Chapter 10: Determining How Costs Behave

6) What are the two assumptions behind a simple linear cost function? Briefly explain the three ways that a linear cost function may behave?

1) Variations in the level of a single activity (the cost driver) explain the variations in the related total costs; and 2) Cost behavior is approximated by a linear cost function within the relevant range. This means that total cost versus the level of a single activity that is related to that cost is a straight line within the relevant range. Once linearity is established, there are three possible types of linearity: 1) A strictly variable cost of the form Y = bX, where b is the slope of the straight line and is the variable cost per unit of the cost driver; 2) A strictly constant cost of the form Y = a, where a is the total fixed cost or constant; and 3) A mixed or semivariable cost of the form Y = a + bX, where a is the total fixed cost or constant, and b is the variable cost per unit of the driver or the slope of the straight line.

6) Which of the following statements is true of a linear cost function? A) It presents variable cost as a slope coefficient. B) It presents total cost as an intercept. C) It presents variable cost as an intercept. D) It presents total cost as slope coefficient.

A) It presents variable cost as a slope coefficient.

2) The account analysis method estimates cost functions ________. A) by classifying cost accounts as variable, fixed, or mixed based on qualitative analysis B) using time-and- motion studies C) at a high cost, which renders it seldom used D) in a manner that cannot be usefully combined with any other cost estimation methods

A) by classifying cost accounts as variable, fixed, or mixed based on qualitative analysis

11) The cost function y = 10,000 + 3X ________. A) represents a mixed cost B) will intersect the y-axis at 3 C) has a slope coefficient of 10,000 D) is a curved line

A) represents a mixed cost

5) Which cost estimation method analyzes accounts in the subsidiary ledger as variable, fixed, or mixed using qualitative methods? A) the account analysis method B) the conference method C) the marginal costing method D) the incremental costing method

A) the account analysis method

3) Crimson Services, Inc., employs 8 individuals. They are all paid $16.50 per hour. How would total costs of personnel be classified? A) variable cost B) mixed cost C) irrelevant cost D) fixed cost

A) variable cost

5) The cost components of a heater include $30 for the compressor, $10 for the sheet molded compound frame, and $75 per unit for assembly. The factory machines and tools cost is $60,000. The company expects to produce 1,000 heaters in the coming year. What cost function best represents these costs? A) y = 60,000 + 115X B) y = 1,000 + 60,000X C) y = 60,000 + 1,000X D) y = 1,000 + 115X

A) y = 60,000 + 115X

2) Bennet Company employs 20 individuals. Eighteen employees are paid $18 per hour and the rest are salaried employees paid $3,000 a month. Which of the following is the total cost function of personnel? A) y = a + bX B) y = b C) y = bX D) y = a

A) y = a + bX

8) If the total cost function is y = 5,000 + 7X, calculate the variable cost for 4,000 units. A) $33,000 B) $28,000 C) $20,000 D) $5,000

B) Explanation: Variable cost for 4,000 units = $7 × 4,000 units = $28,000

4) Variable cost per labor-hour is $8.50. Fixed cost is $10,500. Calculate the total cost for 350 labor hours. Machine hours during the period are 50. A) $10,925 B) $13,475 C) $13,900 D) $3,400

B) Total cost = $10,500 + ($8.50 × 350) = $13,475

1) The conference method estimates cost functions ________. A) using quantitative methods that can be very time consuming and costly B) based on analysis and opinions gathered from various departments C) using time-and- motion studies D) by mathematically analyzing the relationship between inputs and outputs in physical terms

B) based on analysis and opinions gathered from various departments

4) For February, the cost components of a picture frame include $0.30 for the glass, $0.75 for the wooden frame, and $0.80 for assembly. The assembly desk and tools cost $500. Two hundred fifty frames are expected to be produced in the coming year. What cost function best represents these costs? A) y = 1.85 + 500X B) y = 500 + 1.85X C) y = 3.85 + 600X D) y = 1.05 + 500X

B) y = 500 + 1.85X

12) Which of the following functions represents the least total cost assuming the number of units is equal in each case? A) y = 180 + 7X B) y = 90 + 6X C) y = 90 + 7X D) y = 180 + 6X

B) y = 90 + 6X

9) The cost function y = 2,000 + 6X ________. A) has a slope coefficient of 2,000 B) has an intercept of 6 C) is a straight line D) represents a fixed cost

C) is a straight line.

1) A cost function is a ________. A) process of calculating present value of projected cash flows B) process of allocating costs to cost centers or cost objects. C) mathematical description of how a cost changes with changes in the level of an activity relating to that cost. D) is a very thorough and detailed way to identifying a cost object when there is a physical relationship between inputs and outputs

C) mathematical description of how a cost changes with changes in the level of an activity relating to that cost.

