ACCT 314

A Five-Step Decision Making Process in Planning and Control

1. Identify the problem and uncertainties.
2. Obtain information.
3. Make predictions about the future.
4. Make decisions by choosing between alternatives.
5. Implement the decision, evaluate performance, and learn.
What Information is Relevant for Decision Making?
• Information is relevant if:
• Differs across the alternatives, and
• Is about the future.
• Relevant information can be quantitative or qualitative
• Information is irrelevant if:
• Does not vary with the option chosen or action taken
Irrelevant information is NOT useful in decision making!
 Cost—sacrificed resource to achieve a specific objective
 Actual cost—a cost that has incurred (a historical or past cost)
 Budgeted cost—a predicted cost (a future cost)
 Cost object—anything of interest for which a cost is desired
 Costs may be classified as:
 Direct/Indirect
 Variable/Fixed
 Product/Period
 These multiple classifications give rise to important cost combinations:
 Direct and variable
 Direct and fixed
 Indirect and variable
 Indirect and fixed
When costs are linear, the cost function is:
TC = FC + VCp x Q, where
FC = total fixed cost, VCp = variable cost per unit of the cost driver, and Q = the quantity of
the cost driver.
The intercept is the total fixed cost.
The slope is the variable cost per unit of the cost driver.
A cost that includes a fixed cost element and a variable cost element is known as a mixed
cost.
Cost Estimation Techniques
1. Engineered estimate of cost
2. Analysis at the account level
3. Two-point Method
4. High-Low Method
5. Regression Analysis
High-Low Method of Estimating a Cost Function
  The high-low method is a two-point method: the two data points used to estimate costs
are observations with the highest and the lowest activity levels
 The extreme points for activity levels may not be representative of costs in the relevant
range
• this method may underestimate total fixed costs and overestimate variable costs
per unit,
• or vice versa.
Regression Analysis Used to Estimate a Cost Function?
 Regression analysis estimates the parameters for a linear relationship between a
dependent variable and one or more independent (explanatory) variables.
 When there is only one independent variable, it is called simple regression.
 When there is more than one independent variable, it is called multiple regression.

Question 1
Whippany manufacturing wants to estimate costs for each product they produce at its Troy
plant. The Troy plant produces three products at this plant, and runs two flexible assembly
lines. Each assembly line can produce all three products.
Required:
a. Classify each of the following costs as either direct or indirect for each product.
b. Classify each of the following costs as either fixed or variable with respect to the number of
units produced of each product.

Direct Indirect Fixed Variable

Assembly line labor wages X X

Plant manager's wages X X
Depreciation on the assembly line equipment X X
Component parts for the product X X
Wages of security personnel for the factory X X

Question 2
The Wildcat Company has provided the following information:
Units of Output 30,000 Units 42,000 Units
Direct materials $ 180,000 $ 252,000
Workers' wages 1,080,000 1,512,000
Supervisors' salaries 312,000 312,000
Equipment depreciation 151,200 151,200
Maintenance 81,600 110,400
Utilities 384,000 528,000
Total $2,188,800 $2,865,600
Using the high-low method and the information provided above,
a. Identify the linear cost function equation and
b. Estimate the total cost at 36,000 units of output.
a. Variable cost = ($2,865,600 – $2,188,800) / (42,000 – 30,000) = $56.40
Fixed cost = $2,865,600 – $56.40 x 42,000 = $496,800
Cost function is y = $496,800 + $56.40X

b. Output level of 36,000 units = $496,800 + $56.40 x 36,000 = $2,527,200 total cost

Question 4
Chabu’s managerial accountant, Yi-Fan, is classifying the company’s costs according to their
behavior to prepare next year’s budget. Therefore, the cost object is the entire
company.Chabu produces and sells aluminum beverage cans, such as those used for soft
drinks. You may find the following facts about Chabu’s operation useful in responding to
this problem:
• Production machines must be cleaned monthly, regardless of the amount
of use.
• The more cans produced, the more lubrication is needed.
• Chabu’s monthly production and sales volume is usually at least 1,000 cans but can be as
much as 5,000 cans depending on demand.
• Material handling costs include depreciation on equipment and fuel for loaders.
• Cans are packaged into 100-unit groups prior to sale.
• Research and development costs vary between $10,000 and $10,500 per month
• The factory maintenance costs vary between $6,000 and $6,500 monthly.
• Chabu’s staff level is constant at 25 people, who are all paid salaries.
• Raw materials are purchased based on expected production levels.
• Sales commissions (based on a per-case amount) are included in marketing department costs.
Yi-Fan has classified the costs into three categories: fixed, variable, and mixed. Place an X in the
appropriate column of the table below to indicate the most likely behavior of each cost:

