Demonstration Problem

Demonstration Problem

Chapter 12 – Exercise 10

Estimating Costs Based on

Behavior Patterns

AccountingWhat the Numbers Mean 10e

Problem Definition

• The following table shows the amount of cost incurred in August for the cost items indicated. During August, 8,000 units of the firm’s single product were manufactured.

Raw materials $41,600Factory depreciation expense 40,500Direct labor 99,200Production supervisor’s salary 6,100Computer rental expense 4,200Maintenance supplies used 800

Problem Requirements

a. How much cost would you expect to be incurred for each of the above items during September when 9,600 units of product are planned for production?

b. Calculate the average total cost per unit for the 8,000 units manufactured in August. Explain why this figure would not be useful to a manager interested in predicting the cost of producing 9,600 units in September.

Problem Solution

• Step 1 – Determine the cost behavior pattern for each cost item:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s salaryComputer rental expenseMaintenance supplies used

Cost Behavior

Problem Solution


Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s salaryComputer rental expenseMaintenance supplies used

Cost Behavior

Is the cost item a variable cost or a fixed cost?

Problem Solution


Raw materials VariableFactory depreciation expenseDirect laborProduction supervisor’s salaryComputer rental expenseMaintenance supplies used

Cost Behavior

Variable costs change

as activity changes.

Problem Solution


Raw materials VariableFactory depreciation expense FixedDirect laborProduction supervisor’s salaryComputer rental expenseMaintenance supplies used

Cost Behavior

Fixed costs remain

constant as activity changes.

Problem Solution


Raw materials VariableFactory depreciation expense FixedDirect labor VariableProduction supervisor’s salaryComputer rental expenseMaintenance supplies used

Cost Behavior

Problem Solution


Raw materials VariableFactory depreciation expense FixedDirect labor VariableProduction supervisor’s salary FixedComputer rental expenseMaintenance supplies used

Cost Behavior

Problem Solution


Raw materials VariableFactory depreciation expense FixedDirect labor VariableProduction supervisor’s salary FixedComputer rental expense FixedMaintenance supplies used

Cost Behavior

Problem Solution


Raw materials VariableFactory depreciation expense FixedDirect labor VariableProduction supervisor’s salary FixedComputer rental expense FixedMaintenance supplies used Variable

Cost Behavior

Problem Solution

• Step 2 - Determine the fixed amount or variable rate for each cost item at 8,000 units of activity:

Raw materialsFactory depreciation expenseDirect laborProduction supervisor’s

salary Computer rental expenseMaintenance supplies used Total Cost

Cost Behavior

Cost @ 8,000 units

$ 41,60040,50099,200

6,1004,200

800$192,400

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

Problem Solution




Cost Behavior

Cost @ 8,000 units

$ 41,60040,50099,200

6,1004,200

800$192,400

$ 5.20

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

Variable rate calculation:

$41,600 / 8,000 units = $ 5.20/unit

Problem Solution




Cost Behavior

$ 41,60040,50099,200

6,1004,200

800$192,400

$ 5.20

Fixed Amount

Variable Rate/Unit

$40,500

VariableFixed

VariableFixedFixed

Variable

Fixed costs items will remain constant regardless of the level of activity (within the relevant range).

