MANAGEMENT ACCOUNTING (VOLUME I) - Solutions Manual

CHAPTER 9
COST BEHAVIOR: ANALYSIS AND USE
I. Questions
1. a. Variable cost: A variable cost is one that remains constant on a per
unit basis, but which changes in total in direct relationship to changes
in volume.
b. Fixe cost: A fixed cost is one that remains constant in total amount,
but which changes, if expressed on a per unit basis, inversely with
changes in volume.
c. Mixe cost: A mixed cost is a cost that contains both variable and
fixed cost elements.
2. a. Unit fixed costs will decrease as volume increases.
b. Unit variable costs will remain constant as volume increases.
c. otal fixed costs will remain constant as volume increases.
d. otal variable costs will increase as volume increases.
!. a. Cost be!a"ior: "ost behavior can be defined as the way in which
costs change or respond to changes in some underlying activity, such
as sales volume, production volume, or orders processed.
b. #ele"ant ran$e: he relevant range can be defined as that range of
activity within which assumptions relative to variable and fixed cost
behavior are valid.
#. Although the accountant recogni$es that many costs are not linear in
relationship to volume at some points, he concentrates on their behavior
within narrow bands of activity %nown as the relevant range. he relevant
range can be defined as that range of activity within which assumptions as
relative to variable and fixed cost behavior are valid. &enerally, within
this range an assumption of strict linearity can be used with insignificant
loss of accuracy.
'. he high(low method, the scattergraph method, and the least(s)uares
regression method are used to analy$e mixed costs. he least(s)uares
regression method is generally considered to be most accurate, since it
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C!a'ter % Cost Behavior: Analysis and Use
derives the fixed and variable elements of a mixed cost by means of
statistical analysis. he scattergraph method derives these elements by
visual inspection only, and the high(low method utili$es only two points in
doing a cost analysis, ma%ing it the least accurate of the three methods.
*. he fixed cost element is represented by the point where the regression
line intersects the vertical axis on the graph. he variable cost per unit is
represented by the slope of the line.
+. he two assumptions are:
1. A linear cost function usually approximates cost behavior within the
relevant range of the cost driver.
2. "hanges in the total costs of a cost ob,ect are traceable to variations
or changes in a single cost driver.
-. .o. /igh correlation merely implies that the two variables move together
in the data examined. 0ithout economic plausibility for a relationship, it
is less li%ely that a high level of correlation observed in one set of data will
be found similarly in another set of data.
1. 2efer to page !12 of the textboo%.
13. he relevant range is the range of the cost driver in which a specific
relationship between cost and cost driver is valid. his concept enables
the use of linear cost functions when examining "45 relationships as long
as the volume levels are within that relevant range.
11. A unit cost is computed by dividing some amount of total costs 6the
numerator7 by the related number of units 6the denominator7. In many
cases, the numerator will include a fixed cost that will not change despite
changes in the denominator. It is erroneous in those cases to multiply the
unit cost by activity or volume change to predict changes in total costs at
different activity or volume levels.
12. "ost estimation is the process of developing a well(defined relationship
between a cost ob,ect and its cost driver for the purpose of predicting the
cost. he cost predictions are used in each of the management functions:
8trategic 9anagement: "ost estimation is used to predict costs of
alternative activities, predict financial impacts of alternative strategic
choices, and to predict the costs of alternative implementation strategies.
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Cost Behavior: Analysis and Use C!a'ter %
5lanning and :ecision 9a%ing: "ost estimation is used to predict costs
so that management can determine the desirability of alternative options
and to budget expenditures, profits, and cash flows.
9anagement and ;perational "ontrol: "ost estimation is used to develop
cost standards, as a basis for evaluating performance.
5roduct and 8ervice "osting: "ost estimation is used to allocate costs to
products and services or to charge users for ,ointly incurred costs.
1!. he five methods of cost estimation are:
a. Account "lassification. Advantages: simplicity and ease of use.
:isadvantages: sub,ectivity of method and some costs are a mix of
both variable and fixed.
b. 4isual fit. he visual fit method is easy to use, and re)uires only that
the data is graphed. :isadvantages are that the scale of the graph
may limit ability to estimate costs accurately and in both graphical
and tabular form, significant perceptual errors are common.
c. /igh(<ow. =ecause of the precision in the development of the
e)uation, it provides a more consistent estimate than the visual fit and
is not difficult to use. :isadvantages: uses only two selected data
points and is, therefore, sub,ective.
d. 0or% 9easurement. he advantage is accurate estimates through
detailed study of the different operations in the product process, but
li%e regression, it is more complex.
e. 2egression. >uantitative, ob,ective measures of the precision and
accuracy and reliability of the model are the advantages of this model?
disadvantages are its complexity: the effort, expense, and expertise
necessary to utili$e this method.
