Managerial Accounting

Chapter 5

Cost Drivers and Cost Behavior

Learning Objectives (Slide 1 of 2)

Distinguish between variable costs and fixed costs, between short run and long run, and define the relevant range.
Identify capacity costs, committed costs, and discretionary costs.
Describe the nature of the various cost behavior patterns.
Describe how managers use cost behavior patterns.
Learning Objectives (Slide 2 of 2)
Describe how to use historical data to estimate costs.
Describe how analysts estimate cost behavior using regression, account analysis, and engineering methods.
Explain the costs, benefits, and weaknesses of the various cost estimation methods.
Identify the derivation of learning curves.
Interpret the results of regression analyses.
Nature of Fixed &
Variable Costs (Slide 1 of 2)
Variable costs - change in total as the level of activity changes
Also known as an engineered cost
There is a definitive physical relationship to the activity measure
Fixed costs - do not change in total with changes in activity levels
Nature of Fixed &
Variable Costs (Slide 2 of 2)
Accounting concepts of variable and fixed costs are short run concepts
Apply to a particular period of time
Relate to a particular level of production
Relevant range is the range of activity over which the firm expects cost behavior to be consistent
Outside the relevant range, estimates of fixed and variable costs may not be valid

Types of Fixed Costs (Slide 1 of 2)

Capacity costs- fixed costs that provide a firm with the capacity to produce and/or sell its goods and services
Also know as committed costs and typically relate to a firms ownership of facilities and its basic organizational
structure
Capacity costs may cease if operations shut down, but continue in fixed amounts at any level of operations
Examples: property taxes, executive salaries

Types of Fixed Costs (Slide 2 of 2)

Discretionary costs - need not be incurred in the short run to operate the business, however, usually they are essential for
achieving long-run goals
Also referred to as programmed or managed costs
Examples: research and development costs, advertising

Other Cost Behavior Patterns (Slide 1 of 2)

Curvilinear variable costs - costs may vary with the volume of activity, but not in constant proportion
For example, as volume increases, the cost of materials may decrease per unit (perhaps due to quantity discounts),
exhibiting decreasing marginal costs
Marginal cost - the cost of producing the next unit

Other Cost Behavior Patterns (Slide 2 of 2)

Learning curves - shows how the time required to perform a task goes down, per unit, as the number of units increases
Some companies experience learning effects on costs
Compete by learning quickly so they become low-cost leaders and capture market share

Semi-variable Costs
Refers to costs that have both variable and fixed components
Examples: repair and maintenance costs, utility costs
 Semifixed Costs
Refers to costs that increase in steps
Example: A quality-control inspector can examine 1,000 units per day. Inspection costs are semifixed with a step up
for every 1,000 units per day
Distinction between fixed and semi-fixed is subtle
Change in fixed costs usually involves a change in long-term assets: a change in semifixed costs often does
not
Cost Estimation Methods
Cost estimates are used in various business decisions, planning exercises, and performance evaluations
Three methods discussed
Statistical regression analysis
Account analysis
Engineering estimation

Estimating Costs Using Historical Data (Slide 1 of 2)

Trying to estimate fixed and variable costs using the following formula

TC=F + VX

Where: TC = Total Costs

F = Fixed Costs
V = Variable Costs
X = Activity Variable

Estimating Costs Using Historical Data (Slide 2 of 2)

The following steps should be taken in analyzing cost data:
Review alternative cost drivers
Plot the data
Examine the data and method of accumulation

Statistical Regression Analysis (Slide 1 of 2)

Used to estimate the relationship between costs and the activity that caused, or is closely associated with, those costs
Costs are the dependent variable(s)
Activity level is the independent variable
Fits the data points to a line using least-squares criterion

Statistical Regression Analysis (Slide 1 of 2)

Results of this analysis yield an estimate of both the fixed component and the cost driver rates (variable component)

Account Analysis
Analysts review each cost account and classifies it according to its relation to a cost driver
The sum of costs for each activity are divided by the sum of the cost driver volumes to determine the cost driver
rates
These cost driver rates correspond to the coefficients calculated using regression analysis

Engineering Method of Estimating Costs

The engineering method indicates what costs should be
Analysts study the physical relation between the quantity of inputs and outputs
Determine the steps required to perform the task, the time needed to complete each step, the number and
type of employees required, and the materials and other inputs needed
The accountant assigns costs to each of the inputs to estimate the cost of the outputs

Data Problems
Missing Data
Outliers
Allocated and discretionary costs
Inflation
Mismatched time periods
Trade-offs in choosing the time period
 Interpreting Regression Analysis Output (Slide 1 of 2)
Standard errors of the coefficients indicate the degree of confidence we can have in the fixed and variable cost coefficients
The smaller the standard error, the more precise the estimate
The t-statistic is the ratio between an estimated coefficient and its standard error
If about 2 or larger, we can be relatively confident that the actual coefficient differs from 0

Interpreting Regression Analysis Output (Slide 2 of 2)

If a variable cost coefficient has a small t-statistic, it may indicate that little relation exists between the activity and changes in
costs
If a fixed cost coefficient has a small t-statistic, it may indicate that these costs have little, if any, fixed cost component

R2
2
R measures how well the line fits the data
An R2 of 1 means that the regression explains all of the variance
An R2 of 0 means that the regression explains none of the variance

Many believe that a low R2 indicates a weak relationship between total costs and the activity base

Cautions When
Using Regression
Users of regression analysis should be cautious in drawing inferences from regression results unless they are familiar with
statistical estimation problems such as:
Multi-collinearity
Autocorrelation, and
Heteroscedasticity
Dranrey Gaon
BSBA-FM3A
ACC311