University of Windsor Accounting Lecture: Cost Behaviors and High-Low Analysis

Accounting Program Structure and Enrollment at the University of Windsor

• Program Intensity: The undergraduate accounting program is highly rigorous, running three full semesters per year with 18 to 22 courses offered every semester.
• Enrollment Trends: Undergraduate enrollment at the University of Windsor has declined over the last five years, mirroring trends in other universities.
• Presidential Strategy: The current president aims to increase undergraduate capacity across all campus programs.
• Physical Infrastructure: Due to past expansion and current demand shifts, some buildings on campus are empty during summers or even during fall and winter semesters. This forces the university to decide whether to repair existing structures or repurpose them.
• Programmatic Differences: While accounting and finance run year-round, other programs may only offer a limited number of classes (e.g., three) during the summer.

Types of Business Costs and Flexibility

• Service Companies: These businesses experience fluctuations based on the specific services provided, leading to distinct busy and slow periods.
• Retailers: Cost and activity patterns in retail are described as being "all over the place."
• Manufacturers: Typically involve a wide variety of variable costs.
• Committed Fixed Costs: These are costs an organization cannot easily exit.
  • Example: Depreciation on a piece of equipment persists unless the equipment is sold.
• Discretionary Fixed Costs: These are costs that can be scaled back or eliminated based on management decisions.
  • Marketing/Advertising: Stopping advertising is a major decision; it can signal that a business is doing so well it doesn't need it, or conversely, that the business is giving up or facing bankruptcy.

Case Studies in Financial Management and Crisis Response

• The 2020 Pandemic: Successful businesses evaluated their inventory, building ownership versus rental status, and overall spending. Businesses renting property found it easier to reduce fixed costs by not renewing leases compared to those that owned their buildings.
• Post-9/11 Airline Crisis: Following the tragedies in New York City, Pennsylvania, and Washington, airlines faced massive cash flow problems as passengers stopped flying.
  • Leasing vs. Owning: Airlines that owned their planes suffered more because they were stuck with the assets. Airlines that leased aircraft were able to let leases expire for planes they no longer needed, providing greater financial flexibility.
• Local Ontario Business Example: A successful business with multiple locations mapped out their owned versus rented properties at the start of the pandemic and chose not to renew leases on unnecessary rented spaces to quickly reduce fixed costs.
• Predatory Marketing Anecdote: A local college (St. Clair College, though not named explicitly in that sentence, it is referred to as "the college" in Windsor) often places its advertising a mile away from the university to target students driving toward the university campus.

Cost Behavior and Graphing Fundamentals

• Graph Axes Mnemonic: To remember the axes, the Y-axis is vertical (resembling the vertical stroke of a "Y") and the X-axis is horizontal.
• Utility Cost Components:
  • Fixed Component: A flat monthly fee (e.g., a water bill often has a high fixed charge before any consumption is measured).
  • Variable Component: Costs associated with actual consumption (e.g., electricity used per kilowatt hour).
• The Cost Equation:
  • $y = a + bx$
  • $y$ = Total Cost (dependent variable).
  • $a$ = Fixed Cost (the intercept on the Y-axis).
  • $b$ = Variable rate (the slope).
  • $x$ = Level of activity.
• Sample Mixed Cost Calculation:
  • Fixed monthly utility charge: $\$40$.
  • Variable rate: $\$0.03$ per kilowatt hour (Note: The instructor mentions current rates are closer to $\$0.11$ or $\$0.12$ in his area).
  • Activity level: $2,000$ watts.
  • Total Bill: $y = 40 + (0.03 \times 2,000) = 40 + 60 = \$100$.

Methods for Estimating and Analyzing Mixed Costs

1. Account Analysis: Reviewing accounts to classify them as fixed or variable.
2. Engineering Approach: Analyzing costs based on industrial engineering evaluations of what costs should be.
3. High-Low Method: A mathematical approach to estimate the variable and fixed components of a mixed cost.
4. Regression Analysis: A statistical tool used to find the line of best fit.
   • Scatter Graphs: Used to visualize data and identify outliers or anomalies.
   • JELR (Just Don't Look Right): A common professional term used by auditors, police, and customs officers to identify anomalies that require further investigation.

