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FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Managerial AccountingManagerial AccountingManagerial AccountingManagerial Accounting
Assoc. Prof. Dr. Mohd Fuad Mohd [email protected]
4th. August 2012
Managerial AccountingManagerial AccountingManagerial AccountingManagerial Accounting
Cost Concept : Importance and RoleCost Concept : Importance and RoleCost Concept : Importance and RoleCost Concept : Importance and Role
in Decision Makingin Decision Makingin Decision Makingin Decision Making
1
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Cost Classifications For Decision Making
2
� Every decision involves a choice between at least two
alternatives.
� Only those costs and benefits that differ between alternatives
are relevant in a decision. All other costs and benefits can and
should be ignored.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Summary Of The Types Of Cost Classifications
� Financial reporting
� Predicting cost behavior
� Assigning costs to cost objects
� Decision making
3
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
ISO 9000 STANDARDSISO 9000 STANDARDSISO 9000 STANDARDSISO 9000 STANDARDS
ISO 9000 standards have become ISO 9000 standards have become ISO 9000 standards have become ISO 9000 standards have become
international measures of quality.international measures of quality.international measures of quality.international measures of quality.
To become ISO 9000 certified, a company To become ISO 9000 certified, a company To become ISO 9000 certified, a company To become ISO 9000 certified, a company
must demonstrate:must demonstrate:must demonstrate:must demonstrate:
1. A quality control system is in use, and the system clearly
4
1. A quality control system is in use, and the system clearly
defines an expected level of quality.
2. The system is fully operational and is backed up with
detailed documentation of quality control procedures.
3. The intended level of quality is being achieved on a
sustained basis.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
LEARNING OBJECTIVE 1
Understand how fixed and Understand how fixed and variable costs behave and how variable costs behave and how to use them to predict costs.to use them to predict costs.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Behavior of Cost (within the relevant range)
Cost In Total Per Unit
Variable Total variable cost changes Variable cost per unit remains
as activity level changes. the same over wide ranges
Cost Classifications For Predicting Cost Behavior
6
of activity.
Fixed Total fixed cost remains Average fixed cost per unit goes
the same even when the down as activity level goes up.
activity level changes.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
EXAMPLES OF VARIABLE COSTS
1. Merchandising companies – cost of goods sold.
2. Manufacturing companies – direct materials, direct labor, and variable overhead.
3. Merchandising and manufacturing companies –commissions, shipping costs, and clerical costs such as
7
commissions, shipping costs, and clerical costs such as invoicing.
4. Service companies – supplies, travel, and clerical.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
THE ACTIVITY BASE (ALSO KNOWN AS COST DRIVER)
A measure of what
Unitsproduced
Machine hours
A measure of what causes the
incurrence of a variable cost
Miles driven
Labor hours
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Total O
verage Charges
on Cell Phone Bill
TRUE VARIABLE COST – AN EXAMPLEAs an example of an activity base, consider overagecharges on a cell phone bill. The activity base is thenumber of minutes used above the allowed minutes inthe calling plan.
Minutes Talked
Total O
verage Charges
on Cell Phone Bill
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
TRUE VARIABLE COSTS
The amount of a true variable cost used during the period
varies in direct proportion to the activity level. The overage
charge on a cell phone bill was one example of a true
variable cost.
10
Volume
Cost
Direct material is another
example of a cost that
behaves in a true variable
pattern.
FACULTY OF BUSINESS
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STEP-VARIABLE COSTS
Small changes in the level of production are not likely to have
any effect on the number of maintenance workers employed.
11
Volume
Cost
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Cost In Total Per Unit
Variable Total variable cost is Variable cost per unit remains
Average fixed costs per unit decrease as the activity
level increases.
COST BEHAVIOR PATTERNS – FIXED
12
Variable Total variable cost is Variable cost per unit remains
proportional to the activity the same over wide ranges
level within the relevant range. of activity.
