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Chapter 3-accounting.docx

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Ryerson University
ACC 406
Vincent Cappelli

Chapter 3 – Cost behavior  Cost behavior represents the foundation on which managerial accounting is built, managers must properly understand cost behavior in order to make wise decisions.  Cost behavior is the general term for describing whether a cost changes when the level of output changes  Costs can be variable, fixed, or mixed; knowing how costs change as output changes is essential to planning, controlling and decision making.  Fixed cost is a cost that does not change in total as output changes- they are costs that in total are constant within the relevant range as the level of output increases or decreases. Two types of fixed costs;  First one: Discretionary fixed costs are fixed costs that can changed or avoided relatively easily at management discretion. This cost might depend on the size of the ad but not the number of units produced or sold.  Second one: Committed fixed costs are fixed costs that cannot easily changed; often these costs are those that involve a long-term contract (leasing) or a purchase of a property, plant and equipment.  Variable cost on the other hand increase in total with an increase in an output and decrease in total with a decrease in output- they are costs that in total vary in direct proportion to changes in output within the relevant range.  Budgeting, deciding to keep or drop a product line, and evaluating the performance of segments all benefit from knowledge of cost behavior.  The term variable cost do not exist in a vacuum they only have meaning when related to come output measure .. other words a cost is fixed or variable with respect to some outpit measure or driver.  To determine cost behavior, you have to determine business activity “what causes the cost of this particular activity to go up or down”  Cost driver is a casual measurement that causes cost to change; identifying and managing the cost drivers helps manages better predict and control costs.  Relevant range is the range of output over which the assumed cost relationship is valid for the normal operations of a firm. The relevant range limits the cost relationship to the range of operations that the firm normally expects to occur.  In each case (fixed, mixed, or variable) the cost is related to only one driver and is defined within the relevant range.  The cost relationship considered is between the supervision cost and the number of items processed.  The number of items processed is called output measure or driver.  Higher output means that the fixed costs can be spread over more units and are thus smaller per unit.  Unit fixed costs can often be misleading and may lead to poor decisions.  To find total variable cost , equation  Total variable costs= variable rate x amount of output  As units produced increase, the total variable costs also increases; it can be seen as that as total cost increases in direct proportion to increases in the number of computers processed.  Refer to exhibit 3-4 for graph of semi variable; it is when economies of scale are present, the true total cost function is increasing at a decreasing rate.  Relevant range is defined as the range of activity for which the assumed cost relationships are valid.  Mixed costs are costs that have both a fixed and variable component.  Equation for mixed costs  total cost= total fixed costs + total variable cost.  Mixed costs are represented by a line that intercepts the vertical axis. The y-intercept corresponds to the fixed cost and the slope of the line gives the variable cost per unit of activity driver.  Step cost behavior are when cost functions are discontinuous.  A step cost displays a constant level of cost for a range of output and then jumps to a higher level of cost at some point where it remains for a similar range of output.  EXHIBIT 3-5 TO 3-6B shows the different types of graphs of step costs.  Narrow steps in the graph means the cost changes in response to fairly small changes in output; if the step costs are very narrow, we can approximate the step cost as strictly variable cost.  Methods for separating mixed cost into fixed and variable components: high low method, scattergraph method and least square method.  Equation for total cost for straight line total cost= fixed cost + (variable rate x output)  The dependent variable is variable whose value depends on the value of another variable. Total cost is dependent variable.  Independ
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