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and

Cost Estimation

1

**Types of Cost Behavior Patterns
**

Summary of VC and FC Behavior

Cost

In Total

Per Unit

VC

Total VC is

proportional to the activity

level within the RR.

RR

**VC per unit remains
**

the same over wide ranges

of activity.

activity

**Total FC remains the
**

same even when the activity

level changes within the

RR.

**FC per unit goes
**

down as activity level goes up.

FC

2

Minutes Talked 4 .The Activity Base Units p produced Machine hours A measure off what h t causes the i incurrence off a VC Miles driven Labor hours 3 True VC Example Total Phone e Bill $$ $ A VC is a cost whose total dollar amount varies in direct proportion to changes in the activity level. Supposed you had a phone bill that is based on the number of minutes talked.

Volume 5 VC Per Unit Example P Min Per nute Phon ne Cha arge $$ $ A VC remains constant if expressed on a per unit basis. constant For example. The cost per minute talked is constant. minute Minutes Talked 6 .True Variable Costs Total DM Co ost $$ Direct materials is a true or proportionately VC because the total cost of direct material used during a period will vary in direct proportion to the level of production activity. example 10 cents per minute.

A service company will normally have a high proportion of VCs. 3. A public utility with large investments in equipment will tend to have fewer VCs. Merchandising and manufacturing companies – commissions. clerical 8 . and clerical costs. A manufacturing company will often have many VCs. labor and variable overhead overhead. like cost of sales. Service companies – supplies. A merchandising company usually will have a high proportion of VCs. For example . 4. . 7 Examples of Variable Costs 1. Merchandising companies – cost of goods sold. travel. and clerical. such as invoicing. shipping costs. . direct labor. 2.Extent of Variable Costs The proportion of VCs differs across organizations. Manufacturing companies – direct materials.

Suppose your monthly phone bill is fixed and does not change.Total C T Cost $$ Step-Variable Costs Volume 9 Total Fixed Costs Example Tota al Phon ne Bill $ $$ A FC is a cost whose total dollar amount remains constant as the activity level changes. no matter how many calls you make. Number of Calls 10 .

FC Per Unit Example Phone Ch harge p per Call $$ Average FCs per unit decrease as the activity level increases. cannot be g y reduced significantly in the short term. The FC per local call decreases as more local calls are made made. May be altered in the y current short-term by managerial decisions Examples Examples Depreciation on Equipment and R lE Real Estate t t T Taxes Advertising and Research and D Development l t 12 . Number of Local Calls 11 Types of Fixed Costs Committed Discretionary y Long-term.

h i CM covers FCs and provides for Net Income.Tottal Cos st $$ The Linearity Assumption g and the Relevant Range Relevant Range R Activity 13 Prepare an Income Statement Using the CM Format Revenue Less: VC CM Total $ 100.000 $ 40.000 60 000 60.000 $ 10.000 Unit $ 50 30 $ 20 The CM fformatt emphasizes Th h i costt b behavior. 14 .000 Less: FC Net Income 30.

Uses off this thi approach h iinclude: l d 1. 16 . Segmented reporting of profit data 4 Special decisions ssuch 4.Uses of the Contribution (CM) Format Th CM iincome statement The t t t fformatt iis used d as an internal planning and decision making tool. ch as pricing and make make--ororbuy analysis 15 Contribution (CM) Format Used primarily for external reporting reporting. Used primarily by management management. Budgeting 3. CVP analysis y 2.

kwh. and your monthly activity level is 2.03 per kwh.Mixed Costs The total mixed cost line can be expressed as an equation: Y = a + bX Where: Y = the total mixed cost a = the total FC (the Y intercept) Y Tota al Utilitty Cost b = the VC p per unit of activity y (the slope of the line) X = the level of activity Variable C t per KW Cost X Activity (Kilowatt Hours) Fixed Monthly Utility Charge 17 Mixed Costs Example If your fixed monthly utility charge is $40. kwh. what is the amount of your utility bill? Y = a + bX Y = $40 + ($0.03 × 2.000) Y = $100 18 .000 kwh. your VC is $0.

000’s s Patient days = 800 19 Scattergraph Method Make a quick estimate of VC per unit and determine the cost equation. Total maintenance at 800 patients Less: Fixed cost Estimated total variable cost for 800 patients VC per unit = $1.000 800 $ 11 11.Scattergraph Method Mainte enance Cost 1.25/patient $1 25/patient25/patient-day Y = $10 $10.000 = $1.000 000 + $1 $1.000 1.000 $ 1. Y Total maintenance cost = $11 $11.000 0 0 1 2 3 4 X Patient-days Patient days in 1.25X 25X Total maintenance cost Number of patient days 20 .000 000 20 * * * * 10 * ** * ** Intercept = FC: $10.000 000 10.000’s s of Do ollars Use one data point to estimate the total level of activity and the total cost.

400 Total FC = $3.High-Low Method The VC per hour of maintenance is equal to the change in cost divided y the change g in hours.800 – ($8/hour × 800 hours) Total FC = $9. by $2.400 $2 400 = $8.00/hour 300 21 High-Low Method Total FC = Total Cost – Total VC Total FC = $9.800 – $6.400 22 .

errors. The goal of this method is t fit a straight to t i ht line li to t the th data that minimizes the q errors.00 $8.400 $3 400 + $8 $8. sum of the squared 24 . This method uses all of the data points to estimate the fixed and variable costt components t off a mixed cost.High-Low Method The Cost Equation for Maintenance Y = $3.00X 00X 00X 23 Regression Method A method used to analyze mixed costs if a scattergraph plot reveals an approximately linear relationship between the X and Y variables.

25 Regression Method R2 is i the th percentage t off the th variation i ti in i total t t l costt explained by the activity. and the higher the percentage the better better. called the R2. Y Total Cost 20 * * * *2 10 * ** * ** R varies from 0% to 100%. 0 0 1 2 3 Activity 4 X 26 .Regression Method • Software can be used to fit a regression line through the data points. which is a measure of the goodness of fit of the regression line to the data points. • The cost analysis objective is the same: Y = a + bX Regression also provides a statistic.

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