1#. Implementation problems with cost estimation include:
a. cost estimates outside of the relevant range may not be reliable.
b. sufficient and reliable data may not be available.
c. cost drivers may not be matched to dependent variables properly in
each observation.
d. the length of the time period for each observation may be too long, so
that the underlying relationship between the cost driver and the
variable to be estimated is difficult to isolate from the numerous
variables and events occurring in that period of time? alternatively the
period may be too short, so that the data is li%ely to be affected by
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C!a'ter % Cost Behavior: Analysis and Use
accounting errors in which transactions are not properly posted in the
period in which they occurred.
e. dependent variables and cost drivers may be affected by trend or
seasonality.
f. when extreme observations 6outliers7 are used the reliability of the
results will be diminished.
g. when there is a shift in the data, as, for example, a new product is
introduced or when there is a wor% stoppage, the data will be
unreliable for future estimates.
1'. he dependent variable is the cost ob,ect of interest in the cost estimation.
An important issue in selecting a dependent variable is the level of
aggregation in the variable. @or example, the company, plant, or
department may all be possible levels of data for the cost ob,ect. he
choice of aggregation level depends on the ob,ectives for the cost
estimation, data availability, reliability, and costAbenefit considerations. If
a %ey ob,ective is accuracy, then a detailed level of analysis is often
preferred. he detail cost estimates can then be aggregated if desired.
1*. .onlinear cost relationships are cost relationships that are not ade)uately
explained by a single linear relationship for the cost driver6s7. In
accounting data, a common type of nonlinear relationship is trend and
seasonality. @or a trend example, if sales increase by -B each year, the
plot of the data for sales with not be linear with the driver, the number of
years. 8imilarly, sales which fluctuate according to a seasonal pattern
will have a nonlinear behavior. A different type of nonlinearity is where
the cost driver and the dependent variable have an inherently nonlinear
relationship. @or example, payroll costs as a dependent variable estimated
by hours wor%ed and wage rates is nonlinear, since the relationship is
multiplicative and therefore not the additive linear model assumed in
regression analysis.
1+. he advantages of using regression analysis include that it:
a. provides an estimation model with best fit 6least s)uared error7 to the
data
b. provides measures of goodness of fit and of the reliability of the model
which can be used to assess the usefulness of the specific model, in
contrast to the other estimation methods which provide no means of
self(evaluation
c. can incorporate multiple independent variables
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Cost Behavior: Analysis and Use C!a'ter %
d. can be adapted to handle non(linear relationships in the data,
including trends, shifts and other discontinuities, seasonality, etc.
e. results in a model that is uni)ue for a given set of data
1-. /igh correlation exists when the changes in two variables occur together.
It is a measure of the degree of association between the two variables.
=ecause correlation is determined from a sample of values, there is no
assurance that it measures or describes a cause and effect relationship
between the variables.
II. Exercises
Exercise & (Cost Classi+ication)
1. b
2. f
!. e
#. i
'. e
*. h
+. l
-. a
1. ,
13. %
11. c or d
12. g
Exercise ( (Cost Esti,ation- .i$!-Lo/ Met!o)
Requirement (1)
"ost e)uation using s)uare fee as the cost driver:
4ariable costs:
@ixed costs:
5#,+33 C @ixed "ost D 51.1!# x #,3'3
%-0
5#,+33 E 52,-33
#,3'3 E 2,!+'
C 51.1!#
C!a'ter % Cost Behavior: Analysis and Use
@ixed "ost C 513+
F)uation ;ne: otal "ost C 513+ D 51.1!# x s)uare feet
here are two choices for the /igh(<ow points when using openings for the
cost driver. At 11 openings there is a cost of 52,-33 and at 13 openings there
is a cost of 52,-+'.
