MANAGEMENT ACCOUNTING (VOLUME I) - Solutions Manual

CHAPTER 9 COST BEHAVIOR: ANAL SIS AN! USE

I. Questions 1. a. Va"ia#l$ %ost: A variable cost is one that remains constant on a per unit basis, but which changes in total in direct relationship to changes in volume. b. &i'$( %ost: A fixed cost is one that remains constant in total amount, but which changes, if expressed on a per unit basis, inversely with changes in volume. c. Mi'$( %ost: A mixed cost is a cost that contains both variable and fixed cost elements. 2. a. Unit fixed costs will decrease as volume increases. b. Unit variable costs will remain constant as volume increases. c. d. otal fixed costs will remain constant as volume increases. otal variable costs will increase as volume increases.

!. a. Cost #$)a*io": "ost behavior can be defined as the way in which costs change or respond to changes in some underlying activity, such as sales volume, production volume, or orders processed. b. R$l$*ant "an+$: he relevant range can be defined as that range of activity within which assumptions relative to variable and fixed cost behavior are valid. #. Although the accountant recogni$es that many costs are not linear in relationship to volume at some points, he concentrates on their behavior within narrow bands of activity %nown as the relevant range. he relevant range can be defined as that range of activity within which assumptions as relative to variable and fixed cost behavior are valid. &enerally, within this range an assumption of strict linearity can be used with insignificant loss of accuracy. '. he high(low method, the scattergraph method, and the least(s)uares regression method are used to analy$e mixed costs. he least(s)uares regression method is generally considered to be most accurate, since it
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C)a-t$" 9 Cost Behavior: Analysis and Use

derives the fixed and variable elements of a mixed cost by means of statistical analysis. he scattergraph method derives these elements by visual inspection only, and the high(low method utili$es only two points in doing a cost analysis, ma%ing it the least accurate of the three methods. *. he fixed cost element is represented by the point where the regression line intersects the vertical axis on the graph. he variable cost per unit is represented by the slope of the line. he two assumptions are: 1. A linear cost function usually approximates cost behavior within the relevant range of the cost driver. 2. "hanges in the total costs of a cost ob,ect are traceable to variations or changes in a single cost driver. -. .o. /igh correlation merely implies that the two variables move together in the data examined. 0ithout economic plausibility for a relationship, it is less li%ely that a high level of correlation observed in one set of data will be found similarly in another set of data. 1. 2efer to page !12 of the textboo%. 13. he relevant range is the range of the cost driver in which a specific relationship between cost and cost driver is valid. his concept enables the use of linear cost functions when examining "45 relationships as long as the volume levels are within that relevant range.

+.

11. A unit cost is computed by dividing some amount of total costs 6the numerator7 by the related number of units 6the denominator7. In many cases, the numerator will include a fixed cost that will not change despite changes in the denominator. It is erroneous in those cases to multiply the unit cost by activity or volume change to predict changes in total costs at different activity or volume levels. 12. "ost estimation is the process of developing a well(defined relationship between a cost ob,ect and its cost driver for the purpose of predicting the cost. he cost predictions are used in each of the management functions: 8trategic 9anagement: "ost estimation is used to predict costs of alternative activities, predict financial impacts of alternative strategic choices, and to predict the costs of alternative implementation strategies.

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Cost Behavior: Analysis and Use C)a-t$" 9