Total fixed costs remain the
same even when the activity Average fixed costs per unit
Fixed level changes within the decrease as the activity
relevant range. level increases.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
TYPES OF FIXED COSTS
Discretionary
May be altered in the short-term by current managerial decisions
Discretionary
May be altered in the short-term by current managerial decisions
Committed
Long-term, cannot be significantly reduced in
the short term.
Committed
Long-term, cannot be significantly reduced in
the short term.
13
Examples
Advertising and Research and Development
Examples
Depreciation on Buildings and Equipment and Real
Estate Taxes
managerial decisionsmanagerial decisionsthe short term.the short term.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
THE TREND TOWARD FIXED COSTS
The trend in many industries is toward greater
fixed costs relative to variable costs.
As machines take overAs machines take over
many mundane tasksmany mundane tasks
Knowledge workersKnowledge workers
tend to be salaried,tend to be salaried,
14
many mundane tasksmany mundane tasks
previously performedpreviously performed
by humans, by humans,
““knowledge workersknowledge workers””
are demanded forare demanded for
their minds rathertheir minds rather
than their muscles.than their muscles.
tend to be salaried,tend to be salaried,
highlyhighly--trained andtrained and
difficult to replace. Thedifficult to replace. The
cost of compensatingcost of compensating
these valued employeesthese valued employees
is is relatively fixedrelatively fixed
rather than variable.1rather than variable.1
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
IS LABOR A VARIABLE OR A FIXED COST?
The behavior of wage and salary costs can differ
across countries, depending on labor regulations,
labor contracts, and custom.
In France, Germany, China, and Japan, management has
little flexibility in adjusting the size of the labor force.
Labor costs are more fixed in nature.
15
Labor costs are more fixed in nature.
In the United States and the United Kingdom, management
has greater latitude. Labor costs are more variable in nature.
Within countries managers can view labor costs differently
depending upon their strategy. Most companies in the
United States continue to view direct labor as a variable cost.
FACULTY OF BUSINESS
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Rent Cost in Thousands
of Dollars
60
FIXED COSTS AND THE RELEVANT RANGE
90
Relevant
Range
The relevant range of
activity for a fixed
cost is the range of
activity over which
16
Rent Cost in Thousands
of Dollars
0 1,000 2,000 3,000
Rented Area (Square Feet)
0
30
activity over which
the graph of the cost
is flat.
FACULTY OF BUSINESS
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FIXED COSTS AND THE RELEVANT RANGE
For example, assume office space is available at a For example, assume office space is available at a
rental rate of $30,000 per year in increments of rental rate of $30,000 per year in increments of
1,000 square feet. 1,000 square feet.
17
Fixed costs would increase in Fixed costs would increase in
a step fashion at a rate of a step fashion at a rate of
$30,000 for each additional $30,000 for each additional
1,000 square feet. 1,000 square feet.
FACULTY OF BUSINESS
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Step-variable costs can
FIXED COSTS AND THE RELEVANT RANGE
18
How does this stepHow does this step--
function pattern function pattern
differ from a stepdiffer from a step--
variable cost?variable cost?
Step-variable costs can be adjusted more
quickly as conditions change and . . .
The width of the activity steps is much wider for
the fixed cost.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Which of the following statements about cost
behavior are true?
a. Fixed costs per unit vary with the level of activity.
b. Variable costs per unit are constant within the
relevant range.
19
relevant range.
c. Total fixed costs are constant within the relevant
range.
d. Total variable costs are constant within the
relevant range.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Which of the following statements about costbehavior are true?
a. Fixed costs per unit vary with the level of activity.
b. Variable costs per unit are constant within the
20
b. Variable costs per unit are constant within the relevant range.
c. Total fixed costs are constant within the relevant range.
d. Total variable costs are constant within the relevant range.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Y
A mixed cost contains both variable and fixed
elements. Consider the example of utility cost.
