Managerial Accounting Exam 1 (Ch. 14, 1, + 2)

Critical Questions Statement of Cash Flows Answers

1. Is the company generating sufficient positive cash flows from its ongoing operations to remain viable? 2 Will the company be able to repay its debts? 3.Will the company be able to pay its usual dividend? 4. Why do net income and net cash flow differ? 5. To what extent will the company have to borrow money in order to make needed investments?

Making Decisions

Differential cost (differs between alternatives) Sunk cost (should be ignored) Opportunity Cost (forgone benefit)

Conversion Cost (formula)

Direct labor + manufacturing overhead

Prime cost (formula)

Direct materials + direct labor

Product Cost

Direct materials + direct labor + manufacturing overhead

Manufacturing Costs

direct materials and direct labor=direct costs manufacturing overhead: indirect cost

Analysis of Mixed Costs

the fixed portion of a mixed cost represents the minimum cost of having a service ready and available for use the variable portion represetns the cost incurred for actual consumption of the service, thus it varies in proportion to the amount of service actually consumed

Cost structure

the relative proportion of each type of cost in an organization

Balance Sheet and Income Statement Equation

(1) Change in cash + changes in noncash assets= Changes in liabilities + changes in stockholders' equity (2)Net cash flow=change in cash (3) changes in stockholders' equity= Net income- Dividends + changes in capital stock (4) Net cash flow= Net income-Changes in noncash assets+ changes in liabilites- Dividends + changes in capital stock statement of cash flows is constructed by starting with net income and then adjusting it for changes in noncash balance sheet accounts

Three major financial statements required for external reports

-income statement -balance sheet -statement of cash flows

Diagnosing a Cost Behavior with a Scattergraph Plot

1. Y is plotted on the vertical axis (dependent variable) 2. x is plotted on horizontal axis (indepedent variable) Cost behavior is considered linear whenever a straight line is a reasonable approximation for the relation between cost and activity plotting the data on a scattergraphi is an essential diagnostic step that should be performed before permforming the high-low method or least-squares regession calc if the scattergraph plot reveas linear cost behavior, then it makes sense to perform the high-low or least-squares regression calc. to separate the mixed cost into its variable and fixed components if it doesn't depict linear cost behavior, then it makes no sense to proceed

Nonmanufacturing costs or Period Costs (also sometimes called non-Inventoriable Costs)

All costs of the company not classified as manufacturing costs These costs are expensed as incurred, never are assets These costs are immediately expensed- referred to as SG&A or Operating Expenses These costs are never an asset

Big Picture

Asset=Liabilites + Equity Generally speaking if: Asset increases -> use of cash Liability increases -> source of cash Equity: Stock increases -> source of Cash Look at RE to find out about: Net income -> source of cash Cash dividends paid -> use of cash Now classify sources/use as OA, IA, or FA

Accounting System

Budgets -All managers contribute to the planning through the budget process -The Budgetign process gets the organization talking Collect and Summarize Data -Day to day accounting functions are performed, JEs, G/L, subledger functions Performance Reports (end of the period) -Perrformance reports (comparsion of budget to actual and variance)

Investing Activities include

Cash paid or received from: Purchases of LT Assets (ex: purchase of land, buildings, equip, LT investments in stock/debt of another company, LT loans made to others, LT N/R etc.) Sales of Long-Term assets (show the ACTUAL AMOUNT of cash received/paid in JE -> must reconstruct JE using extra info; remember to adjust for GAin or loss in OA and adjust for noncash expesnes in OA

Assigning Costs to Cost Objects

Cost Classifications -Direct Cost -Idirect Cost

Costs can also be classified as to their behavior, or how they repsond to changes in activity level (or activity base)

Cost behavior analysis is the study of how specific costs respond to changes in the level of business activity Knowledge regarding cost behavior helps management plan operations and decide between different alternative courses of aciton -know that there is a positive relationship between these variables, but what is the relationshi

