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Project

MANAGERIAL ACCOUNTING

:Submitted to

Madam NAHEED MALIK

:Submitted By

084 Muhammad HABIBULLAH


166 Zahid yousaf
024 Aslam javaid
139 Sharjeel arslan

COMSATS INSTITUTE OF
INFORMATION
TECHNOLOGY
.LAHORE
In The name of ALLAH The Most Beneficent & Most
.Merciful
:Cost Behavior
Cost behavior refers to how a cost will change as the level of
activity changes. Attempting to make a decision without a throughout understanding
.of cost behavior can leads to failure

:Types of Cost Behavior Pattern


;There are three types of costs
Fixed Cost-1
Variable Cost-2
Semi Variable Cost-3
.The relevant proportion of each cost in an organization is known as its cost Structure

:Variable Cost
Variable Cost is a cost whose total amount varies in direct proportion to change in the
activity level. If activity levels double, the total variable cost also doubles. If activity level changes by
10% then variable cost also increases by 10%
Variable cost remains constant if expressed on a per unit basis. For example

Number of Guests ($)Cost of meal per Guest ($) Total cost of Meal
250 30 7,500
500 30 15,000
750 30 22,500
1000 30 30,000

:The Activity Base


Activity base is a measure of whether causes the incurrence of variable cost. An activity base is a cost
driver. Some other cost drivers are direct labor hours, machine hours, unit produced & unit sold. Other
,examples of activity base includes the no of miles driven by salesperson
;There are two types of variable costs
True Variable-1
Step-Variable Cost-2

:True Variable Costs


Direct material is a true or proportionally variable cost because
the amount used during a period will vary in direct proportion to the level of.
Production activity. Moreover, any amounts purchased but not used can be stored
.and carried forward to the next period as inventory

:Step-Variable Cost
The cost of a resource that is obtainable only in large chunks and
that increases or decreases only in response to fairly wide changes in activity is
known as a step variable cost. For example the wages of skilled repair technicians
.are often consider as being a step variable cost

:The Linearity assumption and The Relevant Range

There is linear relationship between cost and volume. Many costs that are classified
as variable actually behave in curvilinear fashion. Many costs are not linear, a
curvilinear cost may be approximated with a straight; line within a narrow band of
.activity is known as relevant range
:Fixed Costs
Total fixed remains constant within the relevant range of activity. For
example, the company a company rents a building for $500 per month to store its
equipments within the relevant range, the total amount of rent paid by company is the
same regardless of its guests. Fixed cost remains same in total. The average fixed
cost per unit become smaller as the level of activity increases

:Types of Fixed Cost


;There are two types of fixed costs
committed fixed cost-1
:Discretionary Fixed Cost-2

:Committed Fixed Cost


Investment in facilities, equipment, and the basic organization
that can't be significantly reduced even for short periods of times without fundamental
changes are referred to committed fixed costs. An example of such costs includes
depreciation of building & equipment, real state taxes, insurance expense and
salaries of top management and operating personnel. Even if operations are
interrupted or cut back during a recession. For example, a company doesn't sell its
.organizational structure

:Discretionary Fixed Cost


Discrete costs usually arise due to annual decisions by
management to spend on certain fixed cost item. Examples of discretionary cost are
advertising, research, public relations, development programs & internships for
.students

:Difference between committed & discretionary cost


There are two types of differences between committed and discretionary costs
'planning time-1
The planning time for discretionary cost is short usually single year. &
.committed fixed cost has time horizon of many years
discretionary cost can be cut for short period of time with minimal damages to long-2
term goals of organization. For example, the planning program can be reduced due
to poor economic conditions. Discretionary costs can be adjusted from year to year
.or perhaps during year according situation

?Is Labor a Fixed or Variable cost


The behavior of wages and salaries may differ from
country to country depending upon labor policies, labor contracts, and customs.
Where worker is permanent then its cost is fixed. If worker is part time temporary
.then labor cost is complex mixture of fix and variable cost
:Fixed Cost and the Relevant Range
The levels of discretionary fixed cost are typically
decided at the beginning of the year and depend upon need of planned program
such as advertising and training. The scope of these programs will depend, in tern,
on overall anticipated activity. For example if company wants to increase sales by
25% then it have to advertise heavily so, planned level of activity might affect total
discretionary cost. Discretionary fixed costs are easier to adjust than committed fixed
cost. They also tend to be less lumpy committed fixed cost consists of costs such as
building, equipment, and salaries of key personals. It is difficult to buy a piece of
equipment. Step variable cost can often be adjusted quickly as conditions changes.
.However fixed cost can never be changed
The second difference is that the width of step depicted for step variable costs is
.much narrow then step depicted if fixed cost