5lanning and :ecision 9a%ing: "ost estimation is used to predict costs so that management can determine the desirability of alternative options and to budget expenditures, profits, and cash flows. 9anagement and ;perational "ontrol: "ost estimation is used to develop cost standards, as a basis for evaluating performance. 5roduct and 8ervice "osting: "ost estimation is used to allocate costs to products and services or to charge users for ,ointly incurred costs. 1!. he five methods of cost estimation are: a. Account "lassification. Advantages: simplicity and ease of use. :isadvantages: sub,ectivity of method and some costs are a mix of both variable and fixed. b. 4isual fit. he visual fit method is easy to use, and re)uires only that the data is graphed. :isadvantages are that the scale of the graph may limit ability to estimate costs accurately and in both graphical and tabular form, significant perceptual errors are common. c. /igh(<ow. =ecause of the precision in the development of the e)uation, it provides a more consistent estimate than the visual fit and is not difficult to use. :isadvantages: uses only two selected data points and is, therefore, sub,ective. d. 0or% 9easurement. he advantage is accurate estimates through detailed study of the different operations in the product process, but li%e regression, it is more complex. e. 2egression. >uantitative, ob,ective measures of the precision and accuracy and reliability of the model are the advantages of this model? disadvantages are its complexity: the effort, expense, and expertise necessary to utili$e this method.

1#. Implementation problems with cost estimation include: a. cost estimates outside of the relevant range may not be reliable. b. sufficient and reliable data may not be available. c. cost drivers may not be matched to dependent variables properly in each observation. d. the length of the time period for each observation may be too long, so that the underlying relationship between the cost driver and the variable to be estimated is difficult to isolate from the numerous variables and events occurring in that period of time? alternatively the period may be too short, so that the data is li%ely to be affected by
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C)a-t$" 9 Cost Behavior: Analysis and Use

accounting errors in which transactions are not properly posted in the period in which they occurred. e. dependent variables and cost drivers may be affected by trend or seasonality. f. when extreme observations 6outliers7 are used the reliability of the results will be diminished. g. when there is a shift in the data, as, for example, a new product is introduced or when there is a wor% stoppage, the data will be unreliable for future estimates. 1'. he dependent variable is the cost ob,ect of interest in the cost estimation. An important issue in selecting a dependent variable is the level of aggregation in the variable. @or example, the company, plant, or department may all be possible levels of data for the cost ob,ect. he choice of aggregation level depends on the ob,ectives for the cost estimation, data availability, reliability, and costAbenefit considerations. If a %ey ob,ective is accuracy, then a detailed level of analysis is often preferred. he detail cost estimates can then be aggregated if desired.

1*. .onlinear cost relationships are cost relationships that are not ade)uately explained by a single linear relationship for the cost driver6s7. In accounting data, a common type of nonlinear relationship is trend and seasonality. @or a trend example, if sales increase by -B each year, the plot of the data for sales with not be linear with the driver, the number of years. 8imilarly, sales which fluctuate according to a seasonal pattern will have a nonlinear behavior. A different type of nonlinearity is where the cost driver and the dependent variable have an inherently nonlinear relationship. @or example, payroll costs as a dependent variable estimated by hours wor%ed and wage rates is nonlinear, since the relationship is multiplicative and therefore not the additive linear model assumed in regression analysis. 1+. he advantages of using regression analysis include that it: a. provides an estimation model with best fit 6least s)uared error7 to the data b. provides measures of goodness of fit and of the reliability of the model which can be used to assess the usefulness of the specific model, in contrast to the other estimation methods which provide no means of self(evaluation c. can incorporate multiple independent variables

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Cost Behavior: Analysis and Use C)a-t$" 9

d. can be adapted to handle non(linear relationships in the data, including trends, shifts and other discontinuities, seasonality, etc. e. results in a model that is uni)ue for a given set of data 1-. /igh correlation exists when the changes in two variables occur together. It is a measure of the degree of association between the two variables. =ecause correlation is determined from a sample of values, there is no assurance that it measures or describes a cause and effect relationship between the variables. II. Exercises E'$"%is$ , (Cost Classi1i%ation) 1. 2. !. #. '. *. +. -. 1. 13. 11. 12. b f e i e h l a , % c or d g

E'$"%is$ . (Cost Esti2ation3 Hi+)-Lo4 M$t)o() Requirement (1) "ost e)uation using s)uare fee as the cost driver: 4ariable costs: 5#,+33 E 52,-33 #,3'3 E 2,!+' @ixed costs: 5#,+33 C @ixed "ost D 51.1!# x #,3'3
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C 51.1!#

