-7 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use THE LEARNING CURVE AND NONLINEAR COST BEHAVIOR Incremental Unit-Time Learning Curve •The incremental unit-time learning curve model decreases by a constant percentage each time the cumulative quantity of units produced doubles LO-7 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use EXHIBIT 3.16—SPREADSHEET FOR CUMULATIVE AVERAGE-TIME LEARNING MODEL LO-7 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use EXHIBIT 3.17—GRAPH OF CUMULATIVE TOTAL HOURS REQUIRED AND THE CUMULATIVE AVERAGE TIME PER UNIT LO-7 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use MANAGERIAL JUDGMENT • The most widely used method in practice • Managers may just use their experiences and observations to determine fixed and variable costs • Managers may identify mixed costs and use experience to determine what part is fixed – thus denoting the rest as variable LO-8 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use MANAGERIAL JUDGMENT • This is a simple method and can yield good results when the manager has a good understanding of the processes • However poor judgment yields poor results LO-8 © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use END OF CHAPTER © 2014 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use ... BASICS OF COST BEHAVIOR Mixed MixedCost Cost JCM Audio Systems, Inc Fixed Cost of Selling $30 0,000 30 0,000 30 0,000 30 0,000 30 0,000 Speakers Selling Cost Variable Cost Total Cost Sold Per Unit of. .. BASICS OF COST BEHAVIOR Mixed MixedCosts Costs • Mixed costs are costs that has both a fixed and a variable component Y = Fixed cost + Total variable cost Y = F + VX where Y = Total cost (Usually... ACTIVITIES, AND COST BEHAVIOR Step -Cost Step-CostBehavior Behavior • A step cost function displays a constant level of cost for a range of output and then jumps to a higher level of cost at some