Activity Analysis,

Cost Behavior, and

Cost
Estimation
Chapter 6
McGraw-Hill/I rwin
Copyright 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
Learning Objective1
6-2
Cost
prediction
Using knowledge
of cost behavior
to forecast
level of cost at
a particular
activity. Focus
is on the future.
Introduction
Cost
behavior
Relationship
between
cost and
activity.
Process of
determining
cost behavior,
often focuses
on historical
data.
Cost
estimation
6-3
Learning Objective 2
6-4
Total Variable Cost Example
Your total Pay Per View bill is based on how many
Pay Per View shows that you watch.
Number of Pay Per View shows
watched
T
o
t
a
l

P
a
y

P
e
r

V
i
e
w

B
i
l
l

6-5
Variable Cost Per Unit Example
The cost per Pay Per View show is constant. For
example, $4.95 per show.
Number of Pay Per View
shows watched
C
o
s
t

p
e
r

P
a
y

P
e
r

V
i
e
w

s
h
o
w

6-6
Step-Variable Costs
Activity
C
o
s
t

Total cost remains
constant within a
narrow range of
activity.
6-7
Step-Variable Costs
Activity
C
o
s
t

Total cost increases to a
new higher cost for the
next higher range of
activity.
6-8
Total Fixed Cost Example
Your monthly basic cable TV bill probably does not
change no matter how many hours you watch.
Number of hours watched
M
o
n
t
h
l
y

B
a
s
i
c

C
a
b
l
e

B
i
l
l

6-9
Fixed Cost Per Unit Example
The average cost per hour decreases as more hours
are spent watching cable television.
Number of hours watched
M
o
n
t
h
l
y

B
a
s
i
c

c
a
b
l
e

B
i
l
l

p
e
r

h
o
u
r

w
a
t
c
h
e
d

6-10
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
6-11
R
e
n
t

C
o
s
t

i
n

T
h
o
u
s
a
n
d
s

o
f

D
o
l
l
a
r
s


0 1,000 2,000 3,000
Rented Area (Square Feet)
30
60
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.
Step-Fixed Costs
6-12
Step-variable costs
can be adjusted more
quickly and . . .
The width of the
activity steps is much
wider for the
step-fixed cost.
How does this type
of fixed cost differ
from a step-variable
cost?
Step-Fixed Costs
6-13
Semivariable Cost
A semivariable
cost is partly
fixed and partly
variable.
Consider the
following
example:.
6-14
Fixed Monthly
Rental Charge
Variable Lease
Charge Per Hour
Rental Charge Per Hour
T
o
t
a
l

L
e
a
s
e

C
o
s
t

Semivariable Cost
The slope is
the variable
cost per unit
of activity.
6-15
Curvilinear Cost
Curvilinear
Cost Function
Relevant Range
Activity
T
o
t
a
l

C
o
s
t

Curvilinear
Cost Function
A straight-line
(constant unit
variable cost) closely
approximates a
curvilinear line within
the relevant range.
6-16
Learning Objective 3
6-17
Curvilinear Cost
Curvilinear
Cost Function
Relevant Range
Activity
T
o
t
a
l

C
o
s
t

Curvilinear
Cost Function
A straight-Line
(constant unit
variable cost) closely
approximates a
curvilinear line within
the relevant range.
6-18
Learning Objective 4
6-19
Engineered, Committed, and
Discretionary Costs
Discretionary
May be altered in the
short term by current
managerial decisions.
Committed
Long-term, cannot be
reduced in the short
term.
Engineered
Physical relationship
with activity measure.
Depreciation on
Buildings and
equipment
Advertising and
Research and
Development
Direct
Materials
6-20
Cost Behavior in Other Industries
Merchandisers
Cost of Goods Sold
Manufacturers
Direct Material, Direct
Labor, and Variable
Manufacturing Overhead
Merchandisers and
Manufacturers
Sales commissions and
shipping costs
Service Organizations
Supplies and travel
Examples of variable costs
6-21
Examples of fixed costs
Merchandisers, manufacturers, and
service organizations
Real estate taxes
Insurance
Sales salaries
Depreciation

Cost Behavior in Other Industries
6-22
Learning Objective 5
6-23
Account-Classification Method
Visual-Fit Method
High-Low Method
Least-Squares Regression Method
Cost Estimation
6-24
Account Classification Method
Cost estimates are based on a
review of each account making up
the total cost being analyzed.
6-25
Visual-Fit Method
A scatter diagram of past cost behavior
may be helpful in analyzing mixed costs.
6-26
Plot the data points on a
graph (total cost vs. activity).
0 1 2 3 4
*
T
o
t
a
l