C)a-t$" 9 Cost Behavior: Analysis and Use

@ixed "ost C 513+ F)uation ;ne: otal "ost C 513+ D 51.1!# x s)uare feet

here are two choices for the /igh(<ow points when using openings for the cost driver. At 11 openings there is a cost of 52,-33 and at 13 openings there is a cost of 52,-+'. "ost e)uation using 11 openings as the cost driver: 4ariable costs: 5#,+33 E 52,-33 11 E 11 @ixed costs: 5#,+33 C @ixed "ost D 52!+.'3 x 11 @ixed "ost C 51-+.'3 F)uation wo: otal "ost C 51-+.'3 D 52!+.'3 x openings C 52!+.'3

"ost e)uation using 13 openings as the cost driver: 4ariable costs: 5#,+33 E 52,-+' 11 E 13 @ixed costs: 5#,+33 C @ixed "ost D 5232.+- x 11 @ixed "ost C 5-#+.1F)uation hree: otal "ost C 5-#+.1- D 5232.+- x openings C 5232.+-

5redicted total cost for a !,233 s)uare foot house with 1# openings using e)uation one:
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Cost Behavior: Analysis and Use C)a-t$" 9

513+ D 51.1!# x !,233 C 5!,+!'.-3 5redicted total cost for a !,233 s)uare foot house with 1# openings using e)uation two: 51-+.'3 D 52!+.'3 x 1# C 5!,'12.'3 5redicted total cost for a !,233 s)uare foot house with 1# openings using e)uation three: 5-#+.1- D 5232.+- x 1# C 5!,*-*.13 here is no simple method to determine which prediction is best when using the /igh(<ow method. In contrast, regression provides )uantitative measures 62(s)uared, standard error, t(values,G7 to help asses which regression e)uation is best. 5redicted cost for a 2,#33 s)uare foot house with - openings, using e)uation one: 513+ D 51.1!# x 2,#33 C 52,-2-.*3 0e cannot predict with e)uation 2 or e)uation ! since - openings are outside the relevant range, the range for which the high(low e)uation was developed. Requirement 2 &i+u"$ 9-A shows that the relationship between costs and s)uare feet is relatively linear without outliers, while &i+u"$ 9-B shows a similar result for the relationship between costs and number of openings. @rom this perspective, both variables are good cost drivers. &i+u"$ 9-A

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C)a-t$" 9 Cost Behavior: Analysis and Use

P5,000 P4,500 P4,000 P3,500 P3,000 Cost P2,500 P2,000 P1,500 P1,000 P500 P0 2,375 2,600 2,650 2,850 3,550 3,700 2,450 2,600 2,700 2,800 3,010 4,050

Square Feet

&i+u"$ 9-B

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Cost Behavior: Analysis and Use C)a-t$" 9

Cost versus No. of Openings

P5,000 P4,500 P4,000 P3,500 P3,000 Cost P2,500 P2,000 P1,500 P1,000 P500 P0 10 11 11 12 12 13 13 13 15 16 16 19 Num ber of Openings

E'$"%is$ / (Cost Esti2ation3 A%%ount Classi1i%ation) Requirement 1 @ixed "osts: 2ent :epreciation Insurance Advertising Utilities 9r. =lac%Hs salary otal 4ariable "osts: 0ages ": Fxpense 8hopping =ags otal 513,2'3 #33 +'3 *'3 1,2'3 1-,'33 5!1,-33 51+,-33 **,+'3 1-3 5-#,+!3

4ariable "osts 5er Unit C 5-#,+!3 A -,133 C 51'.23

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C)a-t$" 9 Cost Behavior: Analysis and Use

