Cost Behaviour

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CHAPTER 3
ACTIVITY COST BEHAVIOR

LEARNING OBJECTIVES

AFTER STUDYING THIS CHAPTER, YOU SHOULD BE ABLE TO:
1.Define and describe fixed, variable, and mixed costs.
2.Explain the use of the resources and activities and their relationship to cost behavior. 3.Separate mixed costs into their fixed and variable components using the high-low method, the scatterplot method, and the method of least squares. 4.Evaluate the reliability of the cost formula.

5. Explain how multiple regression can be used to assess cost behavior. 6. Define the learning curve, and discuss its impact on cost behavior. 7. Discuss the use of managerial judgment in determining cost behavior.

CHAPTER SUMMARY

THIS CHAPTER INTRODUCES COST BEHAVIOR AS THE WAY IN WHICH A COST CHANGES IN RELATION TO CHANGES IN ACTIVITY OUTPUT. THE RESOURCE USAGE MODEL HELPS ONE BETTER UNDERSTAND THE COST BEHAVIOR. IT EMPHASIZES THAT THE COMMITTED RESOURCES MAY HAVE EXCESS CAPACITY BECAUSE THEY ARE FREQUENTLY FIXED. THERE ARE THREE METHODS OF SEPARATING MIXED COSTS PRESENTED IN THE CHAPTER WITH THEIR STRENGTHS AND WEAKNESSES. THE METHOD OF LEAST SQUARES PRODUCES THE LINE THAT BEST FITS THE DATA POINTS AND IS THEREFORE RECOMMENDED OVER THE HIGH-LOW AND SCATTERPLOT METHODS. THE LEAST-SQUARES METHOD HAS THE ADVANTAGE OF OFFERING METHODS TO ASSESS THE RELIABILITY OF COST EQUATIONS. THE LEARNING CURVE IS DISCUSSED TO BETTER DESCRIBE A NONLINEAR RELATIONSHIP BETWEEN LABOR HOURS AND OUTPUT. THE CHAPTER CONCLUDES BY DESCRIBING HOW MANAGERS USE THEIR JUDGMENT ALONE OR IN CONJUNCTION WITH THE COST BEHAVIOR ANALYTICAL METHODS.

CHAPTER REVIEW

KNOWLEDGE OF COST BEHAVIOR ALLOWS YOU TO ASSESS CHANGES IN COSTS THAT RESULT FROM CHANGES IN ACTIVITIES. COST ACCOUNTANTS USE THIS KNOWLEDGE TO ASSESS THE EFFECTS OF DECISIONS THAT CHANGE ACTIVITIES.

I.Basics of Cost Behavior

A.Cost behavior is the way a cost changes in relation to changes in the levels of activity usage. B.The types of cost behavior include variable costs, fixed costs, and mixed costs.

|Summary of Variable and Fixed Cost Behavior | |Cost |In Total |Per Unit | |Variable |Total variable cost changes as activity level |Variable cost per unit remains the same over wide | | |changes. |ranges of activity. | |Fixed |Total fixed cost remains the same even when the |Fixed cost per unit goes down as activity level goes | | |activity level changes. |up. |

Review textbook Exhibit 3-1, which graphically illustrates fixed cost behavior. Review textbook Exhibit 3-2, which graphically illustrates variable cost behavior.

■ Mixed costs are costs that have both a fixed and a variable component.

Review textbook Exhibit 3-5, which graphically illustrates mixed cost behavior.

C.Linearity Assumption
A linear cost function is used to approximate the underlying cost function within a relevant range because it is less time consuming and less expensive to estimate. A relevant range is the range of activity for which the assumed cost relationship is valid.

Review textbook Exhibit 3-4, which graphically illustrates linear cost function approximation within the relevant range.

D.Time Horizon
1.The longer the time period, the more likely that a cost will be a variable cost. In the long run, all costs are variable. 2.The short run is a period of time in which at least one cost is fixed. 3.Two factors determine what is long run and what is short run: ■ Management judgment...
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