# MANAGEMENT ACCOUNTING

AGUS SISWANDI 01153056

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Chapter Three
Activity Cost Behavior

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Learning Objectives
 Define and describe cost behavior for fixed, variable, and mixed costs.
 Explain the role of the resource usage model in understanding 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.
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Learning Objectives (continued)
 Evaluate the reliability of a cost equation.
 Explain the role of multiple regression in assessing cost behavior.  Describe the use of managerial judgment in determining cost behavior.

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Cost Behavior
Fixed-Cost Behavior
\$ \$ Relevant Range

Variable-Cost Behavior

Units Produced

Units Produced

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Mixed-Cost Behavior
Linearity Assumption Total Costs

Cost
Fixed Costs

Variable Costs

Number of Units Produced

Total cost = Fixed cost + Total variable cost
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Activity Cost Behavior Model
Inputs: Materials Energy Activities Activity Output

Labor
Capital

Cost Behavior
Changes in Input Cost
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Changes in Output
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Basic Terms
The linearity assumption assumes that variable costs increase in direct proportion to the number of units produced (or activity units used).
Practical capacity is the efficient level of activity performance.

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Types of Fixed Resources
 Flexible Resources  Committed Resources  Discretionary Fixed Expenses

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Flexible Resources

Flexible resources are supplied as used and needed.
They are acquired from outside sources, where the terms of acquisition do not require any long-term commitment for any given amount of the resource
• Example: Materials and energy

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Committed Resources
Committed resources are resources that are supplied in advance of usage.
They are acquired by the use of either an explicit or implicit contract to obtain a given quantity of resource, regardless of whether the amount of the resource available is fully used or not. Committed resources may have unused capacity.
• Example: Buying or leasing a building or equipment

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Discretionary Fixed Expenses

Discretionary fixed expenses are shorter-term committed resources.
• Example: The hiring of new receiving clerks

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Step-Cost Function

Cost Narrow Width

Activity Output (units)

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Step-Fixed Costs

Cost
Normal Operating Range (Relevant Range)

Activity Usage

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Resource Relationships

The relationship between resources supplied and resources used is expressed by the following equation:
Resources available = Resources used + Unused capacity

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Resource Relationships Example
 Three engineers hired at \$50,000 each

 Each engineer is capable of processing 2,500 change orders
 \$90,000 was spent on supplies for the engineering activity  There were 6,000 orders processed

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Resource Relationships Example (continued)
Available orders = Orders used + Orders unused
7,500 orders = 6,000 orders + 1,500 orders Fixed engineering rate = \$150,000/7,500 = \$20 per change order

Variable engineering rate = \$90,000/6,000
= \$15 per change order
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Resource Relationships Example (continued)
Cost of orders supplied = Cost of orders used + Cost of unused orders = [(\$20 + \$15) x 6,000] + (\$20 x 1,500) = \$240,000 Of course, the \$240,000 is precisely equal to the \$150,000 spent on engineers and the \$90,000 spent on supplies.

The \$30,000 of excess engineering capacity means that a new product be introduced without increasing current spending on engineering.

could

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Methods for Separating Mixed Costs into Fixed and Variable Components

 The High-Low Method  The Scatterplot Method  The Method of Least Squares

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High-Low Method: An Example
Month January February March April May Setup Costs \$1,000 1,250 2,250 2,500 3,750 Setup Hours 100 200 300 400 500

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The High-Low Method (continued)

Variable Rate (V) = Change in cost/Change in output V = (High cost - Low cost) / (High output - Low output) V = (\$3,750 - \$1,000) / (500 - 100) V = \$2,750 / 400 V = \$6.875 per setup hour

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The High-Low Method (continued)
\$3,750 = Fixed costs + \$6.875 (500) Fixed costs = \$3,750.00 - \$3,437.50 Fixed costs = \$312.50

The cost formula using the high-low method is: Total cost = \$312.50 + (\$6.875 x setup hours)

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Activity Cost \$4,000

Scatterplot Method
Important: Cost function is only relevant within relevant range

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3,000

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2,000

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1,000

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100

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200

Analyst can fit line based on his or her experience

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300 400 Activity Hours
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Nonlinear Relationship
Activity Cost

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Activity Output
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Upward Shift in Cost Relationship
Activity Cost * * *

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Activity Output
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Presence of Outliers
Activity Cost

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Activity Output
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Least Squares

Constant Std Err of Y Est R squared No. of Observations Degrees of Freedom X Coefficient(s) Std Err of Coef. 6.75 0.9464847243

125 299.304749934466 0.944300518134715 5 3

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Least Squares (continued)

The results give rise to the following equation:

Setup Costs = \$125 + (\$6.75 x # of setup hours)
R2 = .944, or 94.4 percent of the variation in setup costs is explained by the number of setup hours variable.

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Multiple Regression
TC = b0 + b1X1 + b2X2 + . . .

b0 = the fixed cost or intercept bi = the variable rate for the ith independent variable Xi = the ith independent variable

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Multiple Regression (continued)
Month January February March April May June July August September October November December MHrs 1,340 1,298 1,376 1,405 1,500 1,432 1,322 1,416 1,370 1,580 1,460 1,455 Summer 0 0 0 0 1 1 1 1 1 0 0 0 Utility Cost \$1,688 1,636 1,734 1,770 2,390 2,304 2,166 2,284 1,730 1,991 1,840 1,833

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Multiple Regression (continued)

Constant Std Err of Y Est R squared No. of Observations Degrees of Freedom X Coefficient(s) Std Err of Coef. 1.09715750519456 0.210226332115593

243.11149907159 55.5082829356447 0.96717927255452 12 9 510.49073361447 32.5489645352191

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Multiple Regression (continued)

The results gives rise to the following equation:

Utilities cost = \$243.11 + \$1.097(MH) + \$510.49(Summer)
R2 = .967, or 96.7 percent of the variation in utilities cost is explained by the machine hours and summer variables.

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Cost Behavior and Managerial Judgment
Some Tips
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Use past experience Try to confirm results with operating personnel Use common sense to confirm statistical studies

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End of Chapter 3

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