Chapter 6

Activity Analysis, Cost Behavior, and Cost Estimation

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objective 1

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Introduction
Cost estimation
Process of determining cost behavior, often focusing on historical data.

Cost behavior
Relationship between cost and activity.

Cost prediction
Using knowledge of cost behavior to forecast level of cost at a particular activity. Focus is on the future.

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Learning Objective 2

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Total Variable Cost Example

Your total Pay Per View bill is based on how many Pay Per View shows that you watch.
Total Pay Per View Bill Number of Pay Per View shows watched
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Variable Cost Per Unit Example

The cost per Pay Per View show is constant. For example, $4.95 per show.
Cost per Pay Per View show Number of Pay Per View shows watched
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Step-Variable Costs

Total cost remains constant within a narrow range of activity.

Activity

Cost
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Total Fixed Cost Example

Your monthly basic cable TV bill probably does not change no matter how many hours you watch.

Monthly Basic Cable Bill Number of hours watched

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Fixed Cost Per Unit Example

The average cost per hour decreases as more hours are spent watching cable television.
Monthly Basic cable Bill per hour watched Number of hours watched
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Step-Fixed Costs
Total cost doesnt change for a wide range of activity, and then jumps to a new higher cost for the next higher range of activity. 90 Rent Cost in Thousands of Dollars

60

30

1,000 2,000 3,000 Rented Area (Square Feet)

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Semivariable Cost
Slope is variable cost per unit of activity. Total Utility Cost

Variable
Utility Charge Fixed Monthly Utility Charge Activity (Kilowatt Hours)
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Curvilinear Cost
Curvilinear Cost Function

Total Cost

Relevant Range

A straight-line (constant unit variable cost) closely approximates a curvilinear line within the relevant range.

Activity
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Learning Objective 3

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Curvilinear Cost
Curvilinear Cost Function

Total Cost

Relevant Range

A straight-Line (constant unit variable cost) closely approximates a curvilinear line within the relevant range.

Activity
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Learning Objective 4

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Engineered, Committed and Discretionary Costs

Committed
Long-term, cannot be reduced in the short term.

Discretionary
May be altered in the short term by current managerial decisions.

Engineered
Physical relationship with activity measure. Depreciation on Buildings and equipment Advertising and Research and Development
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Direct Materials

Learning Objective 5

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

Account Classification Method

Cost estimates are based on a review of each account making up the total cost being analyzed.
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Visual-Fit Method
A scatter diagram of past cost behavior may be helpful in analyzing mixed costs.

Estimated fixed cost = $10,000

Total Cost in 1,000s of Dollars

20

10

* * * *

* ** * Vertical distance ** is total cost,

approximately $16,000.

0 0 1 2 3 4 Activity, 1,000s of Units Produced

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The High-Low Method

OwlCo recorded the following production activity and maintenance costs for two months:
Units 9,000 5,000 Cost $ 9,700 6,100

High activity level Low activity level

Using these two levels of activity, compute: the variable cost per unit. the total fixed cost.
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The High-Low Method

High activity level Low activity level Change Units 9,000 5,000 4,000 Cost $ 9,700 6,100 $ 3,600

Unit variable cost = $3,600 4,000 units = $.90 per unit Fixed cost = Total cost Total variable cost
Fixed cost = $9,700 ($.90 per unit 9,000 units) Fixed cost = $9,700 $8,100 = $1,600

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Learning Objective 5 cont., 6 and 7 can be found in the Text Book

McGraw-Hill/Irwin

Copyright 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

End of Chapter 6

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