"ost @unction F)uation: y C 5!1,-33 D 51'.23 x 6":Hs sold7 Requirement 2 .ew 8ales C -,133 x 1.2' C 11,12' units C round to 11,1!3 otal "osts C 5!1,-33 D 51'.23 x 611,1!37 C 51!+,+*3 5er Unit otal "osts C 51!+,+*3 A 11,1!3 C 512!.-3 Add 51 profit per disc: 512!.-3 D 513 C 51!!.-3 Requirement 3 Ad,usted .ew 8ales C -,133 x 11.'3 C 13,2#3 units 2evenue C 51!!.-3 x 613,2#37 C 51!+,313 otal "ost C 5!1,-33 D 51'.23 x 613,2#37 C 5121,2-3 "ost 5er :isc C 5121,2-3 A 13,2#3 C 512*.!3 5rofit 5er :is% C 51!!.-3 E 512*.!3 C 5+.'3

E'$"%is$ 0 (Cost Esti2ation Usin+ G"a-)s3 S$"*i%$) Requirement 1

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Cost Behavior: Analysis and Use C)a-t$" 9

Sales and Advertising Expense

P160,000 P140,000 P120,000 Sales P100,000 P80,000 P60,000 P40,000 P20,000 P2,500 P5,000 P5,500 P3,000 P3,500 P4,000 P4,500 P0

Advertising Expense

Requirement 2 here seems to be a positive linear relationship for the data between 52,'33 and 5#,333 of advertising expense. <lanesH analysis is correct within this relevant range but not outside of it. .otice that the relationship between advertising expense and sales changes at 5#,333 of expense. III. Problems P"o#l$2 , Requirement (a) /igh level of activity.......................... <ow level of activity........................... :ifference...................................... I 123,333 miles x 53.11* C 51!,123. -3,333 miles x 53.1!* C 513,--3. 4ariable cost per mile: "hange in cost, 5!,3#3 "hange in activity,#3,333 C 53.3+* per mile.
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Miles Driven 123,333 -3,333 #3,333

Total Annual Cost* 51!,123 13,--3 5 !,3#3

C)a-t$" 9 Cost Behavior: Analysis and Use

@ixed cost per year: otal cost at 123,333 miles.................................... 51!,123 <ess variable cost element: 123,333 x 53.3+*...... 1,123 @ixed cost per year............................................. 5 #,-33 Requirement (b) J C 5#,-33 D 53.3+*K Requirement (c) @ixed cost..................................................................... 5 #,-33 4ariable cost: 133,333 miles x 53.3+*........................ +,*33 otal annual cost................................................... 512,#33 P"o#l$2 . Requirement 1 "ost of goods sold...................................................... 8hipping expense........................................................ Advertising expense.................................................... 8alaries and commissions........................................... Insurance expense....................................................... :epreciation expense.................................................. Requirement 2 Analysis of the mixed expenses: Units #,'33 !,333 1,'33 Shi in! "# ense 5'*,333 ##,333 512,333 Salaries an$ Comm% "# ense 51#!,333 13+,333 5 !*,333 4ariable 9ixed @ixed 9ixed @ixed @ixed

/igh level of activity................ <ow level of activity................. :ifference.......................... 4ariable cost element: "hange in cost C 4ariable rate "hange in activity

8hipping expense: 512,333 C 5- per unit. 1,'33 units 5!*,333 8alaries and comm. expense: 1,'33 units C 52# per unit.
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Cost Behavior: Analysis and Use C)a-t$" 9

@ixed cost element: Shi in! "# ense "ost at high level of activity................ <ess variable cost element: #,'33 units x 5-............................ #,'33 units x 52#.......................... @ixed cost element............................... 5'*,333 !*,333 13-,333 523,333 5 !',333 Salaries an$ Comm% "# ense 51#!,333

he cost elements are: 8hipping expense: 523,333 per month plus 5- per unit or J C 523,333 D 5-K. 8alaries and comm. expense: 5!',333 per month plus 52# per unit or J C 5!',333 D 52#K. Requirement 3 <I<J ";95A.J Income 8tatement @or the 9onth Fnded Lune !3 8ales in units................................................... #,'33 8ales revenues................................................. 5*!3,333 <ess variable expenses: "ost of goods sold 6M5'*7......................... 52'2,333 8hipping expense 6M5-7............................ !*,333 8alaries and commission expense 6M52#7................................................... 13-,333 !1*,333 "ontribution margin........................................ 2!#,333

<ess fixed expense: 8hipping expense........................................ Advertising................................................. 8alaries and commissions........................... Insurance.................................................... :epreciation............................................... .et income......................................................