C
o
s
t

i
n

1
,
0
0
0

s

o
f

D
o
l
l
a
r
s

10
20
0
*
*
*
*
*
*
*
*
*
Activity, 1,000s of Units Produced
Visual-Fit Method
6-27
Draw a line through the plotted data points so that about
equal numbers of points fall above and below the line.
Visual-Fit Method
0 1 2 3 4
*
T
o
t
a
l

C
o
s
t

i
n

1
,
0
0
0

s

o
f

D
o
l
l
a
r
s

10
20
0
*
*
*
*
*
*
*
*
*
Activity, 1,000s of Units Produced
6-28
Visual-Fit Method
Vertical distance
is total cost,
approximately
$16,000.
0 1 2 3 4
*
T
o
t
a
l

C
o
s
t

i
n

1
,
0
0
0

s

o
f

D
o
l
l
a
r
s

10
20
0
*
*
*
*
*
*
*
*
*
Activity, 1,000s of Units Produced
Estimated fixed cost = $10,000
6-29
The High-Low Method
Owl Co recorded the following production activity &
maintenance costs for two months:











Using these two levels of activity, compute:
the variable cost per unit.
the total fixed cost.
Units Cost
High activity level 9,000 9,700 $
Low activity level 5,000 6,100
6-30
Units Cost
High activity level 9,000 9,700 $
Low activity level 5,000 6,100
Change 4,000 3,600 $
The High-Low Method
6-31
Units Cost
High activity level 9,000 9,700 $
Low activity level 5,000 6,100
Change 4,000 3,600 $
Unit variable cost =
in cost
in units
The High-Low Method
6-32
Units Cost
High activity level 9,000 9,700 $
Low activity level 5,000 6,100
Change 4,000 3,600 $
Unit variable cost = $3,600 4,000 units = $0.90 per unit
The High-Low Method
6-33
Units Cost
High activity level 9,000 9,700 $
Low activity level 5,000 6,100
Change 4,000 3,600 $
Unit variable cost = $3,600 4,000 units = $0.90 per unit
Fixed cost = Total cost Total variable cost
The High-Low Method
6-34
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)
Units Cost
High activity level 9,000 9,700 $
Low activity level 5,000 6,100
Change 4,000 3,600 $
The High-Low Method
6-35
Units Cost
High activity level 9,000 9,700 $
Low activity level 5,000 6,100
Change 4,000 3,600 $
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
The High-Low Method
6-36
Least-Squares Regression Method
Regression is a statistical procedure used
to determine the relationship between variables
such as activity and cost.
Activity
T
o
t
a
l

C
o
s
t

The objective of
the regression
method is the
general cost equation:
Y = a + bX
6-37
Y = a + bX
Total Cost is the
dependent variable.
The activity (X) is the
independent variable.
The X term coefficient (b)
is the estimate of variable
cost per unit of activity,
the slope of the cost line.
The intercept term (a) is
the estimate of fixed costs.
Equation Form of Least-Squares
Regression Line
6-38
Least-Squares Regression Method
Statistics courses and
computer courses deal
with detailed regression
computations using
Microsoft Excel.
Accountants and
managers must be able to
interpret and use
regression estimates.
6-39
Learning Objective 6
6-40
Terms in the equation have the same
meaning as in simple regression with
only one independent variable.
Multiple Regression
Multiple regression includes two or more independent
variables:





Y = a + b
1
X
1
+ b
2
X
2

6-41
Engineering Method
of Cost Estimation
Cost estimates are based on measurement
and pricing of the work involved.
6-42
Direct Labor
Material required
for each unit is
obtained from
engineering drawings
and specification sheets.
Material prices are
determined from
vendor bids.
Analyze the kind
of work performed.
Estimate the time
required for each labor
skill for each unit.
Use local wage rates to
obtain labor cost
per unit.
Direct Material
Engineering Method
of Cost Estimation
6-43
Effect of Learning
on Cost Behavior
As I make more of these
things it takes me less
time for each one. It must
be the learning curve effect
that the boss was
talking about.
Ive noticed the same
thing. And if you include
all the variable overhead
costs that are also
declining, that must be
the experience curve.
6-44
Learning Curve
Cumulative Production Output
A
v
e
r
a
g
e

L
a
b
o
r

T
i
m
e

p
e
r

U
n
i
t

Learning effects
are large initially.
Learning effects
become smaller, eventually
reaching steady state.
6-45
Learning Objective 7
6-46
Data Collection Problems
1. Missing data.
2. Outlier data points.
3. Mismatched time periods costs.
4. Trade-offs in choosing the time period.
5. Allocated and discretionary costs.
6. Inflation.
6-47
End of Chapter 6
6-48