:Mixed Costs
A mixed cost consist both variable and fixed cost elements.
Mixed costs are also known as semi variable costs the following equation can
?be used to show relationship between mixed costs and level of activity
Y=a+bX

In this equation
Y= total mixed cost
a = the total fixed cost
b = the variable cost per unit of activity
X = the level of activity
Mixed costs are very common. For example, the cost of providing X-ray
service to patient at medical college is mixed cost. How does management go
about estimating about fixed and variable cost of mixed cost? There are two
methods
Account analysis -1
.Engineering approach -2
In account analysis, an account is classified either variable or fixed base on
analysts prior knowledge of how the cost in the account behaves. For
example, direct material may be classified as variable cost and building lease
.may be classified as fixed cost
The engineering approach involves a detailed analysis of what cost behavior
.should be, based on individual evaluation of industrial production methods

:Dependent variable
A variable that is plotted vertical axes is known as depend
dent variable. A variable that is plotted in X axes is known as independent
.variable

:The High Low Method


The high low method is based on the rise over run
formula for slope of straight line. If the cost between activity and cost can be
represented in straight line, then the slope of straight line is equal to the
variable cost per unit of activity. This formula can be used to estimate variable
cost

Variable Cost= slope of Line = Rise = Y2-Y1


Run X2-X1
to analyze mixed cost with high low method, begin by identifying the period
with lowest level of activity and the period with highest level of activity. The
period with lowest level of activity is selected at first point in the above
formula and the period with highest level of activity is selected as second
point. The formula becomes

Variable Cost=Y2-Y1 = cost at the high level of activity-Cost at low level of activity
X2-X1 high activity level – low activity level

Variable Cost =Change in Cost


Change in Activity

Therefore, when the high low method is used, the variable cost is estimated by
dividing the difference in cost between high and low level of activity by the change in
.activity between those two points
For example
Patient days Maintenance cost

High activity level 8000 9800


Low activity level 5000 7400

change 3000 2400

Variable Cost =change in cost = 2400 =$0.80 per day


Change in activity 3000
We can determine fixed cost from this

Fixed cost element = Total cost- variable cost element

(8000×0.80) – $9800 =
.3400 $=

:The Least Square Regression Method


This method uses all the data to separate a
mixed cost into fix and variable cost. A regression line of form Y=a+bX is fitted to
data. Where
A = Total fixed Cost
b=Variable cost per unit of activity

:Multiple Regression Analysis


Multiple regressions is analytical method that is used
when the dependent variable is caused by more than one factor. Although, adding
.more factors, or variables makes the computation more complex
:The Contribution Format of Income Statement
Making distinction between fixed and
variable cost is crucial for decisions. Contribution approach provides managers with
an income statement that clearly distinguishes between fixed and variable cost and
.therefore facilitates planning, control and decision making
:The Contribution Approach
Contribution approach separates fixed and variable costs.
In this we deduct variable expenses from sales to obtain contribution margin. The
contribution margin is the amount remaining sales revenue after variable expenses
has been deducted. This amount contributes toward covering fixed expenses and
.then towards profits for the period
The contribution format of income statement is used as internal planning and
.decision making tools

Traditional Approach
(Cost Organized by Function)

Sales………………………………………………………$12000
Cost of goods sold……………………………………….. 6000

Gross Margin………………………………………………6000
Selling & Administrative expenses
Selling…………………………………3100
Administrative…………………………1900……………..5000
Net Operating Income…………………………………….1000

Contribution approach
(Cost Organized by Function)

Sales…………………………………………………………12000
Variable Expenses
Variable Production……………………2000
Variable selling…………………………..600
Variable administrative………………….400……………..3000
Contribution Margin…………………………………………9000
Fixed Expenses
Fixed production……………………………4000
Fixed selling…………………………………2500
Fixed administrative………………………...1500 8000
Net Operating Income……………………………………….1000

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