MIXED COSTS (SEMIVARIABLE COSTS) Total Utility Cost
21
Fixed Monthly
Utility Charge
Variable
Cost per KW
XActivity (Kilowatt Hours)
Total Utility Cost
FACULTY OF BUSINESS
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MIXED COSTS Total Utility Cost
Y
22
Fixed Monthly
Utility Charge
Variable
Cost per KW
Activity (Kilowatt Hours)
Total Utility Cost
XXXX
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
MIXED COSTS – AN EXAMPLE
If your fixed monthly utility charge is $40, your variable cost is $0.03 per If your fixed monthly utility charge is $40, your variable cost is $0.03 per
kilowatt hour, and your monthly activity level is 2,000 kilowatt hours, what kilowatt hour, and your monthly activity level is 2,000 kilowatt hours, what
is the amount of your utility bill?is the amount of your utility bill?
Y Y Y Y = a a a a + bXbXbXbX
23
Y Y Y Y = a a a a + bXbXbXbX
Y Y Y Y = $40 + ($0.03 × 2,000)
Y Y Y Y = $100$100$100$100
FACULTY OF BUSINESS
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ANALYSIS OF MIXED COSTS: INDUSTRY BASED
In In account analysisaccount analysisaccount analysisaccount analysisaccount analysisaccount analysisaccount analysisaccount analysis, each account is , each account is
classified as either variable or fixed basedclassified as either variable or fixed based
on the analyst’s knowledge of how on the analyst’s knowledge of how
Account Analysis vs. the Engineering ApproachAccount Analysis vs. the Engineering Approach
24
on the analyst’s knowledge of how on the analyst’s knowledge of how
the account behaves.the account behaves.
The The engineering approachengineering approachengineering approachengineering approachengineering approachengineering approachengineering approachengineering approach classifies costs based classifies costs based
upon an industrial engineer’s evaluation of upon an industrial engineer’s evaluation of
production methods, and material, labor and production methods, and material, labor and
overhead requirements.overhead requirements.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
WHY AND HOW TO REDUCE FIXED COSTS
� Typical fixed costs: production facilities, rentals, employees salaries and related
benefits and utilities
� Converting them into variable may reduce risk of financial commitment
and provide flexibility of capacity utilisation
� OutsourcingOutsourcingOutsourcingOutsourcing
� Business with fast and regular change and/or large varieties of
products most likely will benefit from this approach e.g. Nike and
Apple
25
Apple
� Non-core business functions with lower value-add to majority
customers e.g. call centers for enquiries, 3rd party logistics, broker-
dealers’ securities back office operations
� OffshoringOffshoringOffshoringOffshoring
� Honda and Toyota Thailand plants
� HSBC back office functions in China
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
(1) (1)
Use a scattergraph plot to Use a scattergraph plot to diagnose cost behavior.diagnose cost behavior.
HOW TO DETERMINE COSTS BEHAVIOR?
26
diagnose cost behavior.diagnose cost behavior.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Plot the data points on a graph (Total Cost YYYY vs.
Activity XXXX).
*
Maintenance Cost
1,000’s of Dollars
20
**
*
*
*
*
YYYY
THE SCATTERGRAPH METHOD
27
0 1 2 3 4
Maintenance Cost
1,000’s of Dollars
10
0
**
** *
Patient-days in 1,000’s
XXXX
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
THE SCATTERGRAPH METHOD
Draw a line through the data points with about an
equal numbers of points above and below the line.
*
Maintenance Cost
1,000’s of Dollars
20
**
*
*
*
*
YYYY
28
0 1 2 3 4
Maintenance Cost
1,000’s of Dollars
10
0
**
** *
Patient-days in 1,000’s
XXXX
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
THE SCATTERGRAPH METHOD
Use one data point to estimate the total level of activity and the total cost.
*
Maintenance Cost
1,000’s of Dollars
20
*
*
*
*
*
*
*
*
YYYYTotal maintenance cost = $11,000
29
Intercept = Fixed cost: $10,000
0 1 2 3 4
Maintenance Cost
1,000’s of Dollars
10
0
**
* *
Patient-days in 1,000’s
XXXX
Patient days = 800
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
THE SCATTERGRAPH METHOD
Make a quick estimate of variable cost per unit and determine the cost
equation.