7) Which cost estimation method may use time-and- motion studies to analyze the relationship between inputs and outputs in physical terms? A) the accrual accounting method B) the high-low method C) the industrial engineering method D) the cash accounting method

C) the industrial engineering method

3) Quantitative analysis methods estimate cost functions ________. A) using the time-and- motion studies B) based on analysis and opinions gathered from various departments C) using a formal mathematical method to fit cost functions to past data observations D) using the pooling of knowledge from each value chain function

C) using a formal mathematical method to fit cost functions to past data observations.

7) A finance manager has to select one of the four different suppliers of raw materials. The total cost functions under the four options are given below. Assume the quality of the raw material to be the same, which of the following is preferred by the finance manager? A) y = 200 + 5X B) y = 200 + 5.50X C) y = 200 + 4.50X D) y = 200 + 4.70X

C) y = 200 + 4.50X

6) Which cost estimation method uses a formal mathematical method to develop cost functions based on past data? A) the cash accounting method B) the conference method C) the accrual accounting method D) the quantitative analysis method

D) the quantitative analysis method

13) Which of the following is an equation of a fixed cost function? A) y = (a + b)X B) y = a + bX C) y = bX D) y = a

D) y = a

1) A linear cost function can only represent fixed cost behavior.

FALSE Explanation: A linear cost function can represent fixed, mixed, or variable cost behavior.

16) All cost functions are linear.

FALSE Explanation: All cost functions are not linear, but for cost-behavior estimation we assume some are linear within a relevant range.

20) All other things being equal, the longer the time horizon the more likely a cost will be fixed.

FALSE Explanation: All other things being equal, the longer the time horizon, the more likely the cost will be variable.

2) In a graphical display of a cost function, the steepness of a line represents the total amount of fixed costs.

FALSE Explanation: In a graphical display of a cost function, the constant or the y-intercept represents the amount of fixed costs whereas the steepness of a line represents the variable cost.

3) It can be inferred that when there is a high correlation between two variables, one is the cause of the other.

FALSE Explanation: It cannot be inferred that a high correlation between two variables indicates that one is the cause of the other. A high correlation simply indicates that the variables move together.

5) Managers should use past data to create a cost function and then use the exact information provided by that cost function to create the budgetary forecast for the next year.

FALSE Explanation: Managers are interested in estimating past cost-behavior functions because the estimates can help them make more accurate cost predictions, or forecasts, about future costs. But better management decisions, cost predictions, and estimation of cost functions can be achieved only if managers correctly identify the factors that affect costs.

21) Outside of the relevant range, variable and fixed cost-behavior patterns remain constant.

FALSE Explanation: Outside of the relevant range, variable and fixed cost-behavior patterns may change.

14) One assumption frequently made in cost behavior estimation is that changes in total costs can be explained by changes in the level of a single activity.

TRUE

15) A cost function is a mathematical description of how a cost changes with changes in the level of an activity relating to that cost.

TRUE

17) In a cost function y = 18,000, the slope coefficient is zero.

TRUE

18) When estimating a cost function, cost behavior can be approximated by a linear cost function within the relevant range.

TRUE

19) y = a + bX, y = a, and y = bX are the three basic types of linear cost functions.

TRUE

22) A particular cost item could be variable for one cost object and fixed for another cost object.

TRUE

4) An example of a physical cause-and- effect relationship is when additional units of production increase total direct material costs.

TRUE

24) Write a linear cost function equation for each of the following conditions. Use y for estimated costs and X for activity of the cost driver. a. Direct materials cost is $1.70 per pound b. Total cost is fixed at $8,000 per month regardless of the number of units produced. c. Auto rental has a fixed fee of $80.00 per day plus $2.00 per mile driven. d. Machine operating costs include $1,000 of maintenance per month, and $12.00 of coolant usage costs for each day the machinery is in operation.

a. y = $1.70X b. y = $8,000 c. y = $80 + $2.00X d. y = $1,000 + $12X

23) Write a linear cost function equation for each of the following conditions. Use y for estimated costs and X for activity of the cost driver. a. Direct manufacturing labor is $10 per hour. b. Direct materials cost $15.60 per cubic yard. c. Utilities have a minimum charge of $5,000, plus a charge of $0.30 per kilowatt-hour. d. Machine operating costs include $300,000 of machine depreciation per year, plus $100 of utility costs for each day the machinery is in operation.

a. y = $10X b. y = $15.60X c. y = $5,000 + $0.30X d. y = $300,000 + $100 X

10) The cost function y = 150 + 10X ________. A) has a slope coefficient of 150 B) has an intercept of 150 C) is a nonlinear D) represents a fixed cost

b) has an intercept of 150