Tutorial 2 - Wk 2 PDF

Preview

Summary

This is AF 201 Week 2 tutorial which covers unit 2: cost behaviour, cost drivers and cost estimation....

Description

AF201 MANAGERIAL ACCOUNTING 1/20 TUTORIAL 2 WEEK 2

3.5

BP targeted certain costs that needed better management. We can see in the ‘Real Life’ that, in order to reduce discretionary costs, BP identified activities that did not adequately add value to the business. Examples are the regular preparation of reports that were rarely (if ever) used, unnecessary travel (both domestic and international), outsourcing tasks to consultants, and maintaining excessive layers of management. These four root-cause cost drivers were better managed to reduce costs.

3.8

As the level of activity (cost driver) increases, total fixed cost remains constant. However, the fixed cost per unit of activity declines as activity increases, and the fixed cost per unit of activity increases as activity decreases. This change in the average fixed cost per unit may not be understood by a decision making manager who has been presented with product costs that include unitised fixed costs. When product costs include unitised fixed costs, managers can mistakenly treat them as totally variable for decision making. These managers may believe that: 

any short term sales that do not cover the unitised fixed costs may result in losing money, not realising that those sales would help cover fixed costs;



a 20% reduction in production will reduce costs by 20% of the total product costs, not realising that the fixed costs will not reduce at all (within the relevant range);



making 1000 more products will increase costs by one thousand times the product cost, not realising that the extra cost will be less than that since total fixed costs will not change if production is still within the relevant range.

AF201 Tutorial 2 Solutions – Wk 2

Page 1

PROBLEM 3.35 Cost estimation: high low; regression: wholesaler 1

Scatter diagram: Sh i p p i n g d e p a r t me n t c o s t s $ 3 70 0 0 $ 3 60 0 0 $ 3 50 0 0 $ 3 40 0 0 $ 3 30 0 0 $ 3 20 0 0 $ 3 10 0 0 0 0 0 $ 3 00 0 0

3 0 0 0

4 0 0 0

5 0 0 0

6 0 0 0 7 0 0 0

u p p l i e s 8 0 0 0S T h el o we r p a r t o f t h ev e r t i c a l a x i sh a s b e e ns h o r t e n e d

2

l o a d e do r u n l o a d e d ( k g )

High–low method: Variable cost per unit of cost driver

= =

$1.20 per kg of supplies loaded/unloaded

Fixed cost AF201 Tutorial 2 Solutions – Wk 2

$27 000 Page 2

Cost equation based on high–low method: Shipping department cost per month

$27 000 + $1.20X

where X denotes the number of kilograms of supplies loaded/unloaded during the month

3

Cost when 4500 kg are moved: Total cost = 27 000 + (1.20 × 4500) = $32 400

4

Estimating the fixed and variable cost components using regression analysis can be determined by using Excel, the output from which is reproduced below. Regression statistics R

0.77355

R Square

0.59838

Adjusted R Square

0.55821 1195.474

S Total number of observations

Coefficien ts

Standard Erro r

29 828.49

1219.318

0.8851

0.229306

Intercept Kg of supplie s

5

12

The formula to explain the behaviour of the shipping department’s costs is as follows. Y = a + bX, where: X = the independent variable (the kilograms of supplies handled for one month) Y = the dependent variable (cost for one month)

AF201 Tutorial 2 Solutions – Wk 2

Page 3

Y = $29 828.49 + $0.8851X This can be expressed as total cost = fixed costs of $29 828.49 plus $0.8851 per kilogram of supplies handled. 6

Predicted shipping department costs Total cost = $29 828.49 + ($0.8851 × 4500) = $33 811.44

7

On the basis of using the high–low method and regression analysis, the shipping department’s monthly cost behaviour was estimated as follows: Using the high–low method, the following cost estimate was obtained: Material-handling cost per month

=

$27 000 + $1.20 per unit of cost driver

Using regression analysis

=

$29 828.49 + $0.8851 per unit of cost driver

The two methods yield different estimates because the high–low method uses only two data points, ignoring the rest of the information. Regression analysis, on the other hand, is a statistical technique that can be used to estimate the relationship between the dependent variable (cost) and the independent variable (quantity of supplies handled). Regression analysis uses all of the data points to determine the line of best fit. In this case, the two data points used by the high–low method do not appear to be representative of the entire set of data. The cost line determined using regression analysis should be utilised.

CASE 3.42 (45 minutes) Interpreting regression analysis; activity-based costing: service firm 1

Drake’s preliminary estimate for overhead of $18.00 per direct labour hour does not distinguish between fixed and variable overhead. This preliminary rate is applicable only to the activity level at which it was computed (36 000 direct labour hours per year) and may not be used to predict total overhead at other activity levels. The overhead rate developed from the least squares regression recognises the relationship between cost and volume in the data. The regression suggests that there is a component of the cost ($26 201 per month) that is unrelated to total direct labour hours. This cost component is the intercept on the vertical axis and is often considered to be the fixed cost as long as the activity level is within the relevant range. Thus, the least squares regression results in a cost function with two components: fixed cost per month

AF201 Tutorial 2 Solutions – Wk 2

Page 4

and variable cost per direct labour hour. This cost formula can be used to predict total overhead at any activity level within the relevant range. 2

Total variable cost per 1000 square metres

$541.35

* DLH denotes direct labour hours. 3

The minimum bid should include the following incremental costs of the project:

Total variable costs for 50 000 square metres

$27 780.00

Variable costs per 1000 square metres in this bid

$

555.60

4

Yes, Greenscape Pty Ltd can rely on the formula as long as Drake recognises that there are some shortcomings. The fact that least squares regression estimates cost behaviour increases the usefulness of rates calculated from cost data. However, the regression is based on historical costs that may change in the future, and Drake must assess whether the cost equation would need to be revised for future cost increases or decreases.

5

(a)

Total incremental variable overhead

AF201 Tutorial 2 Solutions – Wk 2

Page 5

$2 162

(b)

Total incremental variable overhead (c)

$2 880.50

The two scenarios in (a) and (b) differ in terms of the activities to be undertaken. Scenario (a) involves a large amount of seeding activity and relatively little planting activity. Scenario (b) involves considerably less seeding activity, but a great deal more planting activity. An activity-based costing system accounts for the different costs in projects involving different mixes of activity.

AF201 Tutorial 2 Solutions – Wk 2

Page 6...