"ost e)uation using 11 openings as the cost driver:
4ariable costs:
@ixed costs:
5#,+33 C @ixed "ost D 52!+.'3 x 11
@ixed "ost C 51-+.'3
F)uation wo: otal "ost C 51-+.'3 D 52!+.'3 x openings
"ost e)uation using 13 openings as the cost driver:
4ariable costs:
@ixed costs:
5#,+33 C @ixed "ost D 5232.+- x 11
@ixed "ost C 5-#+.1-
F)uation hree: otal "ost C 5-#+.1- D 5232.+- x openings
5redicted total cost for a !,233 s)uare foot house with 1# openings using
e)uation one:
%-1
5#,+33 E 52,-33
11 E 11
C 52!+.'3
5#,+33 E 52,-+'
11 E 13
C 5232.+-
Cost Behavior: Analysis and Use C!a'ter %
513+ D 51.1!# x !,233 C 5!,+!'.-3
5redicted total cost for a !,233 s)uare foot house with 1# openings using
e)uation two:
51-+.'3 D 52!+.'3 x 1# C 5!,'12.'3
5redicted total cost for a !,233 s)uare foot house with 1# openings using
e)uation three:
5-#+.1- D 5232.+- x 1# C 5!,*-*.13
here is no simple method to determine which prediction is best when using
the /igh(<ow method. In contrast, regression provides )uantitative measures
62(s)uared, standard error, t(values,G7 to help asses which regression
e)uation is best.
5redicted cost for a 2,#33 s)uare foot house with - openings, using e)uation
one:
513+ D 51.1!# x 2,#33 C 52,-2-.*3
0e cannot predict with e)uation 2 or e)uation ! since - openings are outside
the relevant range, the range for which the high(low e)uation was developed.
Requirement 2
Fi$ure %-A shows that the relationship between costs and s)uare feet is
relatively linear without outliers, while Fi$ure %-2 shows a similar result for
the relationship between costs and number of openings. @rom this perspective,
both variables are good cost drivers.
Fi$ure %-A
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C!a'ter % Cost Behavior: Analysis and Use
Fi$ure %-2
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Cost Behavior: Analysis and Use C!a'ter %
Exercise ) (Cost Esti,ation- Account Classi+ication)
Requirement 1
@ixed "osts:
2ent 513,2'3
:epreciation #33
Insurance +'3
Advertising *'3
Utilities 1,2'3
9r. =lac%Hs salary 1-,'33
otal 5!1,-33
4ariable "osts:
0ages 51+,-33
": Fxpense **,+'3
8hopping =ags 1-3
otal 5-#,+!3
4ariable "osts 5er Unit C 5-#,+!3 A -,133
C 51'.23
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C!a'ter % Cost Behavior: Analysis and Use
"ost @unction F)uation: y C 5!1,-33 D 51'.23 x 6":Hs sold7
Requirement 2
.ew 8ales C -,133 x 1.2'
C 11,12' units
C round to 11,1!3
otal "osts C 5!1,-33 D 51'.23 x 611,1!37
C 51!+,+*3
5er Unit otal "osts C 51!+,+*3 A 11,1!3
C 512!.-3
Add 51 profit per disc: 512!.-3 D 513 C 51!!.-3
Requirement 3
Ad,usted .ew 8ales C -,133 x 11.'3
C 13,2#3 units
2evenue C 51!!.-3 x 613,2#37
C 51!+,313
otal "ost C 5!1,-33 D 51'.23 x 613,2#37
C 5121,2-3
"ost 5er :isc C 5121,2-3 A 13,2#3 C 512*.!3
5rofit 5er :is% C 51!!.-3 E 512*.!3
C 5+.'3
Exercise * (Cost Esti,ation Usin$ Gra'!s- Ser"ice)
Requirement 1
%-&5
Cost Behavior: Analysis and Use C!a'ter %
Requirement 2
here seems to be a positive linear relationship for the data between 52,'33
and 5#,333 of advertising expense. <lanesH analysis is correct within this
relevant range but not outside of it. .otice that the relationship between
advertising expense and sales changes at 5#,333 of expense.
III. Problems
6roble, &
Requirement (a) Miles
Driven
Total Annual
Cost*
/igh level of activity.......................... 123,333 51!,123
<ow level of activity........................... -3,333 13,--3
:ifference...................................... #3,333 5 !,3#3
I 123,333 miles x 53.11* C 51!,123.
-3,333 miles x 53.1!* C 513,--3.
4ariable cost per mile:
"hange in cost, 5!,3#3
"hange in activity,#3,333
%-&&
C 53.3+* per mile.
C!a'ter % Cost Behavior: Analysis and Use
@ixed cost per year:
otal cost at 123,333 miles.................................... 51!,123
<ess variable cost element: 123,333 x 53.3+*...... 1,123
@ixed cost per year............................................. 5 #,-33
Requirement (b)
J C 5#,-33 D 53.3+*K
Requirement (c)
@ixed cost..................................................................... 5 #,-33
4ariable cost: 133,333 miles x 53.3+*........................ +,*33
otal annual cost.................................................... 512,#33
6roble, (
Requirement 1
"ost of goods sold...................................................... 4ariable
8hipping expense........................................................ 9ixed
Advertising expense.................................................... @ixed
8alaries and commissions........................................... 9ixed
Insurance expense....................................................... @ixed
:epreciation expense.................................................. @ixed
Requirement 2
Analysis of the mixed expenses:
Units
Shiin!
