Managerial Accounting Chapter 2

* Classify the total costs of each of the following as variable, fixed, mixed, or step *

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Define committed fixed costs:

Committed fixed costs, sometimes referred to as capacity costs, are fixed costs required to maintain the current service or production capacity or to fill previous legal commitments. Examples: depreciation, property taxes, rent, and interest.

What does cost behavior explain?

Cost behavior explains how the total amount for various costs respond to changed in activity volume. It is necessary to understand cost behavior to estimate future costs.

Define cost behavior:

Cost behavior refers to the relationship between a given cost item and the quantity of its related cost driver.

Define cost estimation:

Cost estimation is the determination of the relationship between activity and cost. It is an important part of cost management. It is how costs relate to activity and helps us predict the future.

Define cost prediction:

Cost prediction is the forecasting of future costs. It is a common purpose of cost estimation.

Describe direct labor:

Direct labor is the wages earned by production employees for the time they spend converting raw materials into finished products.

What makes up direct costs?

Direct materials and direct labor makes up direct costs. It is easily traceable to products. It varies with production level.

Describe direct materials:

Direct materials is the cost of primary raw materials converted into finished goods.

What are some examples of mixed costs?

Examples of mixed costs: utilities, equipment maintenance.

Define least-squares regression analysis:

Least-squares regression analysis uses mathematical technique to fit a cost-estimating equation to the observed data. The technique mathematically accomplishes what the analyst does visually with a scatter diagram.

What are 3 other alternative cost driver classifications?

Manufacturing costs are divided into 3 major categories: direct materials, direct labor, and manufacturing overhear.

Describe manufacturing overhead:

Manufacturing overhead includes all of the manufacturing costs other than direct materials and direct labor. This is all other costs. It may or may no be variable. You find fixed costs here.

What do mathematicians regard the least-squares regression analysis as?

Mathematicians regard least-squares regressions analysis as superior to both the high-low and the scatter diagram methods. It uses all available data rather than just two observations and does not rely on subjective judgement in drawing a line.

What are the 4 basic cost behavior patterns?

The 4 basic cost behavior patterns are variable costs, fixed costs, mixed costs, and step costs.

In manufacturing cost hierarchy, what are the 4 categories of activity?

The 4 categories of activities are unit-level activity, batch-level activity, product-level activity, and facility-level activity.

What are the 4 cost behavior patterns presented on the assumption of?

The 4 cost behavior patterns are based on the assumption that a unit of final output is the primary cost driver. Also, assumes that the time period is too short to incorporate changes in strategic cost drivers.

How is the economists model different?

The economists model is different because they assume a non-linear relationship between cost and activity.

What does the least-squares technique do?

The least squares technique creates an equation that minimizes the sum of the vertical squared differences between the estimated and the actual costs at each observation.

Describe relevant range:

The relevant range of a total cost equation is that portion of the range associated with the fixed cost of the current or expected capacity. This total cost equation is only useful in a limited range of activity. Beyond this range, fixed costs are no longer fixed.

What is the uniform increment used in accounting models of cost behaviors called?

The uniform increment is known as the variable cost of one unit.

Following the economics model, what happens when you are within the activity range for which the facility was designed?

Within the relevant range means low marginal costs.

When you've completed the least-squares equation, what should the number be?

You figure out the distance between each dot and the line and you add them together. The number needs to be small. If it is not small, the line is not accurately representing costs. You'd need to move the line so that it is a better estimate.

Administrative costs:

fixed

Depreciation on equipment:

fixed

Depreciation on office equipment:

fixed

Real estate taxes:

fixed

Rent on a building:

fixed

Automobiles rented on the basis of a fixed charge per day plus an additional charge per mile driven:

mixed

Electric power in a factory:

mixed

Salary of the department manager:

mixed

Supplies:

mixed

Total costs:

mixed

Utilities:

mixed

Wages and fringe benefits:

mixed

Salaries of quality inspectors when each inspector can evaluate a maximum of 1,000 units per day:

step

Cost of food sold:

variable

Fees paid delivery help:

variable

Memory chips in a computer assembly plant:

variable

Sales commission:

variable

Wages paid to production employees for the time spent working on products:

variable

What is batch-level activity?

A batch-level activity is performed for each batch of product produced. Batch is a group. It can help you identify costs associated with these activities. Examples include: cost of processing sales order, cost of equipment setup, cost of inspection.

What is facility-level activity?

