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Chapter 3

COMM-2016EL Chapter Notes - Chapter 3: Industrial Engineering, Flight Controller, Systematic Review


Department
Commerce and Administration
Course Code
COMM-2016EL
Professor
Kayla Levesque
Chapter
3

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Chapter 3 Measureet of Cost Behaviour
Cost Drivers and Cost Behaviour
Careful use of linear-cost behaviour with a single cost driver often provides cost estimates that are accurate
enough for most decisions… The added benefit of understanding “true” cost behaviour may be less than the
cost of determining “true” cost behaviour
RECAP: Cost Drivers any factor that affects total cost (any change in the quantity of the cost driver will
cause a change in the total cost of the object)
Linear-Cost Behaviour activity that can be graphed with a straight line when a cost changes proportionately
with changes in a cost driver
Volume as the Primary Driver
For some costs, volume of a product produced or service provided is the primary driver. These costs are easy to
identify with/trace to products or services
An example includes the costs of printing labour, paper, ink, and binding to produce a textbook, the
number of copies printed affects the total costs for each item
We could relatively easily trace the use of these resources to the copies of the text printed… Schedules,
payroll records, and other documents show how much of each was used to produce the book
Activities not Directly Related to Volume
Other costs are more affected by activities not directly related to volume, and often have multiple cost drivers.
These costs are NOT easy to identify with/trace to products or services
An example would be the wages and salaries of the editorial staff or publisher of a textbook… These
personnel produce many different textbooks, and it would be very difficult to determine exactly what
portion of their costs went into a specific book
Understanding and measuring costs that are difficult to trace to outputs can be especially challenging
In practice, many organizations use single cost drivers to describe each cost even though they may have
multiple causes
This approach is easier and less expensive than using nonlinear relationships and/or multiple cost drivers
TYPES OF COST BEHAVIOUR
In addition to the 2 pure versions of cost (fixed & variable), 2 additional types of costs combine characteristics
of both fixed- and variable-cost behaviour:
Step Costs
Step Costs costs that change abruptly at intervals of activity because the
resources and their costs come in indivisible chunks
If the individual chunks of cost are relatively large and apply to a specific,
broad range of activity, the cost is considered a fixed cost over that range of
activity
Within each relevant range, this step cost behaves as a fixed cost
The total step cost at a level of activity is the amount of fixed cost
appropriate for the range containing the activity level
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ex. When oil/gas exploration activity reaches a certain level in a given region, an additional rig must be
leased… However, one level of oil and gas rig leasing will support all volumes of exploration activity within a
relevant range of drilling
In contrast, accountants describe step costs as variable when the individual
chunks of cost are relatively small and apply to a narrow range of activity
Because the steps are relatively small, this step cost behaves much like a
variable cost, and could be used as such for planning with little loss of
accuracy
ex. Suppose one cashier can serve an average of 20 customers per hour, and that
within the relevant range of shopping activity the number of shoppers can range
from 40 to 440 per hour… The corresponding number of cashiers would range
between 2 and 22
Mixed Costs
Mixed Costs costs that contain elements of both fixed- and variable- cost behaviour
The fixed element is determined by the planned range of activity level, and there is usually only one
relevant range of activity and one level of fixed cost
The variable cost element is a purely variable cost that varies proportionately with activity within the
single relevant range
Total Mixed Cost = Fixed Cost + Variable Cost
The knowledge of cost behaviour can be used to:
1. Plan costs
2. Provide feedback to managers; AND
3. Make decisions about the most efficient use of resources
ex. In a hospital, salaries of the maintenance personnel and costs of equipment are fixed at $10,000 per month.
In addition, cleaning supplies and repair materials may vary at a rate of $5 per patient-day delivered by the
hospital
Suppose the hospital expects to service 4,000 patient-days next month. This month’s predicted facilities
maintenance department costs are $10,000 fixed plus the variable cost that equals 4,000 patient-days times $5
per patient-day for a total of $30,000
Maageet’s Influence on Cost Functions
In addition to measuring and evaluating current cost behaviour, managers can influence cost behaviour through
decisions about such factors as:
1. PRODUCT AND SERVICE DECISIONS
Perhaps the greatest influences on product and service costs are a manager’s choices of product mix, design,
performance, quality, features, distribution, etc. Each of these decisions contributes to the organization’s
performance and should be made in a cost-benefit framework
ex. Budget Rent-a-Car would add a feature to its services only if the cost of the feature could be justified
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2. CAPACITY DECISIONS
Capacity Costs - the fixed costs of being able to achieve a desired level of production or to provide a desired
level of service, while maintaining product or service attributes, such as quality
Companies in industries with long-term variations in demand must exercise caution when making capacity
decisions. Fixed-capacity costs cannot be recovered when demand falls during an economic downturn
Variable costs can be controlled whereas fixed-capacity costs cannot
Faced with the strategic decision concerning scale & scope of operations, a company may choose to forgo sales
& market share by controlling overtime and outsourcing costs and keeping the same capacity
Alternatively, if the company is convinced that demand over capacity is to continue in the long-run, adding
fixed costs by increasing capacity makes sense
Committed Fixed Costs
Committed Fixed Costs costs arising from the possession of facilities, equipment, and a basic organization;
the large, indivisible chunks of costs that the organization is obligated to incur or usually would not consider
avoiding
Committed costs include:
Mortgage or lease payments;
Interest payments on long-term debt;
Property taxes;
Insurance; and
Salaries of key personnel
Only major changes in the philosophy, scale, or scope of operations could change these committed fixed costs
in the future periods
Discretionary Fixed Costs
Discretionary Fixed Costs costs determined by management as part of the periodic planning process to meet
the organization’s goals
These costs have no obvious relationship to levels of output activity, but are determined as part of the
periodic planning process
Discretionary costs include:
Advertising and promotion;
Public relations;
Research and development;
Charitable donations;
Employee training programs; and
Purchased management consulting services
Unlike committed fixed costs, managers can alter discretionary fixed costs easily up or down even within a
budget period, if they decide that different levels of spending are desirable
These fixed costs may be essential to the long-run achievement of the organization’s goals, but
managers can vary spending levels broadly in the short-run
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