23,333 +3,333 !',333 1,333 #2,333

1+*,333 5 '-,333

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C)a-t$" 9 Cost Behavior: Analysis and Use

P"o#l$2 / Requirement 1 &ear 233# 233' 233* 233+ 233'umber o( )ea!ues (*) ' 2 # * ! 23 n 6KJ7 ( 6K7 6J7 n 6K27 ( 6K72 ' 62!',3337 ( 6237 6'#,'337 ' 6137 ( 62372 1,+33 6J7 ( b6K7 n 6'#,'337 ( 1,+33 6237 ' 5#,133 Total Cost (&) 51!,333 +,333 13,'33 1#,333 13,333 5'#,'33 *& 5 *',333 1#,333 #2,333 -#,333 !3,333 52!',333 *2 2' # 1* !* 1 13

C C C

C C C

herefore, the variable cost per league is 51,+33 and the fixed cost is 5#,133 per year.

Requirement 2 J C 5#,133 D 51,+33K Requirement 3 he expected value total would be: @ixed cost.............................................................. 5 #,133 4ariable cost 6+ leagues x 51,+337........................ 11,133
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Cost Behavior: Analysis and Use C)a-t$" 9

otal cost.......................................................... 51*,333 he problem with using the cost formula from 627 to derive this total cost figure is that an activity level of + sections lies outside the relevant range from which the cost formula was derived. N he relevant range is represented by a solid line on the graph in re)uirement # below.O Although an activity figure may lie outside the relevant range, managers will often use the cost formula anyway to compute expected total cost as we have done above. he reason is that the cost formula fre)uently is the only basis that the manager has to go on. Using the cost formula as the starting point should not present a problem so long as the manager is alert for any unusual problems that the higher activity level might bring about. Requirement +
51*,333 51#,333 512,333 513,333 5-,333 5*,333 5#,333 52,333 3 1 2 ! # ' * P"o#l$2 0 (R$+"$ssion Anal:sis; S$"*i%$ Co2-an:) 5( + X Y

Requirement 1 &i+u"$ 9-C plots the relationship between labor(hours and overhead costs and shows the regression line. y C 5#-,2+1 D 5!.1! K "conomic lausibilit,. <abor(hours appears to be an economically plausible driver of overhead cost for a catering company. ;verhead costs such as
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C)a-t$" 9 Cost Behavior: Analysis and Use

scheduling, hiring and training of wor%ers, and managing the wor%force are largely incurred to support labor. -oo$ness o( (it. he vertical differences between actual and predicted costs are extremely small, indicating a very good fit. he good fit indicates a strong relationship between the labor(hour cost driver and overhead costs. Slo e o( re!ression line. he regression line has a reasonably steep slope from left to right. he positive slope indicates that, on average, overhead costs increase as labor(hours increase. Requirement 2 he regression analysis indicates that, within the relevant range of 2,'33 to +,'33 labor(hours, the variable cost per person for a coc%tail party e)uals: @ood and beverages 51'.33 <abor 63.' hrs. x 513 per hour7 '.33 4ariable overhead 63.' hrs. x 5!.1! per labor(hour7 1.1+ otal variable cost per person 521.1+ Requirement 3 o earn a positive contribution margin, the minimum bid for a 233(person coc%tail party would be any amount greater than 5#,!1#. his amount is calculated by multiplying the variable cost per person of 521.1+ by the 233 people. At a price above the variable costs of 5#,!1#, =obby &on$ales will be earning a contribution margin toward coverage of his fixed costs. ;f course, =obby &on$ales will consider other factors in developing his bid including 6a7 an analysis of the competition E vigorous competition will limit &on$alesH ability to obtain a higher price 6b7 a determination of whether or not his bid will set a precedent for lower prices E overall, the prices =obby &on$ales charges should generate enough contribution to cover fixed costs and earn a reasonable profit, and 6c7 a ,udgment of how representative past historical data 6used in the regression analysis7 is about future costs. &i+u"$ 9-C 2egression <ine of <abor(/ours on ;verhead "osts for =obby &on$alesH "atering "ompany