Significant Non-Cash Exchanges (or Direct Exchanges) of Any Long-Term Assets, Long-Term Debt, or Stock

DO NOT LIST THESE NON-CASH EXCHANGES ON THE STATEMENT OF CASH FLOWS ANYWHERE, INSTEAD REPORT ON SEPARATE SCHEDULE accompanying the Statement of Cash Flows. Examples include: -Issuance of Common Stock or Preferred Stock to purchase assets -Issuance of Long-Term debt (long-term note or bond) to purchase assets -Conversion of (paying off) bonds (or other long term debt, notes) into Common Stock or Preferred Stock -Conversion of convertible prefrred stock into common stock -Exchanges of long-term assets -Stock dividends issued to shareholders (reported in statement of retained earnings)

Differential Cost and Revenue

In business decisions, each alternative will have costs and benefits that must be compared the costs and benefits of the other available alternatives

Man. OHD

Indirect Materials- materials that can't be convienently traced to the finished product Indirect Labor- all labor costs related to the factory that can't be conveniently traced to the finished prodduct Other indirect costs of the factory

Financing Activities include

Long-term debt (ex bond or LT note) issued/borrowed/sold (ex principal increases) Long term debt retired or paid off Issuance or sale of company's C/s or P/s Repurchase of company's own T/S Repurcahse and retirement of company's own C/S, Preferred Stock, Treasury Stock Cash dividends paid to company's own shareholders Note: Always roll roward RE to make sure you check for dividends and remeber to include NI or NET loss as an OA CF properly

To prepare the Statement of Cash Flows

Look at: Comparative Balance Sheet Income statement and other info (-Review of G/L)

The Linearity Assumption and the Relevant Range

Management accountants ordinarily assume that costs are strictly linear -> the relation between cost on the one hand and activity on the other can be represented by a straight line many costs are actually curvilinear -> the relation between cost and activity is a curve even if a cost is not strictly linear, it can be approdximated within a narrow band of activity known as the relevant range by a straight line

Earnings Quality

Managers and investors often look at the relationship between net income and net cash provided by operating activites to help assess the extent to which a company's earnings are of higher quality, or more indicative of operation performance, when the earnings (1) ar enot nduly inflnced by inflation (2) are computed using conservative accounting principles principles and estimates, and (3) are coorelated with net cash provided by operating activies move in tendem with one another suggests that eranings result from changes in sales and operating expenses if a company's net income is steadily increasing, and its net c ash provided by operating activites is declining, it suggest that net income is being influncedby factors unrelated to operational performances

Accounting for costs in manufacturing companies

Manufacturing costs -Direct materials -Direct labor -Manufacturing overhead Nonmanufacturing costs -Selling Costs -Administrative Costs

Management's Function

Planning Phase - Formulate plans, goals, or objectives -Outline stepes to meet these goals Directing/Motivating Phase (or Action Phase) - Implement goals and objectives and measure performance Control/Evaluation Phase -Feedback and Evaluate: How well does it work? Ensure plans are carried out

Preparing Financial Statements

Product costs (inventoriable) Period costs (expensed)

Financial Accounting

Providing External users with useful information External users= any external group Information regarding cash flows and the stewardship of management Useful information for eternal reports: Balance Sheet, Income Statement, Statement of Cash Flow, Statement of RE etc. is subject to GAAP Emphasis on the past, or history of the organization Emphasis on the whole organization IS Mandatory: Focus is o the information required Data needs to be precise and objective and verifiable (better to be precise even if info is late and useless) Data needs to suit the needs of outsiders Information is funneled, aggregated, and summarized Independent audit (or review) is required