The High-Low Method: Detailed Procedure

• Core Principle: This method focuses strictly on Activity Level first, not dollar values.
• Step 1: Identify Extrema: Find the month with the highest activity level and the month with the lowest activity level from a data set.
• Step 2: Calculate Delta (Change):
  • Change in Cost = High Cost - Low Cost
  • Change in Activity = High Activity - Low Activity
• Step 3: Calculate Variable Rate ($b$):
  • $b = \frac{\text{Change in Cost}}{\text{Change in Activity}}$
• Step 4: Calculate Fixed Cost ($a$):
  • $a = \text{Total Cost} - (\text{Variable Rate} \times \text{Activity Level})$
  • This can be calculated using either the high point or the low point data.

Contribution Margin and Business Logic

• Accounting vs. Traditional Approach: The contribution margin approach separates variable costs from fixed costs, whereas the traditional approach focuses on gross margin (Sales - Cost of Goods Sold).
• Definition: The contribution margin is the amount of sales revenue remaining after variable costs are covered, which then contributes to covering fixed costs and generating profit.
• McDonald's Case Study:
  • A former owner of multiple McDonald's franchises monitored the contribution margin of every product.
  • Hash Brown Example: Sold for $\$1.59$. The variable cost (the cost of the hash brown itself) was only $\$0.09$, resulting in a contribution margin of $\$1.50$ per unit.
  • Waste Tracking: In high-volume businesses like McDonald's, any dropped item is recorded as "waste" so the owner can distinguish between lost sales and lost inventory costs.

Practice Exercise: Blood Test Cost Formula

• Data Analysis:
  • High Activity: February ($3,500$ tests, $\$14,500$ cost).
  • Low Activity: June ($1,500$ tests, $\$8,500$ cost).
• Calculations:
  • Change in Activity: $3,500 - 1,500 = 2,000$ units.
  • Change in Cost: $\$14,500 - \$8,500 = \$6,000$.
  • Variable Rate ($b$): $\$6,000 / 2,000 = \$3$ per test.
  • Fixed Cost ($a$): $\$14,500 - (3 \times 3,500) = 14,500 - 10,500 = \$4,000$.
• Cost Formula: $y = 4,000 + 3x$
• Prediction: For $2,300$ tests, the estimated total cost is $y = 4,000 + (3 \times 2,300) = 4,000 + 6,900 = \$10,900$.

Questions & Discussion

• Professor's Background: The instructor has a diverse work history, including teaching for 25 years (his longest career), working in Customs for six months (left because of poor work-life balance/working every weekend), and auditing.
• Dialogue on personal traits: A student jokes that the professor might have ADHD because he gets bored and moves between jobs. The professor admits if he is bored, he leaves, but notes that auditing allows one to visit many different places and hear many stories.
• Justin Trudeau's Visit: Prime Minister Justin Trudeau visited the University of Windsor but only went to the Engineering Building. The instructor hoped he would visit his income tax class, but was told the Prime Minister avoids such settings because students might ask technical tax questions that he leaves to his staff.
• World Cup: The instructor mentions having a beer to celebrate a team that eventually got kicked out of the World Cup.
• Student Discussion - Aspire Program:
  • Requirements: Students discuss the Aspire certificate, which requires attending three meetings (two already attended by one student), taking a business communication course, and completing a career development plan/resume submission.
  • Deadlines: Journal 2 and the self-critique (four pages double-spaced) are due by July 3rd.
  • Interviews: A student scheduled an Aspire interview for July 7th between $09:30$ and $09:50$, but realized it overlaps with an accounting quiz.
  • Interview Tips: Mention of bringing a file, paper, and pen to interviews to look professional and jot down questions.
• Restaurant Recommendations: Students discuss where to find protein/good food. Suggestions include Sam's (near Peter Peter) or a Swedish restaurant for more "authentic" cuisine compared to McDonald's.