Cost @ 8,000 units

Problem Solution




Cost Behavior

$ 41,60040,50099,200

6,1004,200

800$192,400

$ 5.20

12.40

Fixed Amount

Variable Rate/Unit

$40,500

VariableFixed

VariableFixedFixed

Variable


$99,200 / 8,000 units = $12.40/unit

Cost @ 8,000 units

Problem Solution




Cost Behavior

$ 41,60040,50099,200

6,1004,200

800$192,400

$ 5.20

12.40

Fixed Amount

Variable Rate/Unit

$40,500

6,100

VariableFixed

VariableFixedFixed

Variable

Cost @ 8,000 units

Problem Solution




Cost Behavior

$ 41,60040,50099,200

6,1004,200

800$192,400

$ 5.20

12.40

Fixed Amount

Variable Rate/Unit

$40,500

6,1004,200

VariableFixed

VariableFixedFixed

Variable

Cost @ 8,000 units

Problem Solution




Cost Behavior

$ 41,60040,50099,200

6,1004,200

800$192,400

$ 5.20

12.40

0.10

Fixed Amount

Variable Rate/Unit

$40,500

6,1004,200

VariableFixed

VariableFixedFixed

Variable


$800 / 8,000 units = $ 0.10/unit

Cost @ 8,000 units

Problem Solution




Cost Behavior

$ 41,60040,50099,200

6,1004,200

800$192,400

$ 5.20

12.40

0.10$17.70

Fixed Amount

Variable Rate/Unit

$40,500

6,1004,200

$50,800

VariableFixed

VariableFixedFixed

Variable

Cost @ 8,000 units

Problem Solution




Cost Behavior

$ 41,60040,50099,200

6,1004,200

800$192,400

$ 5.20

12.40

0.10$17.70

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

Cost formula = $50,800 fixed cost + $17.70 per unit variable cost

Cost @ 8,000 units

$40,500

6,1004,200

$50,800

Problem Solution

• Step 3 – Calculate the cost expected to be incurred in September when 9,600 units are manufactured using the cost formula determined in Step 2:



Cost Behavior

Cost @ 9,600 units

$ 5.20

12.40

0.10$17.70

Fixed Amount

Variable Rate/Unit

$40,500

6,1004,200

$50,800

VariableFixed

VariableFixedFixed

Variable

Problem Solution




Cost Behavior

$ 5.20

12.40

0.10$17.70

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

$ 49,920

Calculation:

9,600 units * $5.20 per unit

$40,500

6,1004,200

$50,800

Cost @ 9,600 units

Problem Solution




Cost Behavior

$ 5.20

12.40

0.10$17.70

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

$ 49,92040,500

Fixed costs do not change at 9,600 units.

$40,500

6,1004,200

$50,800

Cost @ 9,600 units

Problem Solution




Cost Behavior

$ 5.20

12.40

0.10$17.70

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

$ 49,92040,500

119,040

Calculation:


$40,500

6,1004,200

$50,800

Cost @ 9,600 units

Problem Solution




Cost Behavior

$ 5.20

12.40

0.10$17.70

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

$ 49,92040,500

119,0406,100

$40,500

6,1004,200

$50,800

Cost @ 9,600 units

Problem Solution




Cost Behavior

$ 5.20

12.40

0.10$17.70

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

$ 49,92040,500

119,0406,1004,200

$40,500

6,1004,200

$50,800

Cost @ 9,600 units

Problem Solution




Cost Behavior

$ 5.20

12.40

0.10$17.70

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

$ 49,92040,500

119,0406,1004,200

960

Calculation:


$40,500

6,1004,200

$50,800

Cost @ 9,600 units

Problem Solution




Cost Behavior

$ 5.20

12.40

0.10$17.70

Fixed Amount

Variable Rate/Unit

VariableFixed

VariableFixedFixed

Variable

$ 49,92040,500

119,0406,1004,200

960$220,720

$40,500

6,1004,200

$50,800

Cost @ 9,600 units

Problem Requirements

a. How much cost would you expect to be incurred for each of the above items during September when 9,600 units of product are planned for production?

b. Calculate the average total cost per unit for the 8,000 units manufactured in August. Explain why this figure would not be useful to a manager interested in predicting the cost of producing 9,600 units in September.

Problem Solution

• Average total cost for August:

• 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 fixed costs do not behave on a per unit basis.

$192,400 / 8,000 = $24.05 per unit

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 9,600 units would give an estimate of $230,880, which is significantly higher than the $220,720 calculated in part a using the cost formula:

Total Cost = $50,800 fixed cost + $17.70 per unit variable cost

AccountingWhat the Numbers Mean 10e

David H. MarshallWayne W. McManus

Daniel F. Viele

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.

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Demonstration Problem