Cost classification
Fixed Variable Mixed
Oil to lubricate the machines X
Salary of the plant manager X
Annual subscription to a trade journal X
Vacation pay for salaried production X
employees
Packaging materials X
 Research and development X
Raw materials X
Material handling costs X
Marketing department costs X
Factory maintenance X

Yeast - Direct
Flour - Direct
Packaging material - Direct
Depreciation on ovens - Indirect
Depreciation on mixing machines - Direct
Rent on factory building - Indirect
Insurance on factory building - Indirect
Factory utilities - Indirect
Finishing department hourly laborers - Direct
Mixing department manager - Indirect
Night guard in factory – Indirect

Tomatoes used in the manufacture of Hunts ketchup - Product

Administrative salaries of executives employed by Jet Blue Airlines Wages of assembly-line
workers at a Ford plant - Period
Marketing expenditures of the Atlanta Braves baseball club - Product
Commissions paid to Coca-Cola's salespeople - Period
Straight-line depreciation on manufacturing equipment owned by Dell Computer - Product
Shipping charges incurred by Office Depot on out-going orders - Period
Speakers used in Sony home-theater systems - Product
Insurance costs related to a Mary Kay Cosmetics' manufacturing plant – Product
Product: –Direct: DM & DL
--Indirect: MOH
Sales – COGS (variable & fixed) = Gross profit
Revenue – Cost = Profit
[(Selling price Sp x quantity Q) – (variable cost Vp x quantity Q)] – Fixed cost = Profit
[(Selling price Sp x quantity Q) – (variable cost Vp x quantity Q)] = Contribution Margin
Total cost = Total Fixed cost + Total Variable cost
Total cost = Total Fixed cost FC + (VpxQ)
Example:
240,000 = FC + (Vp x 35,000)
207,000 = FC + (Vp x 16,500)
->Vp = (240,000 -207,000)/ (35,000 - 16,500) = $1.78
240,000 = FC + (1.78 x 35,000)
->FC = 177,700
Total cost = 177,700 + (1.78 x Q)

Exercise 1:
Tessmer Manufacturing Company produces inventory in a highly automated assembly plant in
Olathe, Kansas. The automated system is in its first year of operation and management is still
unsure of the best way to estimate the overhead costs of operations for budgetary purposes.
For the first six months of operations, the following data were collected:
Observation Machine-hours Kilowatt-hours Total Overhead Costs
January 3,800 4,520,000 - highest $138,000
February 3,650 4,340,000 136,800
March 3,900 - highest 4,500,000 139,200
April 3,300 4,290,000 136,800
May 3,250 4,200,000 126,000
June 3,100 - lowest 4,120,000 - lowest 120,000
Required:
a. Use the high-low method to determine the estimating cost function with machine-hours
as the cost driver.
b. Use the high-low method to determine the estimating cost function with kilowatt-hours as
the cost driver.
c. For July, the company ran the machines for 3,000 hours and used 4,000,000 kilowatt-hours of
power. The overhead costs totaled $114,000. Which cost driver was the best predictor for July?
a. 339,200 = FC + (Vp x 3,900)
320,000 = FC + (Vp x 3,100)
->Vp = (339,200 -320,000)/ (3,900- 3,100) = $24
339,200 = FC + (24 x 3,900)
->FC = 245,600
Total cost = 245,600+ (24 x Q)
b. 338,000 = FC + (Vp x 4,520,000)
320,000 = FC + (Vp x 4,120,000)
->Vp = (338,000 -320,000)/ (4,520,000- 4,120,000) = $0.045
338,000 = FC + (0.045 x 4,520,000)
->FC = 134,600
Total cost = 134,600+ (0.045 x Q)
c. Total cost = 245,600+ (24 x 3,000) = 314,600
Total cost = 134,600+ (0.045 x 4,000,000) = 317,600