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Chapter 1 -
Chapter Three
Activity Cost Behavior
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Learning Objectives
Define and describe cost behavior for fixed, variable, and mixed costs.
Explain the role of the resource usage model in understanding cost behavior. Separate mixed costs into their fixed and variable components using the high-low method, the scatterplot method, and the method of least squares.
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Cost Behavior
Fixed-Cost Behavior
$ $ Relevant Range
Variable-Cost Behavior
Units Produced
Units Produced
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Mixed-Cost Behavior
Linearity Assumption Total Costs
Cost
Fixed Costs
Variable Costs
Labor
Capital
Cost Behavior
Changes in Input Cost
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Changes in Output
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Basic Terms
The linearity assumption assumes that variable costs increase in direct proportion to the number of units produced (or activity units used).
Practical capacity is the efficient level of activity performance.
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Flexible Resources
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Committed Resources
Committed resources are resources that are supplied in advance of usage.
They are acquired by the use of either an explicit or implicit contract to obtain a given quantity of resource, regardless of whether the amount of the resource available is fully used or not. Committed resources may have unused capacity.
Example: Buying or leasing a building or equipment
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Step-Cost Function
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Step-Fixed Costs
Cost
Normal Operating Range (Relevant Range)
Activity Usage
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Resource Relationships
The relationship between resources supplied and resources used is expressed by the following equation:
Resources available = Resources used + Unused capacity
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The $30,000 of excess engineering capacity means that a new product be introduced without increasing current spending on engineering.
could
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Methods for Separating Mixed Costs into Fixed and Variable Components
The High-Low Method The Scatterplot Method The Method of Least Squares
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Variable Rate (V) = Change in cost/Change in output V = (High cost - Low cost) / (High output - Low output) V = ($3,750 - $1,000) / (500 - 100) V = $2,750 / 400 V = $6.875 per setup hour
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The cost formula using the high-low method is: Total cost = $312.50 + ($6.875 x setup hours)
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Scatterplot Method
Important: Cost function is only relevant within relevant range
3,000
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2,000
1,000
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100
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200
500
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Nonlinear Relationship
Activity Cost
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0
Activity Output
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*
0
Activity Output
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Presence of Outliers
Activity Cost
* *
*
0
Activity Output
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Least Squares
Constant Std Err of Y Est R squared No. of Observations Degrees of Freedom X Coefficient(s) Std Err of Coef. 6.75 0.9464847243
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Multiple Regression
TC = b0 + b1X1 + b2X2 + . . .
b0 = the fixed cost or intercept bi = the variable rate for the ith independent variable Xi = the ith independent variable
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Constant Std Err of Y Est R squared No. of Observations Degrees of Freedom X Coefficient(s) Std Err of Coef. 1.09715750519456 0.210226332115593
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Use past experience Try to confirm results with operating personnel Use common sense to confirm statistical studies
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End of Chapter 3
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