acct 2102

Cost Function

Cost Function is defined as how costs are used.

What are the Two categories of Cost Functions?

Product Costs, Period Costs

We used Cost Function categories to…

We used Cost Function categories to prepare lines on the income statement

Gross Profit Formula

Gross Profit = Sales Rev - COGS

Operating Income Formula

Operating Income = Gross Profit - SG&A

Cost Behavior

Cost Behavior is defined as how costs act and respond to changes in activity levels.

What are the Three categories of Cost Behaviors?

Variable Cost, Fixed Cost, Mixed Costs

Cost Behavior is used to…

Cost Behavior is used to prepare the Contribution Margin Income Statement.

Cost Behavior is not…

Cost Behavior is not used to arrive at any line on the Traditional Income Statement.

Managers need to understand how to…

Managers need to understand how to react to changes in volume to make accurate cost predictions and therefore, good business decisions.

What is the Cost Behavior Formula?

Y = MX + B

Cost Behavior Formula Expanded:

Total Cost = Variable Cost per Unit x Number of Units Sold + Total Fixed Costs

Total Variable Cost changes in…

Total Variable Cost changes in direct proportion to changes in volume.

VC per unit is…

VC per unit is constant.

VC graphs always start at the…

VC graphs always start at the origin.

Slope of the line represents the..

Slope of the line represents the VC per unit of activity.

Variable Cost Equation:

Y = MX

Variable Cost Equation Expanded:

Total Variable Cost = Variable Cost Per Unit x Volume of Activity

Fixed Costs

Fixed Costs are costs that do not change in total despite changes in volume.

Example of a Fixed Cost:

Depreciation on equipment.

Fixed Cost per Unit…

Fixed Cost per Unit varies inversely with volume.

Fixed Cost graphs…

Fixed Cost graphs are flat lines that intersect the y-axis.

Fixed Cost Equation:

Y = B

Fixed Cost Equation Expanded:

Total Fixed Costs = Fixed Costs

Mixed Costs contain

Mixed Costs contain both variable and fixed cost components.

Example of Mixed Costs:

Total Cost of water bottle cages.

Water Bottle Cages what is the fixed portion and the variable portion?

Fixed Portion: Equipment Depreciation. Variable Portion: $0.50 per cage.

Total Mixed Costs…

Total Mixed Costs increases with volume.

Mixed Cost per unit…

Mixed cost per unit decreases with volume. But not in direct proportion to volume changes.

Mixed Cost graphs…

Mixed Cost graphs do not start at the origin of the graph.

Mixed Cost Equation:

Y = MX + B

Mixed Cost Equation Expanded:

Total Mixed Cost = Variable Cost per unit x Activity Level + Total Fixed Cost

Relevant Range

Relevant Range is the range over which the cost behavior equation is valid.

Relevant Range Fixed Costs…

Relevant Range Fixed Costs, Total Fixed Costs remain constant.

Relevant Range Variable Costs…

Relevant Range Variable Costs, Variable Costs per unit remain constant.

Relevant Range aka…

For businesses this is thought of as the Normal Range of Operations.

Inside the Relevant Range…

Inside the Relevant Range, Cost Behavior is valid.

Outside of the Relevant Range…

Outside of the Relevant Range, the equation may not be valid, which could provide incorrect results for planning, decision-making, and budgeting.

Cost Behaviors can be what with graph?

Cost Behaviors can be non-linear.

What is an example of a Non-Linear Cost Behavior?

Step Costs and Curvilinear Costs

M and B must be..

M and B must be determined to produce the cost equation.

B is the

B (Fixed Cost) is the y-intercept.

M is the

M (Variable Cost per Unit) is the slope.

What are the three primary methods for determining cost behaviors?

Create a Scatterplot, High-Low Method, Regression Analysis

Scatterplot

A line is visually fit to the data point to determine the line of best fit and develop a cost behavior equation.

Advantages of a Scatterplot:

Provides a visual picture that shows the relationship between x and y. Allows users to easily identify an outlier in the data.

Disadvantages of a Scatterplot:

Somewhat subjective, as line placements can vary by individual.

High-Low Method:

A line is created from two actual data points chosen based on the high and low x values.

Advantages of High-Low Method:

Based on two data points. Very objective (formula-driven analysis).

Disadvantages of High-Low Method 1:

Possibility that either of the two data points used could be an outlier.

