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Lecture

# Chapter 4

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Brock University

Accounting

ACTG 1P11

Norman Chasse

Winter

Description

ACTG 1P11 – MA CHAPTER 6
Cost Behaviour – Analysis & Use
A. Cost Behaviour
- Costs can be described as variable, fixed and mixed, based on
how they change in relation to changes in the volume of output
- Variable – cost total changes in direct proportion to the change in
volume
o Variable Cost (VC) is constant on a per-unit basis
o When a total variable cost is graphed, it will be a straight
upward sloping line starting at the origin (0,0).
o Variable Cost per Unit (VCU) is equal to the slope of the
total variable cost line
o Y = vx; where Y= total cost, v = VCU, x = # of units
EXAMPLE: Each bicycle requires one bicycle chain costing $8. (Variable
cost is constant on a per-unit basis at $8. Total variable cost when 100
bicycles are produced is equal to $8 *100=$800.)
- Fixed – remains constant in total dollar amount through wide
ranges of volume
o FC decreases on a per-unit basis as the activity level
increases
o When graphed, a fixed cost is a straight flat (180°) line that
does not start at the origin; the FC line intercept’s the Y axis
at a level equal to fixed costs
o Y = f; where Y = total cost, f = total fixed cost
EXAMPLE: Fashion photographer Lori Yang rents studio spaces in a
prestige location for $50,000 a year. She measures her firm’s activity in
terms of the number of photo sessions. How would you graph the cost of
studio rental in relation to firm activity?
o Fixed costs are categorized as either committed or
discretionary Committed fixed costs relate to investment in plant,
equipment, and basic administrative structure. It is
difficult to reduce these fixed costs in the short-term.
Examples:
• Depreciation on plant facilities.
• Taxes on real estate.
• Insurance.
• Salaries of key operating personnel.
Discretionary fixed costs arise from annual decisions
by management to spend in certain fixed cost areas.
These costs can often be reduced in the short-term.
Examples:
• Advertising.
• Research.
• Management development programs.
- Mixed - A mixed total cost contains elements of both variable and
fixed costs.
o Total mixed cost = VC + FC
o Both total cost and unit cost vary as the output varies
o When a total mixed cost is graphed, it will be an upward
sloping line that intersects the Y axis at a point other than
zero; the slope of the line is VCU and the intercept is equal
to total fixed costs
o Y = f + vx; where Y=total costs, f = total FC (intercept), v =
VCU (slope) and x = # of units (volume of activity)
o Sometimes described as Y = a + bx
Example: Lori Yang leases an automated photo developer for $2,500 per
year plus 2¢ per photo developed.
Q: How would the cost of the photo developer be shown graphically? What
is the cost Equation? How much will it cost to develop 10,000 photos? B. Relevant range
- Relevant range = range of operations over which the variable/fixed
classification is assumed to be valid. In this range:
o Total FC remains constant
o VCU remains constant
- A change in cost behaviour will occur when operating within a
different relevant range
o An increase in fixed costs shifts the total cost curve upward; the
reverse also applies
o An increase in UVC causes the slope of the total cost curve to
be steeper; the reverse also applies
C. Other Cost Behaviours
- Many costs are neither purely fixed or purely variable; managers will
often approximate these costs as mixed or break them into smaller
relevant ranges
- Variable/fixed equations – assumes a linear cost function
o What happens when the cost is non-linear?
o What happens when we have step-costs; step-variable cost or
step-fixed cost behaviour?
o Ex:
A B C E
D
C
B
A
D. Analysis of Cost Behaviour
- Cost estimation methods are used to determine the fixed and variable
cost components of various costs; managers can then use this
information to predict costs and make business decisions
- Methods include:
o Account analysis – subjective review using professional
judgement
Classify each G/L account as variable, fixed or mixed
o Scatter Plots/Scattergraphs – plot cost and activity on a graph
and plot line through the data points; line is fitted to the plotted
points by eye using a ruler.
Volume data on the x-axis and cost data on the y-axis
If a relationship between the volume and cost data exists,
data points will align close to a straight line; if no
relationship exists, the data points will appear random
This method allows managers to identify and remove
outliers; i.e., abnormal data points
This method lacks precision
Example: Piedmont Wholesale Florists
o High-low method – fixes a mixed cost line based on the cost
and activity level at the highest and lowest activity level data
points
VC per unit est. = (High activity cost - Low activity
Cost) / (High activity - Low activity) FC per unit est. = Total cost at either activity level – Unit
variable cost x activity level
A weakness of the method is that only two data points are
used to create the cost formula. The high and low points
may not be representative of the usual activity and cost.
Example: Kohlson Company
o Regression analysis – aka “Least Squares Regression”

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