"#ense
Salaries
an$ Comm%
"#ense
/igh level of activity................ #,'33 5'*,333 51#!,333
<ow level of activity................. !,333 ##,333 13+,333
:ifference.......................... 1,'33 512,333 5 !*,333
4ariable cost element:
"hange in cost
"hange in activity
8hipping expense:
8alaries and comm. expense:
%-&(
C 4ariable rate
512,333
1,'33 units
C 5- per unit.
5!*,333
1,'33 units
C 52# per unit.
Cost Behavior: Analysis and Use C!a'ter %
@ixed cost element:
Shiin!
"#ense
Salaries an$
Comm%
"#ense
"ost at high level of activity................ 5'*,333 51#!,333
<ess variable cost element:
#,'33 units x 5-............................ !*,333
#,'33 units x 52#..........................

13-,333
@ixed cost element............................... 523,333 5 !',333
he cost elements are:
8hipping expense: 523,333 per month plus 5- per unit or J C
523,333 D 5-K.
8alaries and comm. expense: 5!',333 per month plus 52# per unit or
J C 5!',333 D 52#K.
Requirement 3
<I<J ";95A.J
Income 8tatement
@or the 9onth Fnded Lune !3
8ales in units................................................... #,'33
8ales revenues................................................. 5*!3,333
<ess variable expenses:
"ost of goods sold 6M5'*7......................... 52'2,333
8hipping expense 6M5-7............................ !*,333
8alaries and commission expense
6M52#7................................................... 13-,333 !1*,333
"ontribution margin........................................ 2!#,333
<ess fixed expense:
8hipping expense........................................ 23,333
Advertising................................................. +3,333
8alaries and commissions........................... !',333
Insurance.................................................... 1,333
:epreciation............................................... #2,333 1+*,333
.et income...................................................... 5 '-,333
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C!a'ter % Cost Behavior: Analysis and Use
6roble, )
Requirement 1
&ear
'umber o(
)ea!ues (*)
Total Cost
(&) *& *
2
233# ' 51!,333 5 *',333 2'
233' 2 +,333 1#,333 #
233* # 13,'33 #2,333 1*
233+ * 1#,333 -#,333 !*
233- ! 13,333 !3,333 1
23 5'#,'33 52!',333 13
n 6 KJ7 ( 6 K7 6 J7
n 6K
2
7 ( 6K7
2
' 62!',3337 ( 6237 6'#,'337
' 6137 ( 6237
2
C 1,+33
6 J7 ( b6 K7
n
6'#,'337 ( 1,+33 6237
'
C 5#,133
herefore, the variable cost per league is 51,+33 and the fixed cost is
5#,133 per year.
Requirement 2
J C 5#,133 D 51,+33K
Requirement 3
he expected value total would be:
@ixed cost.............................................................. 5 #,133
4ariable cost 6+ leagues x 51,+337......................... 11,133
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b C
C
a C
C
Cost Behavior: Analysis and Use C!a'ter %
otal cost.......................................................... 51*,333
he problem with using the cost formula from 627 to derive this total cost
figure is that an activity level of + sections lies outside the relevant range from
which the cost formula was derived. Nhe relevant range is represented by a
solid line on the graph in re)uirement # below.O
Although an activity figure may lie outside the relevant range, managers will
often use the cost formula anyway to compute expected total cost as we have
done above. he reason is that the cost formula fre)uently is the only basis
that the manager has to go on. Using the cost formula as the starting point
should not present a problem so long as the manager is alert for any unusual
problems that the higher activity level might bring about.
Requirement +
6roble, * (#e$ression Anal7sis8 Ser"ice Co,'an7)
Requirement 1
Fi$ure %-C plots the relationship between labor(hours and overhead costs and
shows the regression line.
y C 5#-,2+1 D 5!.1! K
"conomic lausibilit,. <abor(hours appears to be an economically plausible
driver of overhead cost for a catering company. ;verhead costs such as
%-&0
51*,333
51#,333
512,333
513,333
5-,333
5*,333
5#,333
52,333
5(
3 1 2 ! - * ' # +
Y
X
C!a'ter % Cost Behavior: Analysis and Use
scheduling, hiring and training of wor%ers, and managing the wor%force are
largely incurred to support labor.
-oo$ness o( (it. he vertical differences between actual and predicted costs
are extremely small, indicating a very good fit. he good fit indicates a strong
relationship between the labor(hour cost driver and overhead costs.
