Accounting 222 Chapter 3
**Variable cost varies, in total, in direct proportion to changes in the level of activity.
**Variable cost varies, in total, in direct proportion to changes in the level of activity.
**discretionary fixed costs can be cut with little damage to long range goals
**discretionary fixed costs can be cut with little damage to long range goals
**if operations are cut back and the company produces less, committed fixed costs do not change
**if operations are cut back and the company produces less, committed fixed costs do not change
Examples of discretionary fixed costs
- advertising - public research - internships - research - management development programss
Examples of committed fixed costs
- depreciation on building and equipment - insurance expense - real estate taxes - salaries of top management and operating personnel
Common activity bases:
- direct labor hours - units produced - miles driven - machine hours - units sold
The contribution approach is useful for:
-cost-volume-profit analysis - budgeting - segmented reporting of profit data
Fixed costs are either ___________ or _______________
Committed or discretionary
Variable cost per unit is ________________. The total dollar amount varies in direct proportion to changes in the activity level but is constant on a per unit basis.
Constant
REMINDER: with with high- low method, you use a scattergraph first, to see if there is a linear relation between cost and activity
REMINDER: with with high- low method, you use a scattergraph first, to see if there is a linear relation between cost and activity
CM Income statement order:
Sales Minus Variable expenses: Variable production (COGS) Variable selling Variable Admin = Contribution margin Minus fixed expenses: Fixed production (MOH) Fixed selling Fixed admin = net operating income
Variable cost =
Y2-Y1/ X2-X1 = cost @ high activity level - cost @ low activity level / high activity level - low activity level change in cost/change in activity
Y= a + bX
Y= total mixed cost a = total fixed cost (the vertical intercept of the line) b = variable cost per unit of activity (the slope of the line) X = level of activity
Cost driver
a casual factor that measures the output of the activity that leads (causes) costs to change - identifying and managing drivers helps managers better predict and control costs ex: weather is a significant cost driver in the airline industry; gas prices are a cost driver in trucking, taxi/uber, shipping costs, etc
Step costs with narrow ranges of activity are usually treated as ______________
a variable cost
When a cost is variable, it varies with its _______________. As the level of this increases, the total variable cost increases proportionally
activity base (the thing that causes the variable cost) -AKA cost driver
High-low method
can be used to analyze mixed costs when a scatter-graph plot shows a linear relationship between the X and Y variables. 1) use the data points from the highest and lowest activity levels (not costs) 2) find the total costs at the high and low points 3) calculate the change in cost between the two data points and divide it by the change in activity level between the two data points. You just calculated an estimate of variable cost per unit of activity
If a cost is variable it is ____________________, so, to determine if a cost is variable, ask if the cost is CAUSED by the activity
caused by an activity
mixed costs
contains both variable and fixed elements
Fixed cost
does not change in total as output changes remains constant, in total, even if the activity level changes. Fixed costs remain constant within the relevant range of activity but AVERAGE FIXED COST PER UNIT DECREASES AS ACTIVITY INCREASES ***when we are making decisions, we talk about total fixed cost, not unit fixed cost
step costs with steps that cover wide ranges of activity can be treated as _______________
fixed costs
Committed fixed costs
fixed costs that cannot easily be changed. Committed fixed costs are investments with a multi-year planning horizon that cannot be easily adjusted in the short term. They typically are investments in facilities or equipment - things that can't be significantly reduced without making big changes in the organization
Step cost
has a constant level of cost for a range of output, then jumps to a higher level of cost where it remains for a range of output
Cost behavior
how a cost will react to changes in the level of activity. It is the foundation of managerial accounting and describes whether a cost changes when the level of output changes.
The trend in business is to_____________________ - in an industry we do an increasing amount of work by machines, not by hand, and automation costs are fixed
increase fixed costs and to decrease variable costs
Variable cost
increases in total with an increase in output and decreases in total with a decrease in output
Independent variable (X)
measures output and explains changes in the cost or other dependent variable (Y) - the independent variable causes or is closely associated with the dependent variable - many managers refer to an independent variable as a cost driver
The equation of a straight line is used to show the relationship between __________________
mixed costs and the activity level Y= a + bX
Fixed costs and variable costs have a ____________. Within this, we assume linearity in our fixed costs.
relevant range
The contribution margin(formatting) Income Statement
separates costs into fixed and variable categories - helps managers distinguish between fixed and variable costs so they can plan, control and make decisions
To put together the Contribution Margin Income Statement.....
subtract variable expenses from sales to find the contribution margin (the amount remaining from sales revenue after variable expenses have been deducted)
Contribution margin
the amount remaining from sales revenue after variable expenses have been deducted
The contribution margin (formatting) is ...
the amount that contributes to fixed expenses and then profit
the intercept
the fixed cost
Relevant range
the range of activity (output) where the assumptions about cost behavior are true for the normal operations of a firm - limits the cost relationship to the range of operations that the firm normally expects to happen - even though fixed costs may change, this not NOT make them variable - they are still a fixed cost - just a higher or lower fixed cost
The high-low method is based on _________________ for the slope of a straight line because the slope equals the variable cost per unit of activity
the rise-over-run formula
The traditional and contribution formats differ:
the traditional approach separates product costs from selling and administrative expenses as required for external reporting purposes. The traditional approach does not focus on cost behavior
the slope of the cost line
the variable rate (variable cost per unit)
Fixed cost element=
total cost - variable element
Total cost =
total fixed cost + total variable cost fixed cost + (variable rate x output)
Discretionary fixed costs
usually come from annual decisions to spend money on some fixed cost items and they can be easily reduced in the short term
dependent variable
value depends on the value of another variable (Y) - total cost is the dependent variable. In business, we try to predict total cost
What are the most common classifications of cost behavior?
variable, mixed, and fixed
Variable costs ______________________
vary in direct proportion to changes in output within the relevant range - can be represented by a linear equation - total variable costs depend on the level of output - total variable costs = variable rate x amount of output