COST MANAGEMENT Accounting & Control Hansen▪Mowen▪Guan Chapter Cost Behavior COPYRIGHT © 2009 South-Western Publishing, a division of Cengage Learning Cengage Learning and South-Western are trademarks used herein under license Study Objectives Define and describe fixed, variable, and mixed costs Explain the use of resources and activities and their relationship to cost behavior Separate mixed costs into their fixed and variable components using the high-low method, the scatterplot method, and the method of least squares 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 Cost Behavior: Fixed Costs Fixed costs are costs that in total are constant within the relevant range as the level of the activity driver varies Two production lines can process 10,000 computers per year each The workers on each line are supervised by a production-line manager who is paid $24,000 per year For production up to 10,000 units, only one supervisor is needed When production is between 10,001 and 20,000 units, two supervisors are required Cost Behavior: Fixed Costs Cost Behavior: Fixed Costs Cost Behavior: Fixed Costs Cost Behavior: Fixed Costs Cost Behavior: Variable Costs Variable costs are costs that in total vary in direct proportion to changes in an activity driver A CD-ROM disk drive is added to each computer at a cost of $30 per computer The total cost of disk drives for each level of production varies Cost Behavior: Variable Costs Cost Behavior: Variable Costs 10 Regression Programs • The best-fitting line is the line with the smallest sum of squared deviations • Regression analysis determines the linear function with the minimum sum of squared deviations • Utilize spreadsheet packages such as Microsoft Excel to perform the computation 27 Regression Analysis for the Method of Least Squares Spreadsheet Data for Anderson Company 28 Regression Analysis for the Method of Least Squares Regression Output for Anderson Company 29 Regression Analysis for the Method of Least Squares The regression analysis gives rise to the following equation for Anderson’s material handling cost: $854.50 + ($12.39 �number of moves) 30 Reliability of Cost Formulas Hypothesis test of parameters – The lower the P-value, the more likely that the true parameter is significantly different from – Traditional benchmarks of significance are 0.10, 0.05 or 0.01 31 Reliability of Cost Formulas Goodness of fit – R2 is the coefficient of determination – Measures the percentage of change in the dependent variable explained by changes in the independent variable – The closer to 1.0, the better; no benchmark 32 Reliability of Cost Formulas Confidence intervals – The standard error is used to determine the ± range of possible values around the predicted value: Standard �t-statistic Confidence Error Interval 33 Multiple Regression • Least-squares method is used to fit an equation involving two or more explanatory variables Y = F + V1X1 + V2X2 etc where X1 = first explanatory variable X2 = second explanatory variable 34 Multiple Regression Spreadsheet Data for Anderson Company X1 X2 35 Multiple Regression Analysis for the Method of Least Squares 36 Multiple Regression Based on the multiple regression analysis, the cost formula is written as: Y = $507 + $7.84X1 + $0.11X2 In November the company expects to make 350 moves with a weight of 17,000 pounds The predicted cost of material handling is: Y = $507 + $7.84(350) + $0.11(17,000) = $507 + $2,744 + $1,870 = $5,121 37 Cumulative Average Time Learning Curve with 80% Learning Rate Cumulative Number of Units (1) 16 32 Cumulative Average Time per Unit in Hours (2) Cumulative Individual Units Total Time: Time for nth Labor Hours Unit-Labor Hours (3) = (1) × (2) (4) 100 80 (80% × 100) 70.21 64 (80% × 80) 59.57 56.17 53.45 51.20 (80% × 64) 40.96 32.77 100 160 210.63 256 297.85 337.02 374.15 409.60 655.36 1,048.64 100 60 50.63 45.37 41.85 39.17 37.13 35.45 28.06 38 Graph of Cumulative Total Hours Required and the Cumulative Average Time per Unit 39 Managerial Judgment • Managerial judgment is critically important in determining cost behavior and is by far the most widely used method in practice • Advantage – simplicity • Disadvantage – poor judgment leads to errors 40 COST MANAGEMENT Accounting & Control Hansen▪Mowen▪Guan End Chapter 41 ... supervisors are required Cost Behavior: Fixed Costs Cost Behavior: Fixed Costs Cost Behavior: Fixed Costs Cost Behavior: Fixed Costs Cost Behavior: Variable Costs Variable costs are costs that in total... a cost of $30 per computer The total cost of disk drives for each level of production varies Cost Behavior: Variable Costs Cost Behavior: Variable Costs 10 Cost Behavior: Variable Costs 11 Cost. .. 12 Cost Behavior: Mixed Costs Y = Fixed cost + Total variable cost Y = F + VX where Y = Total cost For Days Computer, the selling cost is: Y = $300,000 + $50X 13 Cost Behavior: Mixed Costs 14 Cost