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Demonstration Problem

Accounting What the Numbers Mean 9e. Demonstration Problem. Chapter 12 – Exercise 4 Estimating Costs Based on Behavior Patterns. Problem Definition.

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Demonstration Problem

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  1. Accounting What the Numbers Mean 9e Demonstration Problem Chapter 12 – Exercise 4 Estimating Costs Based on Behavior Patterns

  2. Problem Definition • The following table shows the amount of cost incurred in May for the cost items indicated. During May 16,000 units of the firm’s single product were manufactured. Raw materials $83,200 Factory depreciation expense 81,000 Direct labor 198,400 Production supervisor’s salary 12,200 Computer rental expense 8,400 Maintenance supplies used 1,600

  3. Problem Requirements • How much cost would you expect to be incurred for each of the above items during June when 19,200 units of product are planned for production? • Calculate the average total cost per unit for the 16,000 units manufactured in May. Explain why this figure would not be useful to a manager interested in predicting the cost of producing 19,200 units in June.

  4. Problem Solution • Step 1– Determine the cost behavior pattern for each cost item: Cost Behavior Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used

  5. Problem Solution • Step 1 – Determine the cost behavior pattern for each cost item: Cost Behavior Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Is the cost item a variable cost or a fixed cost?

  6. Problem Solution • Step 1 – Determine the cost behavior pattern for each cost item: Cost Behavior Raw materials Variable Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Variable costs change as activity changes.

  7. Problem Solution • Step 1 – Determine the cost behavior pattern for each cost item: Cost Behavior Raw materials Variable Factory depreciation expense Fixed Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Fixed costs remain constant as activity changes.

  8. Problem Solution • Step 1 – Determine the cost behavior pattern for each cost item: Cost Behavior Raw materials Variable Factory depreciation expense Fixed Direct labor Variable Production supervisor’s salary Computer rental expense Maintenance supplies used

  9. Problem Solution • Step 1 – Determine the cost behavior pattern for each cost item: Cost Behavior Raw materials Variable Factory depreciation expense Fixed Direct labor Variable Production supervisor’s salary Fixed Computer rental expense Maintenance supplies used

  10. Problem Solution • Step 1 – Determine the cost behavior pattern for each cost item: Cost Behavior Raw materials Variable Factory depreciation expense Fixed Direct labor Variable Production supervisor’s salary Fixed Computer rental expense Fixed Maintenance supplies used

  11. Problem Solution • Step 1 – Determine the cost behavior pattern for each cost item: Cost Behavior Raw materials Variable Factory depreciation expense Fixed Direct labor Variable Production supervisor’s salary Fixed Computer rental expense Fixed Maintenance supplies used Variable

  12. Problem Solution • Step 2- Determine the fixed amount or variable rate for each cost item at 16,000 units of activity: Cost @ 16,000 units Cost Behavior Fixed Amount Variable Rate/Unit Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost $ 83,200 81,000 198,400 12,200 8,400 1,600 $384,800 Variable Fixed Variable Fixed Fixed Variable

  13. Problem Solution • Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity: Cost @ 16,000 units Cost Behavior Fixed Amount Variable Rate/Unit Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost $ 83,200 81,000 198,400 12,200 8,400 1,600 $384,800 Variable Fixed Variable Fixed Fixed Variable $ 5.20 Variable rate calculation: $83,200 / 16,000 units = $ 5.20/unit

  14. Problem Solution • Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity: Cost @ 16,000 units Cost Behavior Fixed Amount Variable Rate/Unit Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost $ 83,200 81,000 198,400 12,200 8,400 1,600 $384,800 Variable Fixed Variable Fixed Fixed Variable 81,000 $ 5.20 Fixed costs items will remain constant regardless of the level of activity (within the relevant range).

  15. Problem Solution • Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity: Cost @ 16,000 units Cost Behavior Fixed Amount Variable Rate/Unit Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost $ 83,200 81,000 198,400 12,200 8,400 1,600 $384,800 Variable Fixed Variable Fixed Fixed Variable 40,500 $ 5.20 12.40 Variable rate calculation: $198,400 / 16,000 units = $12.40/unit

  16. Problem Solution • Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity: Cost @ 16,000 units Cost Behavior Fixed Amount Variable Rate/Unit Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost $ 83,200 81,000 198,400 12,200 8,400 1,600 $384,800 Variable Fixed Variable Fixed Fixed Variable 40,500 12,200 $ 5.20 12.40

  17. Problem Solution • Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity: Cost @ 16,000 units Cost Behavior Fixed Amount Variable Rate/Unit Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost $ 83,200 81,000 198,400 12,200 8,400 1,600 $384,800 Variable Fixed Variable Fixed Fixed Variable 40,500 6,100 8,400 $ 5.20 12.40

  18. Problem Solution • Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity: Cost @ 16,000 units Cost Behavior Fixed Amount Variable Rate/Unit Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost $ 83,200 81,000 198,400 12,200 8,400 1,600 $384,800 Variable Fixed Variable Fixed Fixed Variable 40,500 6,100 4,200 $ 5.20 12.40 0.10 Variable rate calculation: $1,600 / 16,000 units = $ 0.10/unit