A facility-level activity is performed to maintain general manufacturing capabilities. Examples include: cost of nonspecialized equipment, cost of maintaining nonspecialized equipment, cost of real property taxes, and cost of general advertising.

What is product-level activity?

A product-level activity is performed to support the production of each different type of product. Examples include: cost of product development, cost of marketing, and cost of specialized equipment.

Define a scatter diagram:

A scatter diagram is a graph of past activity and cost data, with individual observations represented by dots. A scatter diagram helps in selecting high and low activity levels representative of normal operating conditions.

What is unit-level activity?

A unit-level activity is performed for each unit of product produced. Examples include: cost of raw materials, utilities cost of operating equipment, some costs of packaging, and sales commissions.

Following the economics model, what happens when you are above the activity range for which the facility was designed?

Above the relevant range means high marginal costs. There are capacity constraints. Costs change drastically once you are out of normal activity range.

What does the economists model assume each additional unit of activity is being accompanied by?

Assumes each additional unit of activity is being accompanied by a varying increment in total cost.

Following the economics model, what happens when you are below the activity range for which the facility was designed?

Below the relevant range means high marginal costs. Not working at a normal pace increases costs.

Define discretionary fixed costs:

Discretionary fixed costs, sometimes called managed fixed costs, are set at a fixed amount each period at the discretion of management. It is possible to reduce discretionary fixed costs without reducing production for a short time. Examples: advertising, maintenance, charitable contributions, employee training, and research.

What is the marginal cost of one unit?

Economic models assume that with each incremental unit of activity is accompanied by a varying increment in total cost. Economists identify the varying increment in total cost as the marginal cost of one unit.

What are some examples of fixed costs?

Examples of fixed costs: depreciation, loan payments, property taxes, administrative personnel, rent.

What are some examples of step costs?

Examples of step costs: payroll, store space, equipment purchase cost.

What are some examples of variable costs?

Examples of variable costs: cost of supplies, credit card processing fees, overtime pay.

What costs are classified as committed or discretionary?

Fixed costs are often classified as committed or discretionary, depending on their immediate impact on the organization if management attempts to change them. These costs are structural and organizational decisions.

Explain fixed costs:

Fixed costs do not change in response to a change in activity volume. Fixed costs may respond to structural and organizational cost drivers over time, but they do not respond to short-run changes.

What is high-low method of cost estimation determining?

High-low cost method of estimation is an approach to determining the variable and fixed elements of mixed costs. It is focused on fixed and variable costs because this is the base of cost.

What does the high-low method of cost estimation utilize?

High-low method of cost estimation utilizes data from two time periods, a representative high activity period and a representative low activity period, to estimate fixed and variable costs.

Explain mixed costs:

Mixed costs, sometimes called semivariable costs, contain a fixed and a variable cost element. Increases with activity, but not in direct proportion.

How are fixed costs determined with the high-low method of cost estimation?

Once variable costs are determined, fixed costs, which are identical in both periods, are computed by subtracting the total variable costs of either the high or the low activity period from the corresponding total costs.

Explain step costs:

Step costs are constant within a narrow range of activity but shift to a higher level when activity exceeds the range. Total step costs increase in a steplike fashion.

What does the use of straight lines in accounting models of cost behaviors assume?

The use of a straight line in accounting models of cost behaviors assumes a linear relationship between cost and activity with each additional unit of activity accompanied by a uniform increment in total cost.

What is wrong with the assumption that the time period is too short to incorporate changes in strategic cost drivers?

This assumption is useful for short-range planning, but, for the purpose of developing plans for extended time periods, it is more appropriate to consider possible variations in one or more strategic cost drivers.

What is the mathematic equation used in the least-squares technique?

To find the distance between the dots and the line: squared vertical distance = estimated cost minus actual cost squared.

What is total costs?

Total costs is direct materials, direct labor, and manufacturing overhead together. this includes mixed, fixed, step, and variable costs. This is used in manufacturing companies.

What is the same under both models?

Under both models, a linear cost function is valid within the relevant ranges. Use caution when outside of the relevant range and do not assume linear relationships.

Raw materials used in production:

Variable

Explain variable costs:

Variable costs change in total in direct proportion to changes in activity. As activity increases, variable cost increases. Directly proportional.

What is the mathematic equation for variable costs per unit?

Variable costs per unit equals the difference in total costs divided by the difference in activity.

When developing a total cost function, what is the independent variable?

When developing a total cost function, the independent variable usually represents some measure of the goods or services provided customers, such as total student credit hours in a university or total sales revenue in a store.