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# COST MANAGEMENT

## Guan Hansen Mowen

COPYRIGHT 2009 South-Western Publishing, a division of Cengage Learning.
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Chapter 3
Cost Behavior
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Study Objectives
1. Define and describe fixed, variable, and mixed costs.
2. Explain the use of resources and activities and their relationship to
cost behavior.
3. Separate mixed costs into their fixed and variable components
using the high-low method, the scatterplot method, and the method
of least squares.
4. Evaluate the reliability of the cost formula.
5. Explain how multiple regression can be used to assess cost
behavior.
6. Define the learning curve, and discuss its impact on cost behavior.
7. Discuss the use of managerial judgment in determining cost
behavior.
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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
Fixed costs are costs that in total are
constant within the relevant range as
the level of the activity driver varies.
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Supervision
Computers
Processed
\$54,000 4,000
54,000 8,000
54,000 10,000
108,000 12,000
108,000 16,000
108,000 20,000
Days Computers, Inc.
Cost Behavior: Fixed Costs
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Supervision
Computers
Processed
\$54,000 4,000
54,000 8,000
54,000 10,000
108,000 12,000
108,000 16,000
108,000 20,000
Days Computers, Inc.
Cost Behavior: Fixed Costs
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Supervision
Computers
Processed Unit Cost
\$54,000 4,000 \$13.50
54,000 8,000 6.75
54,000 10,000 5.40
108,000 12,000 9.00
108,000 16,000 6.75
108,000 20,000 5.40
Days Computers, Inc.
Cost Behavior: Fixed Costs
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Cost Behavior: Fixed Costs
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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
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Cost Behavior: Variable Costs
Total Cost of
CD-ROMs
Number of
Computers
Processed
\$120,000 4,000
240,000 8,000
360,000 12,000
480,000 16,000
600,000 20,000
Days Computers, Inc.
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Cost Behavior: Variable Costs
Total Cost of
CD-ROMs
Number of
Computers
Processed
Unit Cost of
CD-ROMs
\$120,000 4,000 \$30.00
240,000 8,000 30.00
360,000 12,000 30.00
480,000 16,000 30.00
600,000 20,000 30.00
Days Computers, Inc.
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Cost Behavior: Variable Costs
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Mixed costs are costs that have both a
fixed and a variable component.
Ten sales representatives each earn an
annual salary of \$30,000 plus a commission
of \$50 per computer sold. 10,000 computers
are sold.
Cost Behavior: Mixed Costs
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Y = Fixed cost + Total variable cost
Y = F + VX
where
Y = Total cost
For Days Computer, the selling cost is:
Y = \$300,000 + \$50X
Cost Behavior: Mixed Costs
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Cost Behavior: Mixed Costs
Fixed Cost of
Selling
Variable
Cost of
Selling Total Cost
Computers
Sold
Selling Cost
per Unit
\$300,000 \$200,000 \$500,000 4,000 \$125.00
300,000 400,000 700,000 8,000 87.50
300,000 600,000 900,000 12,000 75.00
300,000 800,000 1,100,000 16,000 68.75
300,000 1,000,000 1,300,000 20,000 65.00
Days Computers, Inc.
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Cost Behavior: Mixed Costs
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Flexible resources
Acquired as used and needed
Usually considered variable costs
Examples: materials, energy
Committed resources
Usually considered fixed costs
Examples: buying or leasing buildings, contracts
with employees
Resources, Activities,
and Cost Behavior
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Resources, Activities,
and Cost Behavior
Step cost behavior displays a constant
level of cost for a range of output and then
jumps to a higher level of cost at some
point
Step-Variable costs
Narrow increments
Approximate as a strictly variable assumption
Step-Fixed costs
Wide increments
Assigned to the fixed cost category
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Resources, Activities,
and Cost Behavior
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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
Variable
Component
Fixed
Component
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Y = F + VX
Methods for Separating Mixed Costs
into Fixed and Variable Components
where
Y = Total activity cost
F = Fixed cost component
V = Variable cost per unit
X = Measure of activity output
Straight-line equation:
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Step 1: Solve for variable cost (V)
V = Change in cost Change in activity
High-Low Method
Month
Materials
Handling Cost
Number of
Moves
January \$2,000 100
February 3,090 125
March 2,780 175
April 1,990 200
May 7,500 500
June 5,300 300
July 4,300 250
August 6,300 400
September 5,600 475
October 6,240 425
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High-Low Method
\$7,500 - \$2,000
Step1: \$13.75
500 - 100
V
Low Activity
High Activity
Month
Materials
Handling Cost
Number of
Moves
January \$2,000 100
February 3,090 125
March 2,780 175
April 1,990 200
May 7,500 500
June 5,300 300
July 4,300 250
August 6,300 400
September 5,600 475
October 6,240 425
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High-Low Method
\$7,500 - \$2,000
\$13.75
500 - 100
V
Step 2: Using either the high cost or low cost, solve for
the total fixed costs F
Step 1: Solve for variable cost (V)
V = Change in cost Change in activity
( )
\$2,000 \$13.75(100)
\$625
Y F V X
F
F