  19. Problem Solution • Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity: Cost @ 16,000 units Cost Behavior Fixed Amount Variable Rate/Unit Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost $ 83,200 81,000 198,400 12,200 8,400 1,600 $384,800 Variable Fixed Variable Fixed Fixed Variable 81,000 12,200 8,400 $ 101,600 $ 5.20 12.40 0.10 $17.70

  20. Problem Solution • Step 2 - Determine the fixed amount or variable rate for each cost item at 16,000 units of activity: Cost @ 16,000 units Cost Behavior Fixed Amount Variable Rate/Unit Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost $ 83,200 81,000 198,400 12,200 8,400 1,600 $384,800 Variable Fixed Variable Fixed Fixed Variable 81,000 12,200 8,400 $ 101,600 $ 5.20 12.40 0.10 $17.70 Cost formula = $101,600 fixed cost + $17.70 per unit variable cost

  21. Problem Solution • Step 3– Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determined in Step 2: Cost Behavior Fixed Amount Variable Rate/Unit Cost @ 19,200 units Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Variable Fixed Variable Fixed Fixed Variable 81,000 12,200 8,400 $ 101,600 $ 5.20 12.40 0.10 $17.70

  22. Problem Solution • Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determinedin Step 2: Cost Behavior Fixed Amount Variable Rate/Unit Cost @ 19,200 units Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Variable Fixed Variable Fixed Fixed Variable 81,000 12,200 8,400 $ 101,600 $ 5.20 12.40 0.10 $17.70 $ 99,840 Calculation: 19,200 units * $5.20 per unit

  23. Problem Solution • Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determinedin Step 2: Cost Behavior Fixed Amount Variable Rate/Unit Cost @ 19,200 units Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Variable Fixed Variable Fixed Fixed Variable 81,000 12,200 8,400 $ 101,600 $ 5.20 12.40 0.10 $17.70 $ 99,840 81,000 Fixed costs do not change at 19,200 units.

  24. Problem Solution • Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determinedin Step 2: Cost Behavior Fixed Amount Variable Rate/Unit Cost @ 19,200 units Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Variable Fixed Variable Fixed Fixed Variable 81,000 12,200 8,400 $ 101,600 $ 5.20 12.40 0.10 $17.70 $ 99,840 81,000 238,080 Calculation: 19,200 units * $12.40 per unit

  25. Problem Solution • Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determinedin Step 2: Cost Behavior Fixed Amount Variable Rate/Unit Cost @ 19,200 units Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Variable Fixed Variable Fixed Fixed Variable 81,000 12,200 8,400 $ 101,600 $ 5.20 12.40 0.10 $17.70 $ 99,840 81,000 238,080 12,200

  26. Problem Solution • Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determinedin Step 2: Cost Behavior Fixed Amount Variable Rate/Unit Cost @ 19,200 units Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Variable Fixed Variable Fixed Fixed Variable 81,000 12,200 8,400 $ 101,600 $ 5.20 12.40 0.10 $17.70 $ 99,840 81,000 238,080 12,200 8,400

  27. Problem Solution • Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determinedin Step 2: Cost Behavior Fixed Amount Variable Rate/Unit Cost @ 19,200 units Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Variable Fixed Variable Fixed Fixed Variable 81,000 12,200 8,400 $ 101,600 $ 5.20 12.40 0.10 $17.70 $ 99,840 81,000 238,080 12,200 8,400 1,920 Calculation: 19,200 units * $0.10 per unit

  28. Problem Solution • Step 3 – Calculate the cost expected to be incurred in June when 19,200 units are manufactured using the cost formula determinedin Step 2: Cost Behavior Fixed Amount Variable Rate/Unit Cost @ 19,200 units Raw materials Factory depreciation expense Direct labor Production supervisor’s salary Computer rental expense Maintenance supplies used Total Cost Variable Fixed Variable Fixed Fixed Variable 81,000 12,200 8,400 $ 101,600 $ 5.20 12.40 0.10 $17.20 $ 99,840 81,000 238,080 12,200 8,400 1,920 $441,440

  29. Problem Requirements • How much cost would you expect to be incurred for each of the above items during June when 19,200 units of product are planned for production? • Calculate the average total cost per unit for the 16,000 units manufactured in May. Explain why this figure would not be useful to a manager interested in predicting the cost of producing 19,200 units in June.

  30. Problem Solution • Average total cost for May: • It would not be meaningful to use this average total cost figure to predict costs in the subsequent months; that would involve unitizing the fixed expenses – and they do not behave on a per unit basis. $384,800 / 16,000 =$24.05 per unit

  31. Problem Solution • Average total cost calculations are only valid for the number of units used in the calculation. Average total cost for any other number of units produced would be different because the fixed expenses per unit would decrease for each additional unit produced. • Using the average total cost of $24.05 to estimate the cost of producing 19,200 units would give an estimate of $461,760, which is significantly higher than the $441,440 calculated in part a using the cost formula: Total Cost = $101,600 fixed cost + $17.70 per unit variable cost

  32. Accounting What the Numbers Mean 9e You should now have a better understandingof using cost behavior information. Remember that there is a demonstration problem for each chapter that is here for your learning benefit. David H. Marshall Wayne W. McManus Daniel F. Viele

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