Managerial Accounting

Providing Internal users with useful information Internal users=management Information is needed for decision support and control Decision support: gathering info for ad hoc and routine decision making Control: systems and procedures in place to establish performance goals and ensure that everyone work toward them Useful information for intneral reports Not Subject to GAAP Emphasis on the future: What info do we need to run the company? Emphasis on parts of the organization rather than whole organizaton Is Not Mandatory Data needs to be relevant and timely (Better to be timely and seful even if info is based on estimates) Data needs to suit the needs of the company Information is not funneled, aggregated, and summarized No independent audit (review) is required

account analysis

an account is classified as either variable or fixed based on the analyst's prior knowledge of how the cost in the account behaves

Direct Cost

cost that can be easily and conviently traced tp a specified cost object

Positive (+) cash flows

called cash inflows, cash increases, or cash provided add these items on the cash flow statement

Indirect Materials

sometimes it isn't worth the effort to trace the costs of relatively insignificant materials to end products

Discretionary (fixed) costs

(managed fixed costs) usually arise from annual decisions by management to spend on certain fixed cost items ex: advertising research, public relations can be cut for short periods of time with minimal damage to the longrun goals of the organization

Operating Activities Include

-Cash receipts/collections from customer or others -Cash received/collections from interest revenue Dividend income received from other companies (co. is shareholder) Cash paid for interest on any/all debt Cash paid to vendors or suppliers for purchases of inventory Cash paid to vendors or suppliers for other items Cash paid for employee's salary, wages, or compensation Cash paid for prepaid expenses (ex: insurance, rent, supplies) Cash paid for taxes Net income or Net Loss Depreciation or Amortization expense

Statement of Cash Flows

-highlights the major activities that impact cash flows and affect the overall cash balance answers questions that can't be easily answered by looking at the income statement and balance sheet Valuable analytical tool for managers as well as for investors and creditors Managers tend to be more concerned with forecasted statement of cash flows that are prepared as part of the budgeting process can be used to answer critical questions Managers prepare it by applying a fund principal of double-entry bookeeping -.the change in the cash balance must equal the changes in all other balance sheet accounts besides cash -ensures that properly analyzing the changes in all noncash balance sheet accounts always quantifies the cash inflows and outflows that explain the change in the cash balance

Investing and Financing Activities: Gross Cash Flows

GAAP + IFRS require that the investing and financing sections of the statement of cash flows disclose gross cash flows gross method of reporting cash flows is not used in the operating activites section of the statement of cash flows, where debits and credits are netted against each other to compute gross cash flows for the investing and financing sections, you'll begin by calculating the changes in the balance of each applcable balance sheet account -when a noncurrent asset account balance increases, it signals the need to sub. cash outflows inte h inv. act sec of the statemetn -i fbalance in a noncurent asset account decreases, it signals the need to add cash inflows -liability and equity accounts handled in opposite fashion

Organizing the Statement of Cash Flows

GAAP and IFRS require comapnies to follow prescribed rules when preparing the statement of cash flows -one is organizing the statement into 3 sections that report cash flows resulting from operating activities, investing activities, and financing activities

Sunk COst

a past cost that is already incurred and can't be changed by an current or future decision that is made Ignore sunk costs in decision making since they do not change between alternatives costs are not reevant to the decision

Period Cost

Selling expenses + adminstrative expenses

The Indirect Method: A Three-Step Process

Step 1: Add Depreciation Charges to net income Step 2: analyze net changes in noncash balance sheet accounts that impact net income Step 3: adjust for gains/losses

Period Costs

all the costs taht are not product costs all selling and administrative expenses are treated as period costs not included as part of the cost of either purcahse or manufactured goods are expensed on the income statement in the period in which they are incurred using the usual rules of accrual accounting the period in which a cost is incurred is not necessarily the period in which cash changes hand

Contribution Margin

amount remaining from sales revenues after varibale expenses have been deducted -this amount contributes toward covering fixed used as an internal planning and ecision-making tool emphasis on cost-behavior aids cost-volume-profit-analyiss managemetn performance appraisals, and budgetings helps managers organize data pertinent to numerous decisions

