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COSTING FOR DECISION

MAKING
Chapter 3 Cost Behavior Analysis
LEARNING OBJECTIVES

1. Distinguish fixed, variable, and semivariable costs


2. Define relevant range
3. Determine fixed and variable costs from mixed cost using
High Low method
Scattergraph method
Least square method
RECAP :

 Cost Accounting System


 Job and Process Costing
 Descriptive analysis
 Costs
 Production Costs: Prime, Conversion, non production
 Accumulation and allocation: Direct, Indirect
 Cost accountability

 Predictive Analysis
 Decisions
 Costs
 Behaviour : Variable, Fixed, Mixed
PRODUCTION COSTS

 Materials, Labour and Overhead


DIRECT AND INDIRECT COST
LO1: DEFINE FIXED COST

 Fixed Cost
 A fixed cost is defined as one that does not change in total as
business activity increases or decreases.
 Many factory overhead costs such as straight-line depreciation are
classified as fixed costs.
FIXED COST GRAPHS
FIXED COSTS

• Assume that Minton Inc. manufactures, bottles, and distributes perfume.


The production supervisor is Jane Sovissi, who is paid $75,000 per year.
For the relevant range of 50,000 to 300,000 bottles of perfume, the total
fixed cost of $75,000 does not vary as production increases. As a result,
the fixed cost per bottle decreases as the units produced increase. This
is because the fixed cost is spread over a larger number of bottles, as
follows:

• As shown, fixed costs have the following characteristics:


o Cost per unit decreases as the activity level increases and increases as the activity
level decreases.
o Total cost remains the same regardless of changes in the activity base.
LO1: DEFINE VARIABLE COST

 A cost that increases in total proportionately with an increase in


activity and decreases proportionately with a decrease in activity.
 The relationship between a activity and the variable cost is
linear
 increase by a constant amount for each unit increase in activity.
VARIABLE COST GRAPHS
VARIABLE COSTS

• Assume that Jason Sound Inc. produces stereo systems. The parts for
the stereo systems are purchased from suppliers for $10 per unit and
are assembled by Jason Sound. For Model JS-12, the direct materials
costs for the relevant range of 5,000 to 30,000 units of production are
as follows:

• As shown, variable costs have the following characteristics:


o Cost per unit remains the same regardless of changes in the activity base.
o Total cost changes in proportion to changes in the activity base.
LO1: SEMIVARIABLE COST (MIXED
COST)
 A semivariable cost is defined as one that displays both fixed and
variable characteristics.
 Example
 A minimum quantity of supplies or services may need to be consumed, to
maintain readiness to operate. Beyond this minimum level of cost, which
is essentially fixed, additional cost varies with volume.
 E.g. Handphone charges
SEMI VARIABLE COSTS
SEMI VARIABLE COST

• Assume that Simpson Inc. manufactures sails,


using rented machinery. The rental charges are
as follows:

• The rental charges for various hours used within


the relevant range of 8,000 hours to 40,000 hours
are as follows:
LO 2 RELEVANT RANGE

 The relevant range


 Refers to a range of activity (number of units, hours)
 over which a fixed cost remains constant in total or
 a variable cost remains constant per unit of activity.
 A linear relationship between cost and activity
 Outside the relevant range of activity.
 The cost becomes
 Step
 Non linear
RELEVANT RANGE
RELEVANT RANGE STEPPED FIXED
COST
LO3 : DETERMINE FIXED AND VARIABLE
COSTS FROM MIXED COST
Slope is
variable cost
per unit
of activity.
Electicity Cost

Variable
Utility Charge

Fixed Monthly
Utility Charge
Activity (Labour Hours)
LO3: DETERMINE FIXED AND
VARIABLE COSTS FROM MIXED COST
LO3: HIGH LOW METHOD

 High and Low Points Method


 In the high and low points method, the fixed and variable elements
of a cost are computed from two data points.
RATE OF CHANGE
THE HIGH-LOW METHOD
If sales commissions are $10,000 when
80,000 units are sold and $14,000 when
120,000 units are sold, what is the variable
portion of sales commission per unit sold?

a. $0.08 per unit


b. $0.10 per unit
c. $0.12 per unit
d. $0.125 per unit
THE HIGH-LOW METHOD
If sales commissions are $10,000 when
80,000 units are sold and $14,000 when
120,000 units are sold, what is the fixed
portion of the sales commission?
a. $ 2,000
b. $ 4,000
c. $10,000
d. $12,000
LO3 : SCATTERGRAPH METHOD

 the cost being analyzed is called the dependent variable and is


plotted on a vertical line called the y-axis.
 The associated activity is called the independent variable—for
example, direct labor dollars, direct labor hours, machine hours,
units of output, or percentage of capacity—and is plotted along
a horizontal line called the x-axis.
SCATTERGRAPH
SCATTERGRAPH
METHOD OF LEAST SQUARES

 The method of least squares, sometimes called regression analysis,


determines mathematically a line of best fit, or linear regression line,
through a set of points.
EXHIBIT 3-2
LEAST SQUARE METHOD

 The variable rate for electricity cost, b, is computed as follows:


( xi  x )( yi  y ) Column 6 total $2, 270,000
b    $.0044 per direct labor hour
( xi  x ) 2
Column 5 total 512,000,000
 The fixed cost, a, can be computed using the formula for a
straight line as follows:
COST BEHAVIOR AND DECISIONS

 Cost behavior is the manner in which a cost changes as a related


activity changes.
 The separation of fixed and variable costs is necessary to plan,
analyse, control, measure and evaluate costs at different levels
of activity.

1. Direct costing and contribution margin analysis.


2. Break-even and cost-volume-profit analysis.
TUTORIAL QUESTIONS

 E3-1