MAC 7200 Chapter 3

Cost Behavior Overview

Key Concepts

  • Accountants and managers often assume that cost behavior is linear over some relevant range of activity or cost-driving levels.

  • Relevant Range: Specifies the interval of cost-driver activity within which a specific relationship between a cost and its driver will be valid, based on prior operational experiences.

Linear-Cost Behavior

  • Costs categorized as either fixed or variable within the relevant range of activity.

Management's Influence on Cost Behavior

Key Influences

  • Managers influence costs through:

    • Process and product design

    • Quality levels

    • Product features

    • Distribution channels

  • Decisions must weigh the costs and benefits, impacting the organization’s performance.

Capacity Decisions

  • Fixed costs related to achieving desired production/service levels while maintaining attributes of products/services.

Types of Fixed Costs

Committed Fixed Costs

  • Fixed costs that arise from ownership of facilities, equipment, and basic organizational structure.

    • Examples: Lease payments, property taxes, salaries of key personnel.

Discretionary Fixed Costs

  • Fixed costs determined by management planning processes, with no direct relationship to output levels.

    • Management decides how much to budget each period for discretionary items.

    • Example costs include advertising expenses and training.

Cost Functions

Importance

  • Cost functions are critical for planning and controlling activities within an organization, providing estimates of future costs based on cost drivers.

Steps for Cost Estimation

  1. Measure cost behavior concerning cost drivers.

  2. Use measurements to predict future costs based on expected levels of activity.

Cost Function Equation

  • General equation:

    • Y = Total cost

    • F = Fixed cost

    • V = Variable cost per unit

    • X = Cost-driver activity (units)

    • Example of mixed-cost function: Y = $10,000 + $5.00X

Choice of Cost Drivers

  • Activity analysis helps identify appropriate cost drivers.

  • Insightful cost drivers can lead to better managerial decision-making.

Methods of Measuring Cost Functions

  1. Engineering analysis

  2. Account analysis

  3. High-low analysis

  4. Visual-fit analysis

  5. Least-squares regression analysis

Engineering Analysis

  • Measures costs based on theoretical requirements rather than actual costs encountered.

Account Analysis

  • Classification of costs into fixed and variable costs based on plausible cost drivers.

High-Low Method

  • Analyzes costs based on extreme activity points (highest and lowest), plotting historical data for cost prediction.

Visual-Fit Method

  • Involves visually plotting a cost function through all available data versus just high-low points for greater reliability.

Least-Squares Regression Method

  • Utilizes statistical analysis to create an objective cost function that explains cost behavior.

Coefficient of Determination

  • Measures how well changes in cost drivers explain variability in costs, indicating the reliability and goodness of fit of the cost function.