10 Determining How Costs Behave

LEARNING OBJECTIVES:
1. EXPLAIN THE IMPORTANCE OF CAUSALITY IN
ESTIMATING LINEAR COST FUNCTION
2. EXPLAIN NONLINEAR COST FUNCTIONS, IN
PARTICULAR THOSE ARISING FROM LEARNING
CURVE
3. UNDERSTANDING VARIOUS METHODS OF COST
ESTIMATING

Dibuat Oleh: Judith F. Pattiwael Irawan

 UNDERSTANDING
IN BUSINESS
THE ROLE OF
DECISIONS
COST FUNCTIONS
/

LINEAR & NON-LINEAR COST FUNCTION

Dibuat Oleh: Judith F. Pattiwael Irawan
10 Determining How Costs Behave

LEARNING OBJECTIVES:
2. EXPLAIN NONLINEAR COST FUNCTIONS, IN
PARTICULAR THOSE ARISING FROM
LEARNING CURVE

Dibuat Oleh: Judith F. Pattiwael Irawan

 Nonlinear Cost Function

A Nonlinier Cost Function:

is a cost function for which
the graph of total costs is not a straight line
within the relevant range.

Dibuat Oleh: Judith F. Pattiwael Irawan

Nonlinear Cost Function: Nonlinear Cost Function:
Step Fixed-Cost Function Step Cost Function

Actual Cost Behaviour

$900

$600

$300 linear approximation of cost behavior

7,500 15,000 22,500

X
0 0

Dibuat Oleh: Judith F. Pattiwael Irawan

 LEARNING CURVE
A Learning Curve is a function that measures how labour-hours
per unit decline as units of production increase.
This happens because workers are learning and becoming better at
their jobs. Workers become more familiar with their tasks.
Managers use learning curves to predict how labour-hours.
As workers become more familiar with their tasks, their efficiency
improves. Managers learn how to more efficiently schedule work
and operate the plant. Assembly-Line Balancing – bottle neck
As a result, unit costs decrease as productivity increases, and
the unit-cost function behaves nonlinearity.

Dibuat Oleh: Judith F. Pattiwael Irawan

 Labor hour

unit produced
0

Dibuat Oleh: Judith F. Pattiwael Irawan

EXPERIENCE CURVE
The term experience curve describes a broader
application of the learning curve.
Experience Curve can be extended to other business
function in the value chain, such as marketing,
distribution, and customer service.
An Experience Curve measures the decline in the
cost per unit of these various business functions as
the amount of these activities increases.

Dibuat Oleh: Judith F. Pattiwael Irawan

Many big companies use learning
curves and experience curves to
reduce costs and increase customer
satisfaction, market share, and LEARNING
profitability.
CURVE and
EXPERIENCE
CURVE
For such companies, Learning
Curves and Experience Curves are
key elements of company profit-
maximization strategies.

Dibuat Oleh: Judith F. Pattiwael Irawan

LEARNING CURVE MODEL

Two Learning-
Curve Model:

The Cumulative The Incremental

Average-Time Unit-Time
Learning Model Learning Model

Dibuat Oleh: Judith F. Pattiwael Irawan

 The Cumulative Average-
Time Learning Model
In The Cumulative Average-Time Learning
Model, cumulative average time per unit
declines by a constant percentage each
time the cumulative quantity of units
produced doubles.
The Mathematical relationship
underlying the cumulative average-time
learning model is as follows: y = a X b
Dibuat Oleh: Judith F. Pattiwael Irawan
The Cumulative Average-Time
Learning Model
Consider Rayburn Corporation, a radar systems manufacturer
has an 80% learning curve.
This means that when Rayburn doubles the quantity of units
produced, from X to 2X , the cumulative average time per unit
for 2X units is 80% of the cumulative average time per unit for
X units.
In other words, the average time per unit drops by
20% ( = 100% - 80%)
The calculations for the cumulative average-time learning
model for Rayburn Corporation:

Dibuat Oleh: Judith F. Pattiwael Irawan

Dibuat Oleh: Judith F. Pattiwael Irawan
 The mathematical relationship:
y=aX b

y : Cumulative average time (labor-hours) per unit

X : Cumulative number of units produced
a: Time (labor-hours) required to produce the first unit
b : Factor used to calculate cumulative average time to produce units

