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