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7

Chapter Seven

- Activity Analysis, Cost Behavior, and

CostEstimation

Introduction

Costestimation

Process ofdeterminingcost behavior,often

focusingon historicaldata.

Cost Behavior Patterns

Recall the summary of our cost behavior

discussion from Chapter 2.

Total Variable Cost Example

- Your total long distance telephone bill is

based on how many minutes you talk.

Total Long DistanceTelephone Bill

Minutes Talked

Variable Cost Per Unit Example

- The cost per long distance minute talked is

constant. For example, 5 cents per minute.

Per MinuteTelephone Charge

Minutes Talked

Total Fixed Cost Example

- Your monthly basic telephone bill probably

does not change when you make more local calls.

Monthly Basic Telephone Bill

Number of Local Calls

Fixed Cost Per Unit Example

- The average cost per local call decreases as more

local calls are made.

Monthly Basic Telephone Bill per Local Call

Number of Local Calls

Step-Variable Costs

Total cost remainsconstant within anarrow range

ofactivity.

Cost

Activity

Step-Variable Costs

Total cost increases to a new higher cost for

the next higher range of activity.

Cost

Activity

Step-Fixed Costs

- Example Office space is available at a

rental rate of 30,000 per year in increments of

1,000 square feet. As the business grows more

space is rented, increasing the total cost.

Continue

Step-Fixed Costs

90

Total cost doesnt change for a wide range of

activity, and then jumps to a new higher cost for

the next higher range of activity.

60

Rent Cost in Thousands of Dollars

30

0

0 1,000 2,000

3,000 Rented Area (Square Feet)

Step-Fixed Costs

How does this type of fixed cost differ from a

step-variable cost?

Semivariable Cost

- A semivariable cost is partly fixed and partly

variable.

Consider thefollowing electric utility example.

Semivariable Cost

Total semivariable cost

Variable Utility Charge

Total Utility Cost

Fixed MonthlyUtility Charge

Activity (Kilowatt Hours)

Curvilinear Cost

CurvilinearCost Function

Activity

Cost Estimation

Account-Classification Method

Visual-Fit Method

High-Low Method

Least-Squares Regression Method

Engineering Method of Cost Estimation

Account Classification Method

Cost estimates are based on areview of each

account making up the total cost being analyzed.

Account Classification MethodExample

Visual-Fit Method

- A scatter diagram of past cost behavior

may be helpful in analyzing mixed costs.

Visual-Fit Method

Plot the data points on a graph (total cost vs.

activity).

Visual-Fit Method

Draw a line through the plotted data points so

that about equal numbers of points fall above and

below the line.

Visual-Fit Method

Visual-Fit Method

Total variable cost Total cost Total

fixed costTotal variable cost 16,000

10,000 6,000

Visual-Fit Method

Total variable cost Total cost Total

fixed costTotal variable cost 16,000

10,000 6,000Unit variable cost 6,000

3,000 units 2

The High-Low Method

- OwlCo recorded the following production activity

and maintenance costs for two months - Using these two levels of activity, compute
- the variable cost per unit.
- the total fixed cost.

The High-Low Method

The High-Low Method

??in cost??in units

- Unit variable cost

The High-Low Method

- Unit variable cost 3,600 4,000 units

0.90 per unit

The High-Low Method

- Unit variable cost 3,600 4,000 units

0.90 per unit - Fixed cost Total cost Total variable cost

The High-Low Method

- Unit variable cost 3,600 4,000 units

0.90 per unit - Fixed cost Total cost Total variable cost
- Fixed cost 9,700 (0.90 per unit 9,000

units)

The High-Low Method

- Unit variable cost 3,600 4,000 units

0.90 per unit - Fixed cost Total cost Total variable cost
- Fixed cost 9,700 (0.90 per unit 9,000

units)

The High-Low Method

- Unit variable cost 3,600 4,000 units

.90 per unit - Fixed cost Total cost Total variable cost
- Fixed cost 9,700 (.90 per unit 9,000

units) - Fixed cost 9,700 8,100 1,600

Least-Squares Regression Method

- Regression is a statistical procedure usedto

determine the relationship between variables such

as activity and cost.

The objective ofthe regressionmethod is

thegeneral cost equation Y a bX in cost

terms TC F VX

Total Cost

Activity

Equation Form of Least-Squares Regression Line

TC F VX

Least-Squares Regression Method

- Statistics courses and computer courses deal with

detailed regression computations using computer

spreadsheet software. - Accountants and managers must be able to

interpret and use regression estimates.

Goodness of Fit

20

Total Cost

10

0

0 1 2 3 4

Activity

Multiple Regression

- Multiple regression includes two or more

independent variables - Terms in the equation have the samemeaning as

in simple regression withonly one independent

variable.

TC FC V1X1 V2X2

End of Chapter 7

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