The value of b is calculated as : b = Ln learning curve in decimal form

Ln 2

Dibuat Oleh: Judith F. Pattiwael Irawan

 The mathematical relationship:
y=aX b

- For learning curve 80%, then b = Ln 0.8 / Ln 2 = - 0.3219

Time required to produce the first unit = 100

- When X = 3, then y = a X b = 100 . 3 (-0.3219) = 100 . 0.7021 = 70.21 labor hours

The Cumulative Total Time when X = 3 is 70.21 x 3 = 210.63 labor-hours
- When X = 4, then y = a X b = 100 . 4 (-0.3219) = 100 . 0.6400 = 64.00 labor hours
The Cumulative Total Time when X = 4 is 64.00 x 4 = 256 labor-hours
- When X = 8, then y = a X b = 100 . 8 (-0.3219) = 100 . 0.5120 = 51.20 labor hours
The Cumulative Total Time when X = 8 is 51.20 x 4 = 409,6 labor-hours

Dibuat Oleh: Judith F. Pattiwael Irawan

 Learning Curve Cumulative Average
Time Per unit
Cumulative Average
Time Learning Model
Cumulative Average Time per Unit
100
80
70.21
64.00
Cumulative Average -Time Learning Model 59.56
56.17
53.45
51.20
..
40.96
0 16 32 48 64 80 unit produces
Dibuat Oleh: Judith F. Pattiwael Irawan
Predicting Costs Using Learning Curve at Rayburn Corporation:
Incorporating Learning-Curve Effects into Prices and Standards

Suppose the variable costs subject to learning effect are direct manufacturing labor
at $20 per hour and related overhead at $30 per direct manufacturing labor hour.
Manager should predict the cost, as follow.
Cumulative Cumulative Cumulative Cumulative Average Cost per
Number of Average Time Total Time: Costs at $ 50 Unit
Units (X) Per Unit Labour Hours per
(1) Labour Hours (3)=(1) x(2) Labor-Hour
(2) (4) = (3) x $50
1 100 100 $ 5,000 $ 5,000
1x2=2 80 160 8,000 4,000
2x2=4 64 256.00 12,800 3,200
4x2=8 51.20 409.60 20,480 2,560
.. .. .. .. ..
8 x 2 = 16 40.96 655.36 32,768 2,048
Dibuat Oleh: Judith F. Pattiwael Irawan
 C U M U L AT I V E C U M U L AT I V E C U M U L AT I V E
Predicting Costs Using Learning Curve at
C U M U L AT I V E
AV E R A G E T I M E TOTA L T I M E : C O S T S AT $ 5 0 AV E R A G E Rayburn Corporation:
NUMBER OF
UNITS (X)
PER UNIT LABOUR PER COST PER Incorporating Learning-Curve Effects into
L A B O U R H O U RS H O U RS LABOR-HOUR UNIT Prices and Standards
(1)
(2) (3)=(1) X(2) (4) = (3) X $50

1 100 100 $ 5,000 $ 5,000 Suppose the variable costs

subject to learning effect are
1x2=2 80 160 8,000 4,000
direct manufacturing labor
2x2=4 64 256.00 12,800 3,200 at $20 per hour and related
overhead at $30 per direct
4x2=8 51.20 409.60 20,480 2,560
manufacturing labor hour.
.. .. .. .. .. Manager should predict the
8 x 2 = 16 40.96 655.36 32,768 2,048
cost, as follow.

Dibuat Oleh: Judith F. Pattiwael Irawan

 The Incremental Unit-
Time Learning Model
In The Incremental Unit-Time Learning Model,
the incremental time needed to produce
the last unit declines by a constant percentage
each time the cumulative quantity of units
produced doubles.