30
Variable cost per unit = $1,000
800= $1.25/patient-day
YY = $10,000 + $1.25= $10,000 + $1.25XX
Total maintenance costTotal maintenance cost Number of patient daysNumber of patient days
FACULTY OF BUSINESS
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(2) (2)
Analyze a mixed cost using the Analyze a mixed cost using the highhigh--low method.low method.
HOW TO DETERMINE COSTS BEHAVIOR?
32
highhigh--low method.low method.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
THE HIGH-LOW METHOD – AN EXAMPLEAssume the following hours of maintenance work and the total
maintenance costs for six months.
33
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
THE HIGH-LOW METHOD – AN EXAMPLE
The The variable cost per hourvariable cost per hour of of
maintenance is equal to the maintenance is equal to the
change in cost divided by the change in cost divided by the
change in hours.change in hours.
$2,400
34
= $6.00/hour$6.00/hour$2,400
400
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
THE HIGH-LOW METHOD – AN EXAMPLE
35
Total Fixed Cost = Total Cost Total Fixed Cost = Total Cost –– Total Variable CostTotal Variable Cost
Total Fixed Cost = $9,800 Total Fixed Cost = $9,800 –– ($6/hour ($6/hour ×× 850 hours)850 hours)
Total Fixed Cost = $9,800 Total Fixed Cost = $9,800 –– $5,100$5,100
Total Fixed Cost = Total Fixed Cost = $4,700$4,700
FACULTY OF BUSINESS
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THE HIGH-LOW METHOD
36
YY = $4,700 + $6.00= $4,700 + $6.00XX
The Cost Equation for Maintenance
FACULTY OF BUSINESS
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Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the variable portion of sales salaries and commission?
37
a. $0.08 per unit
b. $0.10 per unit
c. $0.12 per unit
d. $0.125 per unit
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Sales salaries and commissions are $10,000 when
80,000 units are sold, and $14,000 when 120,000
units are sold. Using the high-low method, what is the
variable portion of sales salaries and commission?
a. $0.08 per unit
b. $0.10 per unit Units Cost
38
b. $0.10 per unit
c. $0.12 per unit
d. $0.125 per unit
$4,000 ÷ 40,000 units
= $0.10 per unit
$4,000 ÷ 40,000 units
= $0.10 per unit
$4,000 ÷ 40,000 units
= $0.10 per unit
Units Cost
High level 120,000 14,000$
Low level 80,000 10,000
Change 40,000 4,000$
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Sales salaries and commissions are $10,000 when
80,000 units are sold, and $14,000 when 120,000
units are sold. Using the high-low method, what is
the fixed portion of sales salaries and
commissions?
39
a. $ 2,000
b. $ 4,000
c. $10,000
d. $12,000
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Sales salaries and commissions are $10,000 when 80,000 units are sold, and $14,000 when 120,000 units are sold. Using the high-low method, what is the fixed portion of sales salaries and commissions?
a. $ 2,000
b. $ 4,000
40
b. $ 4,000
c. $10,000
d. $12,000
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
LEAST-SQUARES REGRESSION METHOD
A method used to analyze mixed costs if a
scattergraph plot reveals an approximately linear
relationship between the X and Y variables.
This method uses This method uses allall of theof the
data points to estimatedata points to estimate
41
data points to estimatedata points to estimate
the fixed and variablethe fixed and variable
cost components of acost components of a
mixed cost.mixed cost.The goal of this method isThe goal of this method is
to fit a straight line to theto fit a straight line to the
data that data that minimizes theminimizes the
sum of the squared errorssum of the squared errors..
FACULTY OF BUSINESS
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LEAST-SQUARES REGRESSION METHOD
� Software can be used to fit a regression
line through the data points.
