Managerial Accounting: An Introduction To Concepts, Methods, And Uses

1. Managerial Accounting: An Introduction To Concepts, Methods, And Uses Chapter 5 Cost Drivers and Cost Behavior Maher, Stickney and Weil

2. Learning Objectives (Slide 1 of 2) • Distinguish between variable costs and fixed costs, between short run and long run, and define the relevant range. • Identify capacity costs, committed costs, and discretionary costs. • Describe the nature of the various cost behavior patterns. • Describe how managers use cost behavior patterns.

3. Learning Objectives (Slide 2 of 2) • Describe how to use historical data to estimate costs. • Describe how analysts estimate cost behavior using regression, account analysis, and engineering methods. • Explain the costs, benefits, and weaknesses of the various cost estimation methods. • Identify the derivation of learning curves. • Interpret the results of regression analyses.

4. Nature of Fixed & Variable Costs (Slide 1 of 2) • Variable costs - change in total as the level of activity changes • Also known as an engineered cost • There is a definitive physical relationship to the activity measure • Fixed costs - do not change in total with changes in activity levels

5. Nature of Fixed & Variable Costs (Slide 2 of 2) • Accounting concepts of variable and fixed costs are short run concepts • Apply to a particular period of time • Relate to a particular level of production • Relevant range is the range of activity over which the firm expects cost behavior to be consistent • Outside the relevant range, estimates of fixed and variable costs may not be valid

6. Types of Fixed Costs (Slide 1 of 2) • Capacity costs- fixed costs that provide a firm with the capacity to produce and/or sell its goods and services • Also know as committed costs and typically relate to a firm’s ownership of facilities and its basic organizational structure • Capacity costs may cease if operations shut down, but continue in fixed amounts at any level of operations • Examples: property taxes, executive salaries

7. Types of Fixed Costs (Slide 2 of 2) • Discretionary costs - need not be incurred in the short run to operate the business, however, usually they are essential for achieving long-run goals • Also referred to as programmed or managed costs • Examples: research and development costs, advertising

8. Other Cost Behavior Patterns (Slide 1 of 2) • Curvilinear variable costs - costs may vary with the volume of activity, but not in constant proportion • For example, as volume increases, the cost of materials may decrease per unit (perhaps due to quantity discounts), exhibiting decreasing marginal costs • Marginal cost - the cost of producing the next unit

9. Other Cost Behavior Patterns (Slide 2 of 2) • Learning curves - shows how the time required to perform a task goes down, per unit, as the number of units increases • Some companies experience learning effects on costs • Compete by learning quickly so they become low-cost leaders and capture market share

10. Semivariable Costs • Refers to costs that have both variable and fixed components • Examples: repair and maintenance costs, utility costs

11. Semifixed Costs • Refers to costs that increase in steps • Example: A quality-control inspector can examine 1,000 units per day. Inspection costs are semifixed with a step up for every 1,000 units per day • Distinction between fixed and semifixed is subtle • Change in fixed costs usually involves a change in long-term assets: a change in semifixed costs often does not

12. Cost Estimation Methods • Cost estimates are used in various business decisions, planning exercises, and performance evaluations • Three methods discussed • Statistical regression analysis • Account analysis • Engineering estimation

13. Estimating Costs Using Historical Data (Slide 1 of 2) • Trying to estimate fixed and variable costs using the following formula TC=F + VX Where: TC = Total Costs F = Fixed Costs V = Variable Costs X = Activity Variable

14. Estimating Costs Using Historical Data (Slide 2 of 2) • The following steps should be taken in analyzing cost data: • Review alternative cost drivers • Plot the data • Examine the data and method of accumulation

15. Statistical Regression Analysis (Slide 1 of 2) • Used to estimate the relationship between costs and the activity that caused, or is closely associated with, those costs • Costs are the dependent variable(s) • Activity level is the independent variable • Fits the data points to a line using least-squares criterion

16. Statistical Regression Analysis (Slide 1 of 2) • Results of this analysis yield an estimate of both the fixed component and the cost driver rates (variable component)

17. Account Analysis • Analysts review each cost account and classifies it according to its relation to a cost driver • The sum of costs for each activity are divided by the sum of the cost driver volumes to determine the cost driver rates • These cost driver rates correspond to the coefficients calculated using regression analysis

18. Engineering Method of Estimating Costs • The engineering method indicates what costs should be • Analysts study the physical relation between the quantity of inputs and outputs • Determine the steps required to perform the task, the time needed to complete each step, the number and type of employees required, and the materials and other inputs needed • The accountant assigns costs to each of the inputs to estimate the cost of the outputs

19. Data Problems • Missing Data • Outliers • Allocated and discretionary costs • Inflation • Mismatched time periods • Trade-offs in choosing the time period

20. Interpreting Regression Analysis Output (Slide 1 of 2) • Standard errors of the coefficients indicate the degree of confidence we can have in the fixed and variable cost coefficients • The smaller the standard error, the more precise the estimate • The t-statistic is the ratio between an estimated coefficient and its standard error • If about 2 or larger, we can be relatively confident that the actual coefficient differs from 0

21. Interpreting Regression Analysis Output (Slide 2 of 2) • If a variable cost coefficient has a small t-statistic, it may indicate that little relation exists between the activity and changes in costs • If a fixed cost coefficient has a small t-statistic, it may indicate that these costs have little, if any, fixed cost component

22. R2 • R2 measures how well the line fits the data • An R2 of 1 means that the regression explains all of the variance • An R2 of 0 means that the regression explains none of the variance • Many believe that a low R2 indicates a weak relationship between total costs and the activity base

23. Cautions When Using Regression • Users of regression analysis should be cautious in drawing inferences from regression results unless they are familiar with statistical estimation problems such as: • Multicollinearity • Autocorrelation, and • Heteroscedasticity

24. If you have any comments or suggestions concerning this PowerPoint Presentation for Managerial Accounting, An Introduction To Concepts, Methods, And Uses, please contact: • Dr. Donald R. Trippeer, CPA • donald.trippeer@colostate-pueblo.edu Colorado State University-Pueblo