Disadvantages of High-Low Method 2:

Need to graph all data points prior to using the high-low method to determine if outliers exist.

Regression Analysis:

A line is created using statistical analysis and programs.

Simple Regression

Only one X variable is considered.

Multiple Regression:

Multiple X variables considered.

Advantages of Regression Analysis 1 and 2:

Uses all data points equally. Extremely objective.

Advantages of Regression Analysis 3 and 4:

Statistical measure of R2 - tells us if there is a linear relationship exists between x and y. Can identify outliers.

Disadvantages of Regression Analysis:

Output is complex and difficult to interpret at times. Possible that outliers are included in dataset (which is why r2 is so helpful).

Cost-Volume-Profit Analysis the study of….

The study of the relationship among sales (revenue), costs (expenses), and profit (net income).

CVP is used for both

CVP is used for both profit organizations and non-profit organizations.

Why would a NFP use CVP analysis

NFPs use the analysis for the purpose of a target profit of zero.

If sales volume is expected to be higher than the indifference point…

If sales volume is expected to be higher than the indifference point, management should choose the cost structure with the higher fixed costs.

CVP analysis relies on our knowledge of..

CVP analysis relies on our knowledge of cost behavior to express relationships among costs, sales volume, and profit.

The Break-even point is the point at which…

The Break-even point is the point at which operating income is equal to $0.

In target profit calculations, sales revenue is…

In target profit calculations, sales revenue is greater than total costs.

A company’s sales mix is ultimately determined by

A company’s sales mix is ultimately determined by market.

Cost Behavior Analysis

The study of how specific costs respond to changes in the volume of business activity.

Cost Driver

The measure of business activity.

Activity Cost Driver

An activity cost driver is something that drives the cost of a business.

What are some examples of Activity Cost Drivers?

Units of a Product, Machine Hours, Direct Labor Hours, Percentage of Capacity, Machine Setups.

Cost Drivers Continued

A critical aspect is that the activity measure used must have a logical casual relation with costs, and the quantity of the activity must be highly correlated with the level of costs.

Cost Volume Graphs

A cost volume graph illustrates the relationship between changes in cost and volume.

Cost Volume Graphs typically…

Typically plot total costs on the vertical y-axis and either volume or activity level on the horizontal x-axis.

Cost Behavior Formula

Y = MX + B

Cost Behavior Formula Expanded

Total Cost = Variable Cost Per Unit x Number of Units Sold + Total Fixed Costs

What are the three classifications of Cost Behavior Patterns?

Variable Costs, Fixed Costs, Mixed Costs

Variable Costs

Variable Costs are costs that are incurred for every unit of volume.

Total Variable Cost change..

Total Variable Costs change in direct proportion to changes in volume.

Purely Variable Cost Patterns

Purely Variable Cost Patterns always pass through the origin.

A Variable Cost Line always…

A Variable Cost Line always slopes upwards to the right.

Variable Cost: The greater the unit cost

The greater the unit cost, the steeper the slope.

Variable Cost Equation:

Y = MX

Variable Cost Equation Expanded:

Total Variable Cost = Variable Cost Per Unit x Volume of Activity

Fixed Costs

Costs that do not change when the volume of activity changes.

Example of Fixed Costs

Depreciation manufacturing machinery.

Fixed Cost per Unit…

Fixed Costs per unit varies inversely with volume.

Fixed Costs Graphs…

Fixed Cost graphs are a flat line that intersects the y-axis.

Fixed Cost Equation:

Y = B

Fixed Cost Equation Expanded:

Total Fixed Costs = Fixed Costs

Mixed Costs

Described as having both fixed and variable components.

Mixed Costs respond to…

Mixed Costs respond to volume changes but less than proportionately.

Mixed Costs: The fixed portion…

The fixed portion of a mixed service represents the basic charge for a service.

Mixed Cost Equation:

Y = MX + B

Mixed Cost Equation Expanded:

Total Mixed Cost = Rate x Activity + Fixed Cost

Mixed Costs are also known as…

Semi-Variable Costs

Volume Increases: Per Unit Cost: Variable Cost

No Change

Volume Increases: Per Unit Cost: Total Cost

Increase

Volume Increases: Per Unit Cost: Fixed Cost

Decrease

Volume Increases: Total Cost: Fixed Cost

No Change

Volume Increases: Per Unit Cost: Mixed Cost

Decrease

Volume Increases: Total Cost: Mixed Cost

Increase