� The cost analysis objective is the same:
YYYY = = = = aaaa + + + + bXbXbXbX
42
Least-squares regression also provides a statistic,
called the R2, which is a measure of the goodness
of fit of the regression line to the data points.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
SIMPLE REGRESSION ANALYSIS – AN EXAMPLE
MacroMacro CoCo.. wantswants toto knowknow itsits
averageaverage fixedfixed costcost andand variablevariable costcost
perper unitunit..
UsingUsing thethe datadata toto thethe right,right, let’slet’s seesee
howhow toto dodo aa regressionregression usingusing
MicrosoftMicrosoft ExcelExcel..
MacroMacro CoCo.. wantswants toto knowknow itsits
averageaverage fixedfixed costcost andand variablevariable costcost
perper unitunit..
UsingUsing thethe datadata toto thethe right,right, let’slet’s seesee
howhow toto dodo aa regressionregression usingusing
MicrosoftMicrosoft ExcelExcel..
43
MicrosoftMicrosoft ExcelExcel..MicrosoftMicrosoft ExcelExcel..
FACULTY OF BUSINESS
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SIMPLE REGRESSION USING EXCEL – AN EXAMPLE
You will need three pieces of information from your regression analysis:
1. Estimated Variable Cost Per Unit (line slope)
2. Estimated Fixed Costs (line intercept)
44
intercept)
3. Goodness of fit, or R2
To get these three pieces
information we will need to use
three Excel functions.
SLOPE, INTERCEPT, and RSQ
To get these three pieces
information we will need to use
three Excel functions.
SLOPE, INTERCEPT, and RSQ
FACULTY OF BUSINESS
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SIMPLE REGRESSION USING EXCEL – AN EXAMPLE
Place your cursor in Place your cursor in cell F4 and press the cell F4 and press the
45
cell F4 and press the cell F4 and press the = key. Click on the = key. Click on the pull down menu and pull down menu and scroll down to “More scroll down to “More
Functions . . .”Functions . . .”
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Scroll down to the Scroll down to the ““StatisticalStatistical”, ”,
functions. Now functions. Now scroll down the scroll down the
SIMPLE REGRESSION USING EXCEL – AN EXAMPLE
46
statistical statistical functions until you functions until you
highlight highlight ““SLOPESLOPE””
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SIMPLE REGRESSION USING EXCEL – AN EXAMPLE
Here is the Here is the estimate of the estimate of the slope of the line.slope of the line.
47
1. In the Known_y’s box, enter C4:C19 for the range.
2. In the Known_x’s box, enter D4:D19 for the range.
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With your cursor in With your cursor in cell F5, press the = cell F5, press the = key and go to the pull key and go to the pull
down menu for down menu for “Special Functions.” “Special Functions.” Select Select Statistical Statistical and and
48
Select Select Statistical Statistical and and scroll down to scroll down to highlight the highlight the
INTERCEPTINTERCEPT function.function.
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Here is the Here is the estimate of the estimate of the fixed costs.fixed costs.
49
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
Finally, we will Finally, we will determine the determine the ““goodness of goodness of
fitfit”, or ”, or RR22, by , by using the using the RSQRSQ
50
using the using the RSQRSQ
function.function.
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Here is the Here is the estimate of estimate of RR22..
51
1. In the Known_y’s box, enter C4:C19 for the range.
2. In the Known_x’s box, enter D4:D19 for the range.
FACULTY OF BUSINESS
Nurturing professionals with high moral and ethical values
COMPARING THE THREE METHODS
The three methods just discussed provide slightly The three methods just discussed provide slightly
different estimates of the fixed and variable cost different estimates of the fixed and variable cost
components of the mixed cost.components of the mixed cost.
This is to be expected because each method uses This is to be expected because each method uses
52
This is to be expected because each method uses This is to be expected because each method uses
differing amounts of the data points to provide differing amounts of the data points to provide
estimates.estimates.
LeastLeast--squares regression provides the most squares regression provides the most
accurate estimate because it uses all the data accurate estimate because it uses all the data
points.points.