Negative (-) cash flows

called cash outflows, cash decreases, or cash used subtract these items on the cash flow statement

Step Variable Costs

cost of the resource is obtainable only in large chunks and the ost increases or decereases only in respone to farily wide changes in activty

Predicting cost behavior in response to changes in activity

Variable cost (proportional to activity) Fixed cost (constant in total) Mixed Cost (has variable and fixed elements)

Sunk Cost

a cost that has already been incurred and that can't be changed by any decision made now or in the future can't be changed by any decision, they are not differential costs -only differential costs are relevant in a decision, sunk costs should always be ignored

differntial cost

a difference in cost between any 2 alternatives= differential cost also known as an incremental cost, although techinally an incremental cost should refer only to an increase in cost from one alternative to another . decreases in cost should be referred to as decremental costs encompass both cost increases (incremental costs) and cost decreases (decremental costs btween alternate) differntial costs can be either fixed or variable only the idfferences between alternatives are relevant in decisions -same under all altneratives and that are not affected by the decision can be ignored

product costs

cost should be recognized as an expense only when the sale takes place/ when the benefit occurs include all costs involved in acquriing or making a product ex: direct materials, direct labor, and manufacturing overhead "attach" to units of product as the goods are purchased or manufactured and they remain attached as the goods go into inventory awaiying sale initially assigned to an inventor account on the balance sheet -when the goods are sold, the costs are released from inventory as expenses (COGS) and matched against sales revnues on the income statement intially assinged to inventories -> also known as inventoriable costs not necessarily recorded as expenses on the income statement in the period in which they are incurred recorded as expenses in the period in which the related products are sold

Indirect Cost

cost that can't be easily and conviently traced to a specified cost object to be traced to a cost object such as a particular product, the cost must be caused by the cost object

common object

cost that is incurred to support a number of cost objects but can't be traced to them individually type of indirect cost

Fixed Cost

cost that remains constant, in total, regardless of changes in the level of activity ex: straight-line depreciation, insurance, property taxes, rent not affected by changes in activity reamin constant unless influneced by some outside force the average fixed cost per unit becomes progressively smaller as the level of activity increases fixed costs can be viewed as either committed or discretionary

Cost Classifications for Assigning Costs to Cost Objects

costs are assigned to cost objects for a varity of purposes including pricing, preparing profitability studies, and controlling spending a cost object is anything for whcih cost data are desired -costs assigned to objects are either direct or indirect

Fixed Costs Definition

costs that stay constant, in total, regardless of changes in the activity level, but decrease per uit as the activity level increases Cost formula: TOtal Cost=FC or y=a where Fc or a in the formula is the y-intercept of the line

Variable Costs Defintion

costs that vary in total, in direct propotion to changes in the level of activity, but stay consant per unit as the activity base changes (Cost formula: Total Cost= VC(x) or y=bx, where VC or b in the formula is the slope of the line

Manufacturing Costs or Product Costs (also sometimes called Inventoriable Costs)

costs which are incurred to manufacture or make a product Product costs are held in inventory accounts (assets on balance sheet) until product is sold As the product is sold, proudct costs are expensed as COGS

differential revenue

difference in revenues (usually just sales) between any two alternatives

Nonmanufacturing Costs

divided into two categories: selling costs and administrative costs

Investing activities

generate cash inflows and cash outflows related to acquring or disposing of noncurrent assets such as property, plant and equipment, long-term investments, and loans to another entity

Financing activities

generate cash inflows and outflows related to borrowing from and repaying principal to creditors and computing transactions with the company's owners, such as selling or repurchasing shares of common stock and paying dividends

Operating Activities

generate cash inflows and outflows related to revenue and expense transactions that affect net income

Activity Level (activity base or cost driver)

identifies and measures the activity that causes the change in the level of costs measure of what causes a variable cost to change

