Cost Behaviour : Part 1 of 2

Cost Behaviour: Part 1 of 2Sections 1 and 2January 30, 2013

Professor: Khim KellyOffice: HH386B

Office Hours: Mon/Wed 11:30am – 12:30pm and AppointmentEmail: [email protected]

TA: Kun HuoEmail: [email protected]

Ch. 6 Assignment due Feb 4(Mon), 11.59pm

Make sure i-clicker is flashing green to ensure that vote is

registered. Frequency is ‘CB’.

mailto:[email protected]

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

• Fixed costs vs. Variable costs

• Fixed costs– Committed– Discretionary

• Step-variable costs

• Mixed costs

Cost Categories

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

From Chapter 2: Fixed vs. Variable Cost

Activity

$ Variable Cost

Fixed Cost

Relation Between Total Cost and the Level of Activity

Activity

$/Ac

tivity

Fixed Cost

Variable Cost

Relation Between Cost per Activity and the Level of Activity

It is Clicker Time!!

Feel Free to Work Together on Clicker Questions

Clicker Question #1

Q: Which of the following does NOT describe a variable cost?

A. Variable costs are ALWAYS indirect costs to the cost objectB. Variable costs increase in total when the actual level of

activity increases.C. Variable costs (with respect to volume of goods produced)

include direct labour costsD. Variable costs include costs that can be traced directly to the

cost objectE. Variable cost per unit does not change with activity level

Clicker Question #1: Answer

Q: Which of the following does NOT describe a variable cost?

Answer:A. Variable costs are ALWAYS indirect costs to the

cost object

• 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

More on Fixed 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

Step-Variable Cost

• 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

Fixed Cost vs. Step Variable

• 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 + bXa = Fixed Costb = per unit Variable CostX = units of activityY = Total mixed cost

Mixed Cost

Fixed (a)

Variable (b)

Y

X



Example: Mama Khim’s KioskRemember 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.

Mama Khim’s Kiosk ExampleMonthly Costs Variable Fixed

1. Mama Khim’s salary and benefits $3,800

2. Cost of diapers and snacks $14,100

3. Depreciation on the kiosk $5,9004. Cost of packaging for diapers and snack packs $2565. Cost of lubricant for machine used to seal snack packs (more lubricant needed when I seal more snack packs) $12

Total Costs $24,068 ? ?

Clicker Question #2

Q: Calculate the total variable and total fixed costs for the month

A. Joe Mamma!B. Variable $14,100; Fixed $9,968C. Variable $14,356; Fixed $9,712D. Variable $14,368; Fixed $9,700E. Variable $14,112; Fixed $9,956

Mama Khim’s Kiosk ExampleMonthly Costs Variable Fixed

1. Mama Khim’s salary and benefits $3,800 $3,800

2. Cost of diapers and snacks $14,100 $14,100

3. Depreciation on the kiosk $5,900 $5,9004. Cost of packaging for diapers and snack packs $256 $2565. Cost of lubricant for machine used to seal snack packs (more lubricant needed when I seal more snack packs) $12 $12

Total Costs $24,068 $14,368 $9,700


Calculate the total variable and total fixed costs for the month?

Answer:D. Variable $14,368; Fixed $9,700

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?

Mama Khim’s Kiosk Example #2 (P6-12)

April May June

# of Sales units 3,000 3,750 4,500

1. Cost of Goods Sold $168,000 $210,000 $252,000

2. Shipping Expense $44,000 $50,000 $56,000

3. Advertising Expense $70,000 $70,000 $70,000

4. Salaries and commissions $107,000 $125,000 $143,000

5. Insurance expense $9,000 $9,000 $9,000

6. Depreciation on kiosk $42,000 $42,000 $42,000

Information for the last 3 months:


Variable Fixed Mixed

1. Cost of Goods Sold

2. Shipping Expense

3. Advertising Expense

4. Salaries and commissions

5. Insurance expense

6. Depreciation on kiosk

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.



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) MixedD. 1) Mixed; 2) MixedE. 1) Mixed; 2) Variable

Mama Khim’s Kiosk Example #2 Clicker Question #3: Answer



2. Shipping Expense





X

X

X

X

Answer:C. 1) Fixed; 2) Mixed




2. Shipping Expense





X

X

X

X

X

X

• 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

Mixed Cost Analysis

High-Low Method

Cost at highest activity level - Cost at lowest activity level

Highest activity level - Lowest activity level

1. Identify the highest and lowest activity levels (NOT the highest and lowest costs)

2. Calculate variable cost component (b)3. Use the variable cost component (b) with either the

highest or lowest data point to calculate fixed cost component (a)

VC per Unit

=

Mixed Cost: Y = a + b*X

Example: High-Low MethodCost at highest activity level - Cost at lowest activity level

Highest activity level - Lowest activity level

VC per Unit =

Month X-Rays Cost

Jan 6,250 $28,000Feb 7,000 29,000Mar 5,000 23,000Apr 4,250 20,000May 4,500 22,000Jun 3,000 17,000Jul 3,750 18,000Aug 5,500 24,000Sep 5,750 26,000



Q: Use the high-low method to develop the equation for the cost data (select option that is closest to your answer).

Clicker Question #4

MonthPatient Days Mixed Cost

Jan 3,700 27,750 Feb 3,200 22,000 March 4,400 31,000 April 5,000 34,500May 2,700 28,000 June 2,500 22,500 July 3,600 26,500 Aug 1,800 18,750 Sept 4,650 36,500 Oct 3,900 24,000 Nov 2,100 22,500 Dec 4,500 26,750

A. Y = $5,412 + $10.98XB. Yellow = Go Karts + 9-irons C. Y = $8,887 + $5.12XD. Y = $9,891 + $4.92XE. Y = $11,556 + $2.67X


$34,500 - $18,750

5,000 - 1,800=

$15,750

3,200=

$4.92 per Patient-Day=


Jan 3,700 27,750 Feb 3,200 22,000 March 4,400 31,000 April 5,000 34,500May 2,700 28,000 June 2,500 22,500 July 3,600 26,500 Aug 1,800 18,750 Sept 4,650 36,500 Oct 3,900 24,000 Nov 2,100 22,500 Dec 4,500 26,750

$34,500 a + ($4.92 * 5,000)=a $9,891=

Answer: D. Y = $9,891 +$4.92X

Then:

Predicting Costs …


Jan 3,700 27,750 Feb 3,200 22,000 March 4,400 31,000 April 5,000 34,500 May 2,700 28,000 June 2,500 22,500 July 3,600 26,500 Aug 1,800 18,750 Sept 4,650 24,500 Oct 3,900 24,000 Nov 2,100 22,500 Dec 4,500 26,750

What costs do we expect if patient days = 3,900 units?

Y = $9,891 + $4.92X Y = $9,891 + $4.92*3,900Y = $29,079

How did the hospital do?

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

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.

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.

E6-10Monthly operating costs at 70% occupancy:

2,000 rooms x 70% = 1,400 rooms1,400 rooms x $21/day = $882,000

Monthly operating costs at 45% occupancy (given):= $792,000

Change in monthly costs = $ 90,000

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

E6-10

Variable Costs = Change in CostChange in Activity

=500 rooms$90,000

= $180 per room per month

$180 per room30 days in a month

= $6 per room per day

Documents

Cost Behaviour : Part 1 of 2