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©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/F

DETERMINING HOW COSTS BEHAVE

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©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Successor Group

Umair Ahmed 0042 Umair Abbas 0031Shahid Anwar 0034Ali Mardan 0017

Muneeb Ahsan 0022

University of central Punjab(Okara Campus)

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Determining How Costs Behave

Explain the two assumptions

frequently used in cost-behavior

estimation.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Assumptions in Cost-Behavior Estimation

Changes in total costs can be explained bychanges in the level of a single activity.

Cost behavior can adequately beapproximated by a linear function of theactivity level within the relevant range.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Cost Functions And Common Ways

Describe linear cost functions and

three common ways in which they

behave.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Cost Function

What is a cost function?

It is a mathematical expressiondescribing how costs change

with changes in the levelof an activity.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Cost Function

La Playa Hotel offers an airlinethree alternative cost structures toaccommodate its crew overnight:

1. $60 per night per room usage

y = $60x

The slope of the cost function is $60.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Cost Function

$0

$5,000

$10,000

$15,000

$20,000

0 100 200 300

x = Number of rooms

y =

Co

st

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Cost Function

2. $8,000 per month

y = $8,000

$8,000 is called a constant or intercept.

The slope of the cost function is zero.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Cost Function

$0

$5,000

$10,000

$15,000

$20,000

0 100 200 300

x = Number of rooms

y =

Co

st

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Cost Function

3. $3,000 per month plus $24 per room

This is an example of a mixed cost.

y = $3,000 + $24x

y = a + bx

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Cost Function

$0

$5,000

$10,000

$15,000

$20,000

0 100 200 300

x = Number of rooms

y =

Co

st

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Cost Classification and Estimation Function

Choice of cost object

Time span

Relevant range

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Choice of Cost Object Example

If the number of taxis owned by a taxi companyis the cost object, annual taxi registration andlicense fees would be variable costs.

If miles driven during a year on a particular taxiis the cost object, registration and license feesfor that taxi are fixed costs.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Time Span

Whether a cost is variable or fixed with respect to a particular activity depends on the time span.

More costs are variable with longer time spans.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Relevant Range

Variable and fixed cost behavior patterns are valid for linear cost functions only within the given relevant range.

Costs may behave nonlinear outside the range.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Cost Estimation

What is cost estimation?

It is the attempt to measure a pastcost relationship between costs

and the level of an activity.

Past cost-behavior functions can helpmanagers make more accurate

cost predictions.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Cost Estimation Approaches

Industrial engineering method

Conference method

Account analysis method

Quantitative analysis methods

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Account Analysis Example

The cost analyst uses experience andjudgment to separate total costs into

fixed and variable.

Avisha & Co. sells software programs.

Total sales = $390,000

The company sold 1,000 programs.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Account Analysis Example

Cost of goods sold = $130,000

Manager’s salary = $60,000

Secretary’s salary = $29,000

Commissions = 12% of sales

What is the total fixed cost?

$60,000 + $29,000 = $89,000

What is the fixed cost per unit sold?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Account Analysis Example

$89,000 ÷ 1,000 = $89.00

What is the variable cost per unit sold?

Cost of goods sold: $130,000

Commissions: $390,000 × .12 = $46,800

($130,000 + $46,800) ÷ 1,000 = $176.80

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Steps In Estimating A Cost Function

Six steps in estimatinga cost function on the basisof past cost relationships.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Steps In Estimating A Cost Function

Step 1:Choose the dependent variable.

Step 2:Identify the independent variable cost

driver(s).Step 3:

Collect data on the dependent variableand the cost driver(s).

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Steps In Estimating A Cost Function

Step 4: Plot the data.

Step 5: Estimate the cost function.

Step 6: Evaluate the estimated cost function.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

High-Low Method Example

High capacity December: 55,000 machine-hours

Cost of electricity: $80,450

Low capacity September: 30,000 machine-hours

Cost of electricity: $64,200

What is the variable rate?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

High-Low Method Example

($80,450 – $64,200) ÷ (55,000 – 30,000)

$16,250 ÷ 25,000 = $0.65

What is the fixed cost?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

High-Low Method Example

$80,450 = Fixed cost + (55,000 × $0.65)

Fixed cost = $80,450 – $35,750 = $44,700

$64,200 = Fixed cost + (30,000 × $0.65)

Fixed cost = $64,200 – $19,500 = $44,700

y = a + bx

y = $44,700 + ($0.65 × Machine-hours)

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Regression Analysis

It is used to measure the average amount of change in a dependent variable, such as electricity, that is associated with unit increases in the amounts of one or more independent variables, such as machine-hours.

Regression analysis uses all availabledata to estimate the cost function.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Regression Analysis

Simple regression analysis estimates therelationship between the dependentvariable and one independent variable.

Multiple regression analysis estimates therelationship between the dependent variable and multiple independent variables.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Regression Analysis

The regression equation and regression lineare derived using the least-squares technique

The objective of least-squares is to developestimates of the parameters a and b.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Regression Analysis

The regression method is more accurate thanthe high-low method.

The vertical difference (residual term) measuresthe distance between the actual cost and theestimated cost for each observation.

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

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THANKS

THANKS