Cash Flow Statements

explain what happens to "cash and cash equivalents" during the period Cash inflows and cash outflows are separated into three types of activities: Investing, Financing, and Operating

administrative cost

include all costs associated with the general management of an organization rather than with manufacturing or selling ex: executive compensation, general accounting and similar costs involvedi nthe overall general administration of the organization as a whole can be direct or indirect often called selling, general, and administraative (SG&A) costs or just selling and administrative costs

Selling Costs

include all costs that are incurred to secure customer orders and get the finished product to the customer also called order-getting and order-filling costs ex: shipping, sales travel, sales comisssions can be direct or indirect cost

Manufacturing Overhead

includes all manufactuing costs except direct materials and direct labors ex: indirect materials and labor, maintenance and repairs on production equipment, property taxes only those costs associated with operating the factory are included in manufacturing overhead other names: indirect manufacturing cost, factory overhead, factory burden

Mixed Costs Definition

increase in total, as the activity base increases and decrease per unit as the activity base increases contain both a variable and fixed cost component the variabele cost component is the incremental cost incurred for the actual use of the item the fixed cost ocmponent is the minimum cost to ofhaving the item availbe for use mixed costs can be broken down into their variable and fixed cost components Cost formula: Total Cost+= FC +VC(x) or y=a +bx, where FC or a in the formula is the y-intercept of the line and VC or b in the formula is the slope of the line

engineering approach

involves a detailed analysis of what cost behavior should be, based on industrial engineer's evaluation of the production methods to be used, the materials specifications labor requirements, equipment usage, production efficiency, power consumption the high-low and least-squares regression methods estimate the fixed and variable elements of a mixed cost by analyzing past srecords of cost and activity data

Cost Classifications for Predicting Cost Behavior

it is often necessary to predict how a certain cost will behave in resposne to a change in activity

Indirect Labor

labor costs that can't be physically traced to particular products, or that can be traced only at great cost and inconvience treated as part of manufacturing overhead

raw materials

materials that go into the final product may include both direct and indirect materials

Balance Sheet

product costs are held in invenory accounts as assets until product is sold Three types of inventories in a manufacturing company - Raw materials inventory: direct materials and indirect materialss purchased but not yet used in production -Work-in-process Inventory- partially completed goods containing (DM issued, DL costs incurred, and OHD assigned) -Finished Goods Inventory: completed goods that have not been sold; contains DM costs issued + DL costs incurred + OHD assigned

Contribution Format Income Statement

provides managers with an income statment that clearly distinguishes between fixed and variable costs and aids planning, controlling, and decision making separates costs into fixed and variable categories, first deducting varibale expenses from sales to obtain the contribution margin For a merchandising company, COGS is a variable cost that gets included in the "variable expenses" portion of the contribution format income statement

Relevant Range

range of activity within which the assumption that cost behavior is strictly linear is reasonably valid outside of this range, a fixed cost may no longer be strictly fixed or a variable cost may not be strictly variable assumptions made about cost behavior may be invalid if activity falls outside of the relevant range important in understanding fixed costs -cost behavior patterns such as salarie exmployyees are often called step-variable costs -can often be adjusted quickly as conditions change -the width of the steps for step-variable costs is generally so narrow that these costs can be treated essentially as variable costs for most purposes the width of the steps for fixed costs is so wide that these costs should be treated as entirely fixed within the relevant range

Relevant Range definiton

range of activity within which your assumptions are valid Many costs actually behave in a curvilinar fashion except in the relevant range where the cost is approximately linear For a manufacturing company, the relevant range is usually considered the capacity of the company (Predicitons about costs in a company beyond the plant's capacity are not valid) For a manufacturing company this is usually considered the capacity of the company

net cash provided by operating activities

to compute the net amount of cash inflows and outflows resulting from operating activities -can use iether direct or indirect method -both have the same purpose-> to translate accrual-based net income for a cash basis