Dibuat Oleh: Judith F. Pattiwael Irawan

 The Incremental Unit-Time
Learning Model
Consider Rayburn Corporation, a radar systems
manufacturer has an 80% learning curve.
This means that when Rayburn doubles the quantity
of units produced, from X to 2X, the incremental
unit-time per unit for 2X units is 80% of the
incremental unit-time for X units.
In other words, the incremental unit-time drops by
20% ( = 100% - 80%)
The calculations for the incremental unit-time
learning model for Rayburn Corporation:
Dibuat Oleh: Judith F. Pattiwael Irawan
Dibuat Oleh: Judith F. Pattiwael Irawan
 The mathematical relationship:
y=aX b

y : Time (labor-hours) taken to produce the last single unit

X : Cumulative number of units produced
a: Time (labor-hours) required to produce the first unit
b : Factor used to calculate cumulative average time to produce units

The value of b is calculated as: b = Ln learning curve in decimal form

Ln 2

Dibuat Oleh: Judith F. Pattiwael Irawan

 The mathematical relationship:
y=aX b

- For learning curve 80%, then b = Ln 0.8 / Ln 2 = -0.3219

- When X = 3, then y = a X b = 100 . 3 (-0.3219) = 70.21 labor hours
- The Cumulative Total Time when X = 3 is
= 100 + 80 + 70.21
Note:
When X = 1, then y = a X b = 100 . 1 (-0.3219) = 100
When X = 2, then y = a X b = 100 . 2 (-0.3219) = 80

Dibuat Oleh: Judith F. Pattiwael Irawan

 Learning Curve Cumulative Average Time Per unit
Cumulative Average Incremental Unit-
Time Learning Time Learning
Model Model
Cumulative Average Time per Unit 100 100
120
80 90
100 70.21 83.40
64.00 78.5525
80
59.56 74.75
60 56.17 71.66
53.45 69.06
40
51.20 66.82
20 .. ..
40.96 55.75
0
0 16 32 48 64 unit produced Incremental Unit-Time Learning Model
Cumulative Average -Time Learning Model
Dibuat Oleh: Judith F. Pattiwael Irawan
 Learning Curve Cumulative Total Labor-Hours
Cumulative Average Incremental Unit-
Time Learning Time Learning
Model Model
Cumulative Total Labor-Hours 100 100
6000
160 180
5000 210.63 250.21
256.00 314.21
4000
297.82 373.77
3000 337.01 429.94
374.14 483.39
2000
409.60 534.59
1000 .. ..
655.36 892.01
0
0 16 32 48 64 unit produced Incremental Unit-Time Learning Model
Cumulative Average -Time Learning Model
Dibuat Oleh: Judith F. Pattiwael Irawan
1 EXERCISE – Try It!
Maude Design manufactures various picture frames. Each new employee
takes 6 hours to make the first picture frame and 4.8 hours to make the
second. The manufacturing overhead charge per hour is $25.
a) What is the learning-curve percentage, assuming the cumulative
average method?
b) What is the time needed to build 8 picture frames by a new employee
using the cumulative average-time method?.
You may use an index of 0.1520
c) How much manufacturing overhead would be charged to the 8 picture
frames under the cumulative average-time approach?
d) What is the learning-curve percentage, assuming the incremental unit-
time method?
e) What is the time needed to produce the 16th frame by a new employee
using the incremental unit-time method?.
You may use an index of -0.3219
Dibuat Oleh: Judith F. Pattiwael Irawan
 EXERCISE – TRY IT!
2 The Helicopter Division of GLD, Inc., is examining helicopter assembly costs at its Indiana plant. It
has received an initial order for eight of its new land-surveying helicopters. GLD can adopt the
labor-intensive method or the machine-intensive method to assemble the helicopter as per the
data shown int the following table:

Labor-Intensive Assembly Machine-Intensive Assembly

Method Method
Direct material cost per helicopter $ 40,000 $ 36,000
Direct-assembly labor time for first 2,000 Labor hours 800 Labor hours
helicopter
Learning curve for assembly labor 85% Cumulative 90% Incremental
time per helicopter average-time unit-time
Direct-assembly labor cost $30 Per hour $30 Per hour
Equiptment-related indirect $12 Per direct- 45 Per direct-
manufacturing cost assembly labor- assembly labor-
hour hour
Material-handling-related indirect 50% of direct material 50% of direct
manufacturing cost cost material cost
Dibuat Oleh: Judith F. Pattiwael Irawan
2 Questions
1. b = ?
2. How many direct-assembly labor-hours are required to assemble the
first ten helicopters under:
(a) the labor-intensive method
(b) the machine-intensive method?.
__________________________________________________________
3. What is the total cost of assembling the first ten helicopters under
(a) the labor-intensive method
(b) the machine-intensive method?.

Dibuat Oleh: Judith F. Pattiwael Irawan