Management Accounting: Part II

| Cost Behavior | Budget | Variance Analysis | Part I | Part III |

Source:

Textbook: Managerial Accounting, Creating Value in a Dynamic Business Environment (Fifth edition), Ronald W. Hilton

Notes: Management Accounting A, 2003 Semester 1, University of Sydney

Web: http://www.mhhe.com/business/accounting/garrison/Student/olc/garrison9emgracct_s/index.htm

Cost Behavior

Cost Behavior is the relationship between cost and activity. It is relevant to the management functions of planning, control, and decision making. In order to plan operations and prepare a budget, managers need to predict the costs that will be incurred at different levels of production.

Knowledge of Cost Behavior will help the manager to make the desired cost prediction. Cost prediction is a forecast of cost at a particular level of activity.

The determination of cost behavior is called cost estimation.

Cost Behavior Patterns (Suggested Question 7.35)

The cost behavior pattern can depend on the cost driver selected.

Volume-based cost driver and Operation-Based (Page 284)

- Variable cost, TVC increases in direct proportion to the change in activity level, VC/unit keeps constant

- Step-Variable cost, e.g. part-time worker, called upon for relatively small increments of time

- Fixed cost, TFC does not change as activity changes, FC/unit declines when activity increases, for this reason, it is preferable in any cost analysis to work with TFC rather than FC/unit

- Step-Fixed cost, e.g. indirect labor, Illustration Page 279

- Semi-variable cost, has both fixed and variable component.

- Curvilinear cost, e.g. utilities cost,

Curvilinear cost (Page 280, 281)

For low levels of activity (below relevant range), this cost experiences decreasing marginal cost. Marginal cost is the cost of producing the next unit.

For high levels of activity (Above relevant range), this cost experiences increasing marginal cost.

Management only concern cost behavior within the company's relevant range, the range of activity within which the management expects the company to operate.

Straight line used to approximate the cost within the relevant range represents a semi-variable cost behavior pattern. Slope of the straight line which represents a unit variable cost component. The intercept at the vertical axis represents the fixed-cost component.

It is important to limit this approximation to the range of activity in which its accuracy is acceptable.

Types of cost considering in the process of budgeting costs (Page 282)

• Engineered cost, e.g. direct material cost, it is impossible to produce more units without incurring greater material cost for the extra units.
• Committed cost, e.g. property tax, depreciation, salaries of management, results from an organization's ownership or use of facilities and its basic organization structure
• Discretionary cost, e.g. R&D, advertising and promotion, arises as a result of management decision to spend a particular amount for some purpose.

In the advanced manufacturing environment that is emerging, many costs that once were largely variable have become fixed, most becoming committed fixed costs.

Committed versus Discretionary

Management can change committed cost only through relatively major decisions that have long-term implications. These decisions will generally influence costs incurred over a long period of time.

In contrast, discretionary costs can be changed in the short-run much more easily. Management can alter the costs over time because the expenditure for advertising, employee training, or R&D is more flexible.

Cost Estimation (Page 285 - 294)

Assumptions

• All the methods assume that cost behavior depends on one activity variable, even multiple regression uses a small number of independent variable. In reality, costs are affected by factors including weather, mood of employee and the quality of raw materials used.
• Cost behavior patterns are linear (straight line) within the relevant range.

Methods that are used to estimate the relationship between cost and activity

• Account-classification method
• Visual-Fit method
• High-Low Method
• Least-Squares Regression method
• Multiple regression method

Data collection Problems

• Missing data
• Outliers
• Mismatched time periods
• Trade-offs
• Allocated and discretionary costs
• Inflation

Alternative method of cost estimation

• Engineering method
• Learning curve

Specific technique for cost estimation in organization such as banks, government (Page 295)

• Work Measurement ( or Control Factor unit)