ACCT 202 Ch. 2

high low method

...

Analysis of Mixed Costs

account analysis and The engineering approach

2 Types of Fixed Costs

committed fixed costs and

fixed cost

constant within the relevant range. In other words, fixed costs do not change for changes in activity that fall within the "relevant range." For example, your monthly contract fee for your cell phone is a fixed amount for a certain number of minutes. The monthly contract fee does not change based on the number of calls you make.

mixed cost line

expressed with the equation Y = a + bX.

Period Costs

include all selling costs and administrative costs. These costs are expensed on the income statement in the period incurred. All selling and administrative costs are typically considered to be period costs. The usual rules of accrual accounting apply to period costs. For example, administrative salary costs are "incurred" when they are earned by the employees and not necessarily when they are paid to employees.

Manufacturing overhead

includes indirect materials that are part of the finished product, but that cannot be easily traced to it. It includes indirect labor costs that cannot be conveniently traced to the creation of products.

Fixed Cost Per Unit

per unit basis, a fixed cost is inversely related to activity—the per unit cost decreases when activity rises and increases when activity falls. For example, the average fixed cost per cell phone call made decreases as more calls are made in the month.

Direct Materials

raw materials that become an integral part of the finished product and whose costs can be conveniently traced to it. Examples include the aircraft engines on a Boeing 777, the Intel processing chip in a personal computer, the blank video cassette in a pre-recorded video, and a radio in an automobile.

Non-manufacturing costs

selling and administrative costs

Conversion Cost

the sum of direct labor cost and manufacturing overhead cost. The term conversion cost is used to describe direct labor and manufacturing overhead because these costs are incurred to convert materials into the finished product.

Least-Squares Regression Method

used to analyze mixed costs if a scattergraph plot reveals an approximately linear relationship between the X and Y variables. The least-squares regression method is a more sophisticated approach to isolating the fixed and variable portion of a mixed cost. This method uses all of the data points to estimate the fixed and variable cost components of a mixed cost. This method is superior to the scattergraph plot method that relies upon only one data point and the high-low method that uses only two data points to estimate the fixed and variable cost components of a mixed cost. The basic goal of this method is to fit a straight line to the data that minimizes the sum of the squared errors. The regression errors are the vertical deviations from the data points to the regression line. Least-squares regression provides the most accurate estimates because it uses all of the data points.

most commonly used classifications of cost behavior?

variable and fixed costs

variable cost

varies, in total, in direct proportion to changes in the level of activity. For example, if you don't have a texting plan on your cell phone, text messaging costs 5 cents per text. Your total texting bill increases with the number of texts you send.

Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the fixed portion of sales salaries and commissions? a. $ 2,000 b. $ 4,000 c. $10,000 d. $12,000

A. Total cost =Total fixed cost + Total variable cost $14,000 =Total fixed cost + ($0.10 × 120,000 units) Total fixed cost = $14,000 - $12,000 Total fixed cost = $2,000

Administrative Costs

Administrative costs include all executive, organizational, and clerical costs associated with the general management of an organization. Examples of administrative costs include executive compensation, general accounting, secretarial, public relations, and similar costs involved in the overall general administration of the organization as a whole.

Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the variable portion of sales salaries and commission? a. $0.08 per unit b. $0.10 per unit c. $0.12 per unit d. $0.125 per unit

B. $4,000 ÷ 40,000 units = $0.10 per unit UNITS COST High level 120,000 $14,000 low level 80,000 10,000 Change 40,000 $4,000

indirect materials

Materials used to support the production process. Examples: lubricants and cleaning supplies used in the automobile assembly plant.

Selling Costs

Selling costs include all costs necessary to secure customer orders and get the finished product into the hands of the customer. These costs are also referred to as order-getting and order-filling costs. Examples of selling costs include advertising, shipping, sales travel, sales commissions, sales salaries, and costs of finished goods warehouses.

Which of the following costs would be variable with respect to the number of cones sold at a Baskins & Robbins shop? (There may be more than one correct answer.) A. The cost of lighting the store. B. The wages of the store manager. C. The cost of ice cream. D. The cost of napkins for customers.

The cost of ice cream and the cost of napkins for customers would be variable costs. As Baskins and Robbins sells more ice cream cones, we would expect the total cost of ice cream and napkins to increase.

discretionary fixed costs

These fixed costs may be altered in the short-term by current management decisions. Some examples of discretionary fixed costs include advertising and research and development costs.

indirect labor

Wages paid to employees who are not directly involved in production work. Examples: maintenance workers, janitors, and security guards.

If your fixed monthly utility charge is $40, your variable cost is $0.03 per kilowatt hour, and your monthly activity level is 2,000 kilowatt hours, what is the amount of your utility bill?

Y = a + bX Y = $40 + ($0.03 × 2,000) Y =$100

Y

Y is the total mixed cost

a

a is the total fixed cost (or the vertical intercept of the line)

activity base (also called a cost driver)

a measure of what causes the incurrence of variable costs. As the level of the activity base increases, the total variable cost increases proportionally.

Product Costs

all the costs that are involved in acquiring or making a product. More specifically, it includes direct materials, direct labor, and manufacturing overhead. Consistent with the matching principle, product costs are recognized as expenses when the products are sold.

variable cost per unit

as the activity level rises and falls, variable cost per unit is constant. For example, the cost per text message sent is constant at 5 cents per text.

b

b is the variable cost per unit of activity (or the slope of the line),

engineering approach

classifies costs based upon an industrial engineer's evaluation of production methods, materials specifications, labor requirements, equipment usage, power consumption, and so on. This approach is particularly useful when no past experience is available concerning activity and costs.

3 Basic Manufacturing costs

direct materials, direct labor, and manufacturing overhead. These costs are incurred to make a product.

account analysis

each account under consideration is classified as variable and fixed based on the analyst's prior knowledge about how costs behave. This approach is limited in value in the sense that it glosses over the fact that some accounts may have both fixed and variable components.

Prime cost

is the sum of direct materials cost and direct labor cost. (manufacturing cost)

Direct Labor

labor costs that can be easily traced to individual units of product.

committed fixed costs.

These are long-term fixed costs that cannot be significantly reduced in the short term. Some examples include depreciation on buildings and equipment and real estate taxes on factory property.

Mixed costs

Mixed costs (also called semivariable costs) contain both variable and fixed cost elements. The graph depicts the mixed costs of a normal utility bill. As illustrated in the graph, a utility bill contains a fixed and a variable cost component. The fixed portion of the utility bill is constant regardless of kilowatt hours consumed. This cost represents the minimum cost that is incurred to have the service ready and available for use. The variable portion of the utility bill varies in direct proportion to the consumption of kilowatt hours.

Which of the following costs would be considered a period rather than a product cost in a manufacturing company? A. Manufacturing equipment depreciation. B. Property taxes on corporate headquarters. C. Direct materials costs. D. Electrical costs to light the production facility. E. Sales commissions.

Property taxes on corporate headquarters and sales commissions are period costs. All of the other costs listed are product costs.

X

X is the actual level of activity.