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EMBA 802 - Session 4

William F. BentzOctober 4, 1999

Fisher College of Business

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The real voyage of discovery consists not in seeking new landscapes, but in having new eyes.

Marcel Proust

Today’s Quote

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Cost Behavior

• When talking about cost behavior, it is important to distinguish the behavior of total cost from the behavior of average unit costs (weighted mean). To do this, let us consider an illustration using arbitrary equation parameters that serve our purpose.

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Quantities (Q)

Variable Cost Per

Unit

Total Variable

Cost

Total Fixed Cost

Fixed Cost Per

Unit

Total Semi-Variable

Cost

Per Unit Semi-

Variable Cost

Total Semi-Fixed

Cost

Per Unit Semi-Fixed

Cost 100 25$ 2,500$ 12,500$ 125$ 12,600$ 150$ 6,000$ 60.00$ 200 25 5,000 12,500 63 12,700 88 6,000 30.00 300 25 7,500 12,500 42 12,800 67 12,000 40.00 400 25 10,000 12,500 31 12,900 56 12,000 30.00 500 25 12,500 12,500 25 13,000 50 12,000 24.00 600 25 15,000 12,500 21 13,100 46 18,000 30.00 700 25 17,500 12,500 18 13,200 43 18,000 25.71 800 25 20,000 12,500 16 13,300 41 18,000 22.50 900 25 22,500 12,500 14 13,400 39 24,000 26.67

1,000 25 25,000 12,500 13 13,500 38 24,000 24.00

Q Y = v Y = vQ Y = F Y = F/QY =

F + vQY =

(F + vQ)/QY = S*(1 + INT(Q/B))

Y = S*(1 + INT(Q/B))/Q

Cost Behavior Illustration: Total and Unit Costs

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Total Activity Cost Curves

$-$5,000

$10,000$15,000$20,000$25,000$30,000$35,000$40,000

1 3 5 7 9Activity Volume (100's)

Total VariableCost

Total FixedCost

Total Semi-Variable Cost

Total Semi-Fixed Cost

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Costs Per Activity Unit

$-

$50

$100

$150

$200

1 2 3 4 5 6 7 8 9 10

Activity Volume (100's)

Do

llars

of

Co

st Variable Cost

Per Unit

Fixed CostPer Unit

Semi-VariableCost Per Unit

Semi-FixedCost Per Unit

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OSU Bumper Stickers

I am not lost, I am exploring

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Further Observations

• The level of analysis will influence how a cost is modeled.

• For strategic analyses, most costs will be considered variable. For tactical analyses, the same costs might be modeled as part fixed and part variable.

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Another, Different View

A somewhat different view is more meaningful, but cannot easily be modeled as a general case. In this view, scarcity over the decision time frame affects the behavior of costs. Thus scarcity is the issue, not short- or long-run distinctions. (Staubus)

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Plentiful Resources (SR)

• Starting from a plentiful supply of constant-flow resources,– a small increment in activity will cause no

increment in the total cost of these resources

– a small decrement in activity will cause no decrement in the total cost of these resources

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Plentiful Resources (LR)

• In the “long run”, increments in volume will ultimately require cost increments.– small increments in activity will cause

existing resources to be replaced and new resources acquired

– small decrements in activity will cause fewer existing resources to be replaced and thus fewer resources acquired

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Scarce Resources (SR)

• Starting with a shortage of supply of constant-flow resources– even small increments in activity will cause

substantial (above average cost) increases in cost

– small decrements in activity may reduce the scarcity of resources and actually reduce total and average cost

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Scarce Resources (LR)

• Starting with a shortage of supply of constant-flow resources– increments in activity will cause increases

in cost as resources adjust to the demand for production

– decrements in activity will cause decrements in total cost as resources are adjusted downward due to sale or reduced replacements

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Questions?

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Cost Incurred

Cost incurred during a period:

• asset is increased, or

• cost is deducted from revenue of the period as an expense,

• cost is deducted as a loss of the period

Assets = Liabilities + Owners Equity

Owners’ Equity = Contributed + Earned Capital

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Functional Classification

Manufacturing function costs:

• asset (Raw Material, Work in Process, or Finished Goods inventories),

• expense (Cost of Goods Sold, cost of idle capacity, etc.)

• loss (unusual spoilage, loss of materials, abnormal waste)

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Functional Classification

Non-manufacturing costs:

• Distribution costs - expense (no asset*)

• Selling costs - expense (no asset*)

• Marketing costs - expense (no asset*)

• R&D costs - expense of period until one moves into the late development stage

• G&A costs - expense of period (no asset*)

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Product Costs

• Fin. Acct. - inventoriable mfg. Cost

• Mgt. Acct. - all costs, past and future, associated with a product or service from design through warranty and service costs.

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Traceability of Costs

• Directly traceable to a cost object

• Not directly traceable to a cost object

(Really a continuum of traceability)

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Types of Production Activities

• Unit driven costs

• Batch driven costs

• Product sustaining costs

• Facility sustaining

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Importance of Purpose

• Cost management - identify many individual activities for review and possible elimination or change.

• Cost measurement - group the costs driven by the same factors to simplify the system and reduce the number of drivers.

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Traditional Classifications

• Direct materials

• Direct labor

• Indirect manufacturing costs– Overhead or burden– Support costs

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Project Suggestions

• Paragraph framing the issues• Relate to what has been covered in text• Think in terms of pro or cons, not just what

you see at work• Answer the question asked regardless of

your inventory of answers• Consider the important issues to avoid going

on a tear about minor or narrow issues

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ABKY Problem 3-45 (Part a)Annual Patient No. of FixedCost Days Patients (Constant)

Nursing Services 3,000,000$ 3,000,000$ Nursing Administration 1,300,000 1,300,000 Laboratory 300,000 300,000 Medical Supplies 500,000 500,000 Linen & laundry 400,000 400,000 Dietary 800,000 800,000 Employee cafeteria 200,000 200,000 Housekeeping 700,000 700,000 Medical records 250,000 250,000 Social services 200,000 200,000 Patient scheduling 60,000 60,000 Billing & collection 110,000 110,000 Plant operations 300,000 300,000 Plant maintenance 400,000 400,000 Equipment operation 500,000 500,000 500,000 Property insurance 40,000 40,000 Depreciation 1,000,000 1,000,000 Totals 10,060,000$ 7,200,000$ 420,000$ 2,940,000$

Driver activity level 50,000 8,000

Cost per driver unit 144.00$ 52.50$

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ABKY Prob. 3-45 (Parts b & c)

Requirement (b):Y = $2,940,000 + 144X1+ 52.5X2

Requirement (c):Projected 1997 cost 11,332,500$

Projected 1997 patient days 55,000 Projected 1997 patients 9,000

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• Break for it!

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Problem 3-30

Planned Activity ActivityEstimated Activity Cost Cost

Activity Cost Level Rate Driver

Purchase ordering 20,000$ 400 $50.00 No. of orders - X1

Maintnance 44,000 2,000 22.00 Machine hours - X2

Power 36,000 30,000 1.20 Kilowatt hours - X3

Setups 62,500 500 125.00 No. of setups - X4

Supervision 48,000 4,000 12.00 Direct labor hours - X5

Total 210,500$

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Problem 3-30

Equation:

Support costs = $50(orders) + $22(machine hrs.) + $1.2(Kwh) + $125(setups) + $12(DL hrs.)

Yt = 50X1t + 22X2t + 1.2X3t + 125X4t + 12X5t

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Problem 3-30

• The budget equation for the five support activities would be:

Yt = 50X1t + 22X2t + 1.2X3t + 125X4t + 12X5t