Sloe o( re!ression line. he regression line has a reasonably steep slope
from left to right. he positive slope indicates that, on average, overhead
costs increase as labor(hours increase.
Requirement 2
he regression analysis indicates that, within the relevant range of 2,'33 to
+,'33 labor(hours, the variable cost per person for a coc%tail party e)uals:
@ood and beverages 51'.33
<abor 63.' hrs. x 513 per hour7 '.33
4ariable overhead 63.' hrs. x 5!.1! per labor(hour7 1.1+
otal variable cost per person 521.1+
Requirement 3
o earn a positive contribution margin, the minimum bid for a 233(person
coc%tail party would be any amount greater than 5#,!1#. his amount is
calculated by multiplying the variable cost per person of 521.1+ by the 233
people. At a price above the variable costs of 5#,!1#, =obby &on$ales will be
earning a contribution margin toward coverage of his fixed costs.
;f course, =obby &on$ales will consider other factors in developing his bid
including 6a7 an analysis of the competition E vigorous competition will limit
&on$alesH ability to obtain a higher price 6b7 a determination of whether or not
his bid will set a precedent for lower prices E overall, the prices =obby
&on$ales charges should generate enough contribution to cover fixed costs and
earn a reasonable profit, and 6c7 a ,udgment of how representative past
historical data 6used in the regression analysis7 is about future costs.
Fi$ure %-C
2egression <ine of <abor(/ours on ;verhead "osts for =obby &on$alesH
"atering "ompany
%-&1
Cost Behavior: Analysis and Use C!a'ter %
6roble, 0 (Linear Cost A''roxi,ation)
Requirement 1
he linear cost function is plotted in Fi$ure %-9.
.o, the constant component of the cost function does not represent the fixed
overhead cost of the A=8 &roup. he relevant range of professional labor(
hours is from !,333 to -,333. he constant component provides the best
available starting point for a straight line that approximates how a cost
behaves within the !,333 to -,333 relevant range.
Requirement 2
%-&3
8lope coefficient 6b7 C
:ifference in cost
:ifference in labor(hours
C
5'21,333 E 5#33,333
+,333 E #,333
C 5#!.33
Constant (a) C 5'21,333 E 5#!.33 6+,3337
C 522-,333
"ost function C 522-,333 D 5#!.33 6professional labor(hours7
C!a'ter % Cost Behavior: Analysis and Use
A comparison at various levels of professional labor(hours follows. he linear
cost function is based on formula of 522-,333 per month plus 5#!.33 per
professional labor(hours.
otal overhead cost behavior:
9onth 1 9onth 2 9onth ! 9onth # 9onth ' 9onth *
Actual total overhead
costs 5!#3,333 5#33,333 5#!',333 5#++,333 5'21,333 5'-+,333
<inear approximation !'+,333 #33,333 ##!,333 #-*,333 '21,333 '+2,333
Actual minus linear
approximation 561+,3337 5 3 5 6-,3337 5 61,3337 5 3 51',333
5rofessional labor(hours !,333 #,333 ',333 *,333 +,333 -,333
he data are shown in Fi$ure %-9. he linear cost function overstates costs
by 5-,333 at the ',333(hour level and understates costs by 51',333 at the
-,333(hour level.
Requirement 3
.ase$ on
Actual
.ase$ on
)inear Cost
/unction
"ontribution before deducting incremental
overhead 5!-,333 5!-,333
Incremental overhead !',333 #!,333
"ontribution after incremental overhead 5 !,333 5 6',3337
he total contribution margin actually forgone is 5!,333.
Fi$ure %-9
<inear "ost @unction 5lot of 5rofessional <abor(/ours
on otal ;verhead "osts for A=8 "onsulting &roup
%-&4
Cost Behavior: Analysis and Use C!a'ter %
I4. Multiple Choice Questions
1. A 11. " I 21. " !1. : #1. =
2. : 11. " I 22. : !2. = #2. :
!. = 12. " 2!. " !!. A #!. "
#. A 1!. A 2#. A !#. =
'. = 1#. : 2'. : !'. A
*. = 1'. " 2*. = !*. :
+. " 1*. : 2+. : !+. =
-. : 1+. = 2-. = !-. "
1. " 1-. " 21. A !1. =
13. A 11. " !3. : #3. :
I Suortin! Comutations:
11. 613,333 x 27 E 65!,333 x 27 E 5',333 C 51,333
12. N6523 D 5! D 5*7 x 2,333 unitsO D 6513 x 1,333 units7 C 5*-,333
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