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Cost Behavior: Analysis and Use C)a-t$" 9

P90,000 P80,000 P70,000 Over"ead Costs P60,000 P50,000 P40,000 P30,000 P20,000 P10,000 P0 0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 Cost Driver: Labor !ours

P"o#l$2 5 (Lin$a" Cost A--"o'i2ation) Requirement 1 8lope coefficient 6b7 C C Constant (a) :ifference in cost :ifference in labor(hours 5'21,333 E 5#33,333 +,333 E #,333

5#!.33

C 5'21,333 E 5#!.33 6+,3337 C 522-,333

"ost function

C 522-,333 D 5#!.33 6professional labor(hours7

he linear cost function is plotted in &i+u"$ 9-!. .o, the constant component of the cost function does not represent the fixed overhead cost of the A=8 &roup. he relevant range of professional labor( hours is from !,333 to -,333. he constant component provides the best available starting point for a straight line that approximates how a cost behaves within the !,333 to -,333 relevant range. Requirement 2
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C)a-t$" 9 Cost Behavior: Analysis and Use

A comparison at various levels of professional labor(hours follows. he linear cost function is based on formula of 522-,333 per month plus 5#!.33 per professional labor(hours. otal overhead cost behavior:
9onth 1 Actual total overhead costs <inear approximation Actual minus linear approximation 5rofessional labor(hours 5!#3,333 !'+,333 561+,3337 !,333 9onth 2 5#33,333 #33,333 5 3 #,333 9onth ! 5#!',333 ##!,333 5 6-,3337 ',333 9onth # 5#++,333 #-*,333 5 61,3337 *,333 9onth ' 5'21,333 '21,333 5 3 +,333 9onth * 5'-+,333 '+2,333 51',333 -,333

he data are shown in &i+u"$ 9-!. he linear cost function overstates costs by 5-,333 at the ',333(hour level and understates costs by 51',333 at the -,333(hour level. Requirement 3 .ase$ on Actual "ontribution before deducting incremental overhead Incremental overhead "ontribution after incremental overhead 5!-,333 !',333 5 !,333 .ase$ on )inear Cost /unction 5!-,333 #!,333 5 6',3337

he total contribution margin actually forgone is 5!,333. &i+u"$ 9-! <inear "ost @unction 5lot of 5rofessional <abor(/ours on otal ;verhead "osts for A=8 "onsulting &roup

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Cost Behavior: Analysis and Use C)a-t$" 9

P700,000 P600,000 %otal Over"ead Costs P500,000 P400,000 P300,000 P200,000 P100,000 P0 0 1,000 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 #rofessional Labor !ours $illed

I4. Multiple Choice Questions 1. 2. !. #. '. *. +. -. 1. 13. A : = A = = " : " A 11. 11. 12. 1!. 1#. 1'. 1*. 1+. 1-. 11. "I "I " A : " : = " " 21. 22. 2!. 2#. 2'. 2*. 2+. 2-. 21. !3. " : " A : = : = A : !1. !2. !!. !#. !'. !*. !+. !-. !1. #3. : = A = A : = " = : #1. = #2. : #!. "

I Su ortin! Com utations: 11. 613,333 x 27 E 65!,333 x 27 E 5',333 C 51,333 12. N6523 D 5! D 5*7 x 2,333 unitsO D 6513 x 1,333 units7 C 5*-,333

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