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Schulich ACTG 2020 Class 4.docx

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York University
ACTG 2020
Jean Adams

Class 4 Estimating Costs - All managerial decisions deal with choices among different activity levels. Managers must estimate which costs will vary with the activity & by how much. Fixed Costs - Costs that do not change in total as the level of business activity changes - An example of a fixed cost is the insurance on a factory building. The insurance cost doesn’t change as the level of production changes. - Fixed Cost per Unit o Average fixed costs per unit decrease as the activity level increases. The fixed cost per local call decreases as more local calls are made. Variable Costs - Costs that change in total as the level of business activity changes - An example of a variable cost is salesperson commissions - Variable Cost per Unit Total Cost Graph $12,500 $10,000 $7,500 $5,000 $2,500 2,500 5,000 7,50010,000 Units Sold o A variable cost remains constant if expressed on a per unit basis. The cost per minute talked is constant. For example, 10 cents per minute. Determining Total Costs - The basic cost equation is: Total Cost = Fixed Cost + Variable Cost - This graph shows the ccombination of a fixed cost line and a variable cost line. Relevant Range - The assumptions as to cost behavior are valid as long as the activity level is within the relevant range. - The relevant range cannot be specifically determined, but is considered the range of activity at which the company usually operates. Mixed Cost - A mixed cost has both fixed and variable components. E.g. Utility cost The total mixed cost line can be expressed as an equation:Y = a + bX Where: Y = the total mixed cost a = the total fixed cost (the vertical intercept of the line) b = the variable cost per unit of activity (the slope of the line) X = the level of activity Identifying Fixed and Variable Elements of a Mixed Cost - Four of the most commonly used techniques for determining the fixed and variable components of a mixed cost are - 1. The Engineering Approach o Based on the judgment and experience of an expert in cost analysis. o The expert (possibly an engineer) will analyze the cost component to determine which costs are fixed and which are variable, using techniques such as time and motion studies. o It is often used when the company has no past experience concerning a cost’s reaction to activity. - 2. Scatter Graphing o This technique plots historical activity and cost information on a graph. The graph is then analyzed to determine the fixed and variable components of the total cost. o The cost analyst draws a line that appears to be the “best fit” to the data. The line represents the estimated cost behaviour pattern. - 3. The High-Low Method o Assume the following hours of maintenance work and the total maintenance costs for six months, Y = $3,400 + 8X - 4. Least Squares Regression Analysis o A method used to analyze mixed costs if a scatter graph plot reveals an approximate relationship between X and Y variable o This method uses all of the data points to estimate the fixed and variable cost components of a mixed cost o The goal of this method is to fit a straight line to the data that minimizes the sum of the squared errors o The cost analysis objective is the same: Y = a + bX o Least-squares regression also provides a statistic, called R^2, that is a measure of the goodness of fit of the regression line to the data points (or the percentage of the variation in total cost explained by activity o Always use this m
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