Cost Behaviour 1 PDF

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Summary

Taught by Professor Emmanuel Adegbite...

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Lecture 4A (management accounting) – Cost Behaviour Cost behaviour refers to how costs change in relation to volume or activity. Cost Classifications for Predicting Cost Behaviour  

Total variable costs change when activity changes Total fixed costs remain unchanged when activity changes

The Management Cycle   

Managers use their knowledge of cost behaviour to estimate future costs and the impact of operational changes on future profitability They also use assumptions about cost behaviour in almost every decision they make They must understand cost behaviour patterns to anticipate cost ramifications of alternatives in order to decide correctly

Variable Costs    

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Total costs that change in direct proportion to changes in productive output On a per unit basis However variable costs remain constant as volume changes Examples o Direct materials o Direct and indirect labour (hourly) o Operating supplies o Sales commissions Variable costs for different types of organisations o Retailers – cost of goods sold o Service organisations – supplies and travel o Manufacturers – direct material, direct labour, and variable manufacturing overhead o Retailers and manufacturers – sales, commissions and shipping costs

Fixed Costs     

Costs that remain constant within a relevant range of volume or activity On a per unit basis However, fixed costs vary inversely with changes in volume E.g. fixed cost of the car per mile driven decreases as more miles are driven Examples o Depreciation o Rent o Supervisory salaries o Auditors’ fees

Activity Base   

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A variable cost must vary with something – this is the activity base A cost may be variable w.r.t. one activity base but fixed w.r.t. another Examples o Petrol cost varies with the miles driven but it fixed w.r.t. how many people are in the car o Road tax is fixed w.r.t. miles driven but varies with the size of the vehicle These activity bases are cost drivers as they cause the incurrence of a variable cost o Units produced o Machine hours o Miles driven o Labour hours

Relevant Range  

Seldom is a fixed cost fixed over all levels of activity The relevant range is the volume range within which actual operations are likely to occur

The Linearity Assumption and the Relevant Range

A common fixed-cost behaviour pattern

Summary of VC and FC Cost Behaviour Cost In total Variable Total variable cost is proportional to the activity level within the relevant range Fixed Total fixed cost remains the same even when the activity level changes within the relevant range

Per unit Variable cost per unit remains the same over wide ranges of activity Fixed cost per unit goes down as activity level goes up

Mixed Costs   

Has both fixed and variable components Part of the cost changes with volume or usage and the other part of the cost is fixed over time E.g. an electricity bill o Has a fixed monthly utility charge o Then has a variable utility charge o The total mixed cost line can be expressed as an equation y = a +bX o Where:  y = total mixed cost  a = the total fixed cost (y-intercept)  b = the variable cost per unit of activity (slope)  X = the level of activity

Variable, Fixed and Mixed costs of Companies e.g. Manufacturer e.g. desk manufacturer Variable Cost Fixed Cost  Wood  Supervisor salary  Direct labour (paid  rent hourly) e.g. Service company, e.g. bank Variable Cost Fixed Cost  Casual labour  Computer equipment  Cash machines e.g. retailing company Variable Cost  cost of goods sold

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Fixed Cost Salaried employees Building depreciation

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Mixed Cost electrical power telephone heat

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Mixed Cost electrical power telephone heat

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Mixed Cost electrical power telephone heat

Types of Fixed Costs Long-term  Long-term fixed costs cannot be reduced in the short term  Examples o Depreciation on buildings and equipment Short-term  May be altered in the short-term by current managerial decisions  Examples o Advertising o Research and development Trends toward Fixed Costs   

Increased automation Increase in salaried knowledge workers who are difficult to train and replace Implications o Managers are more “locked-in” with fewer decision alternatives o Planning becomes more crucial because fixed costs are difficult to change with current operating decisions

The Contribution Format Sales Less: variable costs Contribution Less: fixed costs Net profit

Total £100,00 0 60,000 £40,000 30,000 £10,000

Unit £50 30 £20

The contribution margin (£40,000) format emphasizes cost behaviour. Contribution margin covers fixed costs and provides for profit....