Direct Materials

refer to any materials that are used in the final products and the finished product of one company can become the raw materials of another company materials that become an integral part of the finished product and whose costs can be conveiently traced to the finished product

Cost Behavior

refers to how a cost reacts to changes in the level of activity -as the activity level rises and falls, a particular cost may rise and fall as well- or it may remain constant costs are often categorized as variable, fixed, or mixed

Cost Classifications for Preparing Financial Statements

when preparing a balance sheet and an income statement, companies need to classify their costs as product costs or period costs costs are recognized as expenses on the cinome statement in the period that benefits from the cost the matching principal is based on the accrual concept that costs incurred to generate a particular revenue should be recognized as expenses in the same period that the revenue is recognized

Committed fixed costs

represent organizational investments with a multiyear planning horizon that can't be significantly reduced even for short periods of time without making fundamental changes ex: investments in facilities and equipment, insurance expenses remain largely unchanged in the short term because the costs of restoring them later are likely to be far greater than any short-run shavings that might be realized

Conversion Cost

sum of direct labor cost and manufacturing overhead cost

The Statement of Cash Flows: Key Concepts

summarizes all of a company's cash inflows and cahs outflows during a period explains the change in cash balance cash broadly defined to incllude both cash and cash equivalents cash equivalents- most companies invest their excess cash reseves in these types of interest-bearing assets that can be easily converted into cash (included with cash in a statement of cash flows)

Incremental Costs (differential costs, marginal costs)

the additional costs associated with choosing one course of action (or one alternative) over another. Relevant for decision aking since the cost changes between alternative

Incremental Revenues (differential revenues, marginal revenues)

the additional revenue produced from one alternative vs another Releveant for decision making since the cost changes between alternatives (difference in cost between 2 alternatives)

COntrib. Margin

the amount that each unit contributes toward covering the FC of the firm and therby provindg profit to the firm As long as Cm is positive, the only barrier to profit is volume Cm per unit remains constant as long as salers per unit and VC per nit do not change the amount of total sales, total variable costs, and total contribution margin in the contribution income statement above all depnd on the level of activity Fixed costs do not dpeend on the level of acitivty COGS is a variable cost in Merchandising COmpany, mixed cost in A manufacturing company

Opportunity Cost

the potential benefit that is given up when one alternative is selected over another -every alternative involves an opportunity cost

Opportunity Costs

the potential beneift that is given up when one course of action is slected over another benefit foregone by following one alternative is chosen over another opportunity costs are reevants for decision making since they change between alternatives not typically entered into the accounting records in a JE since company has chosen over altnerative

activity base

measure of whatever causes the incurrence of a variable cost (sometimes called cost driver) ex: direct labor hours, machine-hours, units produced assume that the activity base under consideration is the total volume of goods and services provided by the organization total variable costs change as the activity level changes, a variable cost is constant if expressed on a per unit basis

Free Cash Flow (from text)

measure used by managers to look at the relationship among 3 numbers from the statement of cash flows net cash provided by operating activities, additions to property, plant, and equipment (capital expenditures) and dividends measures a company's ability to fund its capital expenditures for PPE and its dividends from its net cash provided by operating activitiea positive numer indicates that the company gnerated enough cash flow from its operating activities to fund its capital expenditures and dividend payments a negative number suggests that the company needed to obtain cash from other sources -doesn't automatically signal poor performance

Free Cash Flow

measures the company's ability to fund capital expenditures for PPE and CAsh Dividends paid from Operating Activities (positive number means can fund expenditures) Net cash flow from operating activities Less: Capital Expenditures Less: Dividends =Free Cash Flow

Prime Costs

the sum of direct materials cost and direct labor costs

Indirect Method

net income is adjusted to a cash basis these amounts are derived indirectly by removing from net income nay items that do not affect cash flows shows the reasons for any differences between net income and net cash provided by operating activities 99% of companies use this method -if direct method used, companies must also provide a supplenentary report that uses the indirect method -if indirect method is used, no req. to use direct method