Low cost
( )
\$7,500 \$13.75(500)
\$625
Y F V X
F
F

High cost
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Scatterplot Method
Step 1: Plot the data points on a scattergraph
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Scatterplot Method
Step 2: Choose the two data points most representative
of the data to describe the cost behavior line
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Method of Least Squares
Actual
Cost
Predicted
Cost Deviation
Deviation
Squared
2,000 1,742 258 66,564
3,090 2,088 1,002 1,004,004
2,780 2,780 - -
1,990 3,126 (1,136) 1,290,496
7,500 7,278 222 49,284
5,300 4,510 790 624,100
4,300 3,818 482 232,324
6,300 5,894 406 164,836
5,600 6,932 (1,332) 1,774,224
6,240 6,240 - -
5,205,832 Total measure of closeness
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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
Microsoft Excel to perform the
computation
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Anderson Company
Regression Analysis
for the Method of Least Squares
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SUMMARY OUTPUT
Regression Statistics
Multiple R 0.92894908
R. Square 0.862946394
Square
Standard Error 770.4987038
Observations 10
ANOVA
df SS MS F
Regression 1 29903853.98 29903853.98 50.37132077
Residual 8 4749346.021 593668.2526
Total 9 34653200
Coefficient Standard Error t-Stat P-value
Intercept 854.4993582 569.7810263 1.49967811 0.172079925
X Variable 1 12.3915276 1.745955536 7.097275588 0.000102268
Regression Output for
Anderson Company
Regression Analysis
for the Method of Least Squares
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The regression analysis gives rise to the following
equation for Andersons material handling cost:
Regression Analysis
for the Method of Least Squares
\$854.50 + (\$12.39 number of moves)
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Reliability of Cost Formulas
Hypothesis test of parameters

The lower the P-value, the more likely that the
true parameter is significantly different from 0
0.10, 0.05 or 0.01
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Reliability of Cost Formulas
Goodness of fit

R
2
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
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Reliability of Cost Formulas
Confidence intervals

The standard error is used to determine the
range of possible values around the
predicted value:

Standard Confidence
t-statistic
Error Interval

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X
1
= first explanatory variable
X
2
= second explanatory variable

Multiple Regression
Least-squares method is used to fit an
equation involving two or more
explanatory variables
Y = F + V
1
X
1
+ V
2
X
2
etc.
where
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Multiple Regression
Anderson Company
Month
Materials
Handling
Cost
Number
of Moves
Pounds
Moved
January \$2,000 100 6,000
February 3,090 125 15,000
March 2,780 175 7,800
April 1,990 200 600
May 7,500 500 29,000
June 5,300 300 23,000
July 4,300 250 17,000
August 6,300 400 25,000
September 5,600 475 12,000
October 6,240 425 22,400
X
2
X
1
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Multiple Regression Analysis
for the Method of Least Squares
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.999420
R Square 0.998841
Standard Error 75.762721
Observations 10
ANOVA
df SS MS F
Regression 2 34613020.07 17306510.04 3015.076722
Residual 7 40179.92954 5739.989934
Total 9 34653200
Coefficients Standard Error t Stat P-value
Intercept 507.309711 57.322496 8.850098 0.000048
X Variable 1 7.835162 0.234048 33.476720 0.000000
X Variable 2 0.107181 0.003742 28.642864 0.000000
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Y = \$507 + \$7.84X
1
+ \$0.11X
2
Y = \$507 + \$7.84(350) + \$0.11(17,000)
= \$507 + \$2,744 + \$1,870
= \$5,121
Multiple Regression
Based on the multiple regression analysis, the
cost formula is written as:
In November the company expects to make 350
moves with a weight of 17,000 pounds. The
predicted cost of material handling is:
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1 100 100 100
2 80 (80% 100) 160 60
3 70.21 210.63 50.63
4 64 (80% 80) 256 45.37
5 59.57 297.85 41.85
6 56.17 337.02 39.17
7 53.45 374.15 37.13
8 51.20 (80% 64) 409.60 35.45
16 40.96 655.36 28.06
32 32.77 1,048.64
Cumulative Cumulative Cumulative Individual Units
Number Average Time Total Time: Time for nth
of Units per Unit in Hours Labor Hours Unit-Labor Hours
(1) (2) (3) = (1) (2) (4)
Cumulative Average Time Learning
Curve with 80% Learning Rate
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Graph of Cumulative Total Hours Required
and the Cumulative Average Time per Unit
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Managerial Judgment
Managerial judgment is critically important
in determining cost behavior and is by far
the most widely used method in practice