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Cost Behaviour : Part 1 of 2

Make sure i -clicker is flashing green to ensure that vote is registered. Frequency is ‘CB’. . Ch. 6 Assignment due Feb 4(Mon), 11.59pm. Cost Behaviour : Part 1 of 2. Sections 1 and 2 January 30, 2013 Professor: Khim Kelly Office: HH386B

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Cost Behaviour : Part 1 of 2

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  1. Make sure i-clicker is flashing green to ensure that vote is registered. Frequency is ‘CB’. • Ch. 6 Assignment due Feb 4(Mon), 11.59pm Cost Behaviour: Part 1 of 2 • Sections 1 and 2 • January 30, 2013 • Professor: Khim Kelly • Office: HH386B • Office Hours: Mon/Wed 11:30am – 12:30pm and Appointment • Email: kokelly@uwaterloo.ca • TA: Kun Huo • Email: khuo@uwaterloo.ca

  2. 30 Jan 2013 Overview • Study tip • Do your self-study problems without looking at the solutions! (solutions are posted on LEARN) • Last lecture … • Finishing touches to Chapter 5 ABC • A complete ABC example • Today’s lecture … • Introduction to cost behaviour (Chapter 6) • How to use costs behaviour to predict costs • Analyze mixed costs

  3. Cost Categories • Fixed costs vs. Variable costs • Fixed costs • Committed • Discretionary • Step-variable costs • Mixed costs

  4. From Chapter 2: Fixed vs. Variable Costs • Total costs … • Total costs = Fixed costs + Variable costs • Fixed costs (i.e. rent, insurance, etc.) • Costs that remain unchanged within a relevant range, regardless of the level of activity • Caveat: Most fixed costs will change if there is a large enough change in activity • Costs per unit of activity decreases as activity level increases • Variable costs (i.e. DM, DL, sales commissions, shipping, etc.): • Costs that changes in direct proportion to changes in the level of activity within a relevant range • Costs per unit of activity is constant as activity level changes

  5. From Chapter 2: Fixed vs. Variable Cost Relation Between Cost per Activity and the Level of Activity Relation Between Total Cost and the Level of Activity $ Variable Cost $/Activity Variable Cost Fixed Cost Fixed Cost Activity Activity

  6. It is Clicker Time!! Feel Free to Work Together on Clicker Questions

  7. Clicker Question #1 Q: Which of the following does NOT describe a variable cost? • Variable costs are ALWAYS indirect costs to the cost object • Variable costs increase in total when the actual level of activity increases. • Variable costs (with respect to volume of goods produced) include direct labour costs • Variable costs include costs that can be traced directly to the cost object • Variable cost per unit does not change with activity level

  8. Clicker Question #1: Answer Q: Which of the following does NOT describe a variable cost? Answer: • Variable costs are ALWAYS indirect costs to the cost object

  9. More on Fixed Cost … • Otherwise known as capacity costs • Constant in total dollars within the relevant range • Committed • Particularly difficult to adjust, long-term: plants, major equipment, etc. • Discretionary • More flexible, short-term: R&D, insurance, advertising

  10. Step-Variable Cost • Costs that are incurred in ‘chunks’ • Fixed within a particular range, step in increments. • Be careful to prevent ‘fat’ build-up • Examples • Salaried staff • Space • Delivery truck

  11. Fixed Cost vs. Step Variable • Fixed costs will change with a substantial change in volume/activity. • Isn’t this just a step-variable cost? • Two key differences: • Width (volume of activity) of the step • Ease of making the step

  12. Mixed Cost • Elements of both fixed and variable • Some fixed cost even with no activity or regardless of activity level (intercept “a”) • Increasing per unit cost as activity climbs (slope “b”) • Y = a + bX a = Fixed Cost b = per unit Variable Cost X = units of activity Y = Total mixed cost Y Variable (b) Fixed (a) X

  13. It is Clicker Time!! Feel Free to Work Together on Clicker Questions

  14. Example: Mama Khim’s Kiosk Remember Mama Khim’s Kiosk (diapers and baby snack packs)? She needs your help classifying various costs as fixed or variable with respect to the volume of goods (diapers and snack packs) sold. Calculate the portion of variable and fixed costs.

