02 Cost Behavior and CVP Analysis SV

Topic 3A: Cost Behavior

1. Classifying Costs by Behavior

• Understand how costs vary based on activity levels.

• Key Question: How will profits change with changes in selling price, volume, or costs?

2. Estimated Cost to Run a Stall at Geylang Serai Bazaar

• Source: https://dollarsandsense.sg/how-much-does-it-cost-to-run-a-stall-at-geylang-serai-bazaar/

3. Learning Objectives

• Differentiate between:

  • Variable Costs

  • Fixed Costs

  • Mixed Costs

• Analyze cost behavior using:

  • Scattergraph Method

  • High-low Method

  • Least Squares Regression Method

4. Variable Costs (Recap)

• Variable costs (VC) increase with activity.

• Cost per unit remains constant as activity increases.

• Calculation Example:

  • VC per unit = Total Variable Costs / Number of Units

5. Fixed Costs (Recap)

• Total Fixed Costs (FC) remain constant as activity increases.

• Cost per unit decreases as activity increases.

• Calculation Example:

  • FC per unit = Total Fixed Costs / Number of Units

6. Cost Classifications for Predicting Behavior

• Variable Costs

  • Total variable costs change with activity.

  • Variable cost per unit remains the same across a relevant range.

• Fixed Costs

  • Total fixed costs do not change with activity level unless outside relevant range.

  • Average fixed cost per unit goes down as activity level rises.

7. The Activity Base (Cost Driver)

• Definition: Measure causing the incurrence of a variable cost.

• Examples of Activity Bases:

  • Direct materials based on production units.

  • Equipment maintenance based on machine hours.

  • Direct labor costs based on labor hours.

8. Cost Behavior Analysis: Curvilinear Cost Function

• A linear approximation is valid within the relevant range, simplifying analysis.

• Relevant range: the range where cost assumptions hold true.

9. Types of Variable Costs

• True Variable Costs: Directly proportional to activity level (e.g., direct materials).

• Step Variable Costs: Adjust in larger increments; only change after certain levels of activity are reached (e.g., maintenance workers).

10. Types of Fixed Costs

• Discretionary Fixed Costs: Can be adjusted in the short term (e.g., advertising).

• Committed Fixed Costs: Long-term and inflexible (e.g., long-term leases).

11. Fixed Costs and the Relevant Range

• Fixed costs may step up when reaching new capacity thresholds (e.g., renting additional space).

12. Direct Labor: Variable or Fixed?

• Direct labor is generally treated as a variable cost but can be fixed depending on labor laws and contractual agreements.

13. Mixed Costs

• Definition: Contains both fixed and variable elements (e.g., utility costs).

• Total cost behaves as:

  • Total Costs = Fixed Costs + (Variable Cost per Unit × Activity Level)

14. Mixed Costs Calculation Example

• Utility Cost = $40 fixed + $0.03 variable per kWh for high usage.

15. Cost Comparison and Summary

• Variable Costs:

  • Change with activity levels; consistent per unit.

• Fixed Costs:

  • Remain constant; decreases per unit as activity increases.

• Mixed Costs:

  • Combination of both variable and fixed elements; varies with activity yet fixed amounts exist.

16. Methods for Analyzing Mixed Costs

• Scattergraph Method: Visualize cost behavior.

• High-low Method: Determine variable and fixed costs using highest and lowest points.

• Least-Squares Regression Method: Utilizes all data points for more accuracy in estimating costs.