Cash Flow Statement is used to

predict ability to generate future cash flows and run operations predict ability to pay future dividends predict abilitity to pay liabilities/debt predict ability to buy needed investments predict solvency of company reconcile net income and cash

Traditional Format Income Statement

prepared primarily for external reporting purposes organizes costs into 2 categories -COGS and selling and adminstrative expenses Gross margin= Sales-COGs Gross margin-selling and admin= net operating income the COGS reports the product costs attached to the merchant sold during the period the S+A expenses report all period costs that have been expensed and incurred COGS= Beg. Merc. Inv. + Purchases- Ending Merch. Inv. has serious limitations when used for internal purposes -doesnt't distinguish between fixed and variable costs Internally, managers need cost data organized by cost behavior to aid in planning, controlling, and decision making -contribution format income statment created as a result

Direct Labor

consists of labor costs that can be easily traced to individual units of a product sometimes called touch labor because direct labor workers typically touch the product while it is being made

Mixed Costs

contains both variable and fixed cost elements also known as semivariable costs equation to express the relationship between a mixed cost and the level of activity (y=a + bx) y= total mixed cost a= total fixed cost the steeper the slope, the higher the variable cost per unit b= variable cost per unit of activity (slope of the line) x= level of the activity

Income Statement

selling price for goods sold is recognized as Revenue or Sales; while the product costs for goods that have been sold is in COGS expense In a manufacturing company, COGS contains costs for DM isued + DL Costs incurred + OHD assigned to make the product All period costs, both selling and marekting as well as administrative costs are expensed on the income statement as expenses

The High-Low Method

used when scatterplot graph indicates a linear relation between cost and activity, the fixed and variable cost elements of a mixed cost can be estimat4ed using the high-low method or the least-squares regression method based on the rise-over-run formula for the slope of a straight line if the relation betwen cost and activity can be represented by a straight line, the n the slope of a straght line is equal to the variable cost per unity oc activity Variable cost= slope To analyze mixed costs with the high-low method, begin by identifying the period with the lowest level of activity Variable cost= Cost at the hight activity level-Cost at the low activity level/ High activity level- Low activity level Fixed cost element= Total cost- variable cost element sometimes the high and low levels of activity don't coincide with the hight and low amounts of costs the costs at the highest and lowest levels of activity are always used to analyze a mixed cost under the high-low method -the analyst would like to use data that refelct the greatest possible variation in activity utilizes only 2 data points-> major defect -generally 2 data points aren't enought to produce accurate results -periods with the highest and lowest activity tend to be unsual a cost formula that is estimated solely using data from these unusual periods may misrepresent the true cost behavior during normal periods

The Least-Squares Regression Method

uses all of the data to separte a mixed cost into its fixed and variable components a regression line of the form, y= a + bx is fitted to the data, where A represents the total fixed cost and b represents the variable cost per unit of activity vertical deviations are called the regression errors computes the regression line that minimizes the sum of these squared errors computer calculates this generally provides more accurate cost estimates than the high-low method because rather than relying on just 2 data points, it uses all of the data points to fit a line that minimizes the sum of the squared errors

Variable Cost

varies, in total, in direct proportionto changes in the level of activity ex: COGS for a merchandising company, direct materials, direct labor, variable elements of manufacturing overhead for a cost to be variable, it must be variable with respect to something -that "something" is its activity base

Cash Equivalents

very, very short term, highly liquid investments (original maturity date <3 months) that are almost cash (ex: T-bills, short-term marketable securities, commercial paper and money market funds) Investments made often to generate a return on idle cash The purchases and sales of Short-Term Investments or short-term marketable securities are part of the overall change in cash and cash equivalents explained in the Cash Flow statement (ex: these are not reported separately as a line item in the statement itself, instead the change is part of overall change in cash occuring during the year)