  15. Mama Khim’s Kiosk Example

  16. Clicker Question #2 • Q: Calculate the total variable and total fixed costs for the month • A. Joe Mamma! • B. Variable $14,100; Fixed $9,968 • C. Variable $14,356; Fixed $9,712 • D. Variable $14,368; Fixed $9,700 • E.Variable $14,112; Fixed $9,956

  17. Mama Khim’s Kiosk Example

  18. Clicker Question #2: Answer • Calculate the total variable and total fixed costs for the month? • Answer: • D. Variable $14,368; Fixed $9,700

  19. Mama Khim’s Kiosk Example #2 Mama Khim’s “Healthy” Baby Snack Pack is so popular that it is now shipped all over the world. Mama Khim is relying on you to determine whether the following expenses on her company’s income statement are variable, fixed, or mixed?

  20. Mama Khim’s Kiosk Example #2 (P6-12) Information for the last 3 months:

  21. Mama Khim’s Kiosk Example #2 (P6-12) X X Note: Variable cost per unit is constant as activity level increases. Mixed cost per unit tends to decrease as activity level increases due to the fixed cost component.

  22. It is Clicker Time!! Feel Free to Work Together on Clicker Questions

  23. Mama Khim’s Kiosk Example #2 Clicker Question #3 • Q: What type of costs are 1) Advertising and 2) Salaries & Commissions? • A. 1) Fixed; 2) Variable • B. 1) Variable; 2) Variable • C. 1) Fixed; 2) Mixed • D. 1) Mixed; 2) Mixed • E. 1) Mixed; 2) Variable

  24. Mama Khim’s Kiosk Example #2 Clicker Question #3: Answer X X X X Answer: C. 1) Fixed; 2) Mixed

  25. Mama Khim’s Kiosk Example #2 (P6-12) X X X X X X

  26. Mixed Cost Analysis • How does management estimate both the fixed and variable components of costs? • High-low method • Least-squares regression • Both … • Require repeated observations of activity level and cost • Result in an equation that contains a fixed cost and per-unit of activity variable cost • Assume linearity relationship between cost and activity

  27. High-Low Method • Identify the highest and lowest activity levels (NOT the highest and lowest costs) • Calculate variable cost component (b) • Use the variable cost component (b) with either the highest or lowest data point to calculate fixed cost component (a) VC per Unit Cost at highest activity level - Cost at lowest activity level = Highest activity level - Lowest activity level Mixed Cost: Y = a + b*X

  28. Example: High-Low Method VC per Unit Cost at highest activity level - Cost at lowest activity level = Highest activity level - Lowest activity level

  29. It is Clicker Time!! Feel Free to Work Together on Clicker Questions

  30. Clicker Question #4 Q: Use the high-low method to develop the equation for the cost data (select option that is closest to your answer). • A. Y = $5,412 + $10.98X • B. Yellow = Go Karts + 9-irons • C. Y = $8,887 + $5.12X • D. Y = $9,891 + $4.92X • E. Y = $11,556 + $2.67X

  31. Clicker Question #4: Answer $34,500 - $18,750 = 5,000 - 1,800 $15,750 = 3,200 = $4.92 per Patient-Day Then: = $34,500 a + ($4.92 * 5,000) = a $9,891 Answer: D. Y = $9,891 +$4.92X

  32. Predicting Costs … What costs do we expect if patient days = 3,900 units? Y = $9,891 + $4.92X Y = $9,891 + $4.92*3,900 Y = $29,079 How did the hospital do?

  33. Summary • Today’s lecture … • Fixed costs, variable costs, step variable costs, mixed costs • How to use costs behaviour to predict costs • Analyze mixed costs (High-Low Method) • Next lecture … • Analyze mixed costs (Regression) • Another example of High-Low method • Contribution margin approach

  34. Additional Practice Try this question without using your notes. It is a good test of whether you understand the basics of using the high-low method to predict costs.

  35. E6-10 Northern lights Inns have a total of 2,000 rooms. On average, 70% of them are occupied each day. On average, operating costs per room per day are $21 (assuming 30 day months). This contains both variable and fixed cost elements. During Oct, the occupancy rate dropped to 45%. A total of $792,000 in operating cost was incurred during Oct. Estimate variable cost per occupied room per day.

  36. E6-10 Monthly operating costs at 70% occupancy: 2,000 rooms x 70% = 1,400 rooms 1,400 rooms x $21/day = $882,000 Monthly operating costs at 45% occupancy (given): = $792,000 Change in monthly costs = $ 90,000

  37. E6-10 Rooms occupied at 70% occupancy: 2,000 rooms x 70% = 1,400 rooms Rooms occupied at 45% occupancy: 2,000 rooms x 45% = 900 rooms Change in monthly activity = 500 rooms

  38. E6-10 Variable Costs = Change in Cost $90,000 = Change in Activity 500 rooms = $180 per room per month $180 per room = $6 per room per day 30 days in a month

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