Cost classification for predicting cost behavior
Cost behavior refers to how a cost reacts to
changes in the level of activity. The most
common classification are :
.variable costs
.Fixed costs
.mixed costs
Variable Cost :
A cost that varies, in total, in direct proportion to changes in the
level of activity.(cost structure)
Variable Cost Per Unit is constant.
the activity Base (Cost Driver) :A measure of what causes the
incurrence of a variable cost, for example (units
produced/kilometer driven/machine hours/labor hours/units
sold).
Fixed Cost :
A cost that remains constant, in total, regardless of changes in
the level of activity, not affected by changes in activity.
Fixed Cost Per Unit: if expressed on a per units basis, the
average fixed cost per units varies inversely with changes in
activity. the average fixed cost decrease as more units made.
There are two types of fixed costs for planning purpose (decision
making):
Committed
(multiyear planning)
Long-term, cannot be reduced
in the sort term.
Depreciation
Discretionary
(managed fixed costs)
May be altered in the short
term by current managerial
decisions.
Adverting and Research
and development
The linearity Assumption and the Relevant Range
Relevant range is the range of activity within which the
assumption that cost behavior is strictly linear is reasonably
valid.
Fixed cost & relevant range : relevant range good to understanding fixed cost
Cost
In total
Per unit
Variable
Increase & decrease in proportion to changes in
activity level
constant
Fixed
Not affected by changes in the activity level
within the relevant range
Decrease when activity level
arise increase when activity
level falls
Mixed costs : contains both variable and fixed cost elements.
The total mixed cost line can be expressed as an equation :
Y = a + bX
Where :
Y=the total mixed cost.
a=the total fixed coast
b=the variable coat per units of activity
X=the level of activity
The Analysis of Mixed Costs
Account analysis : an account is classified as either variable of fixed based
on the analyst's knowledge of how the account behaves.
Engineering approach: classifies costs based upon industrial engineers
evaluation of production methods, and material ,labor, and overhead
requirement.
1-Diagnosing Cost behavior with a scatter graph plot
month activity
january 5600
february 7100
march
5000
april
6500
may
7300
june
8000
july
6200
cost
7900
8500
7400
8200
9100
9800
7800
12000
10000
8000
6000
4000
2000
0
0
1000
2000
3000
4000
5000
6000
7000
8000
9000
2-The High-low method
month
january
february
march
april
may
june
july
activity
5600
7100
5000
6500
7300
8000
6200
cost
7900
8500
7400
8200
9100
9800
7800
High activity level (June)…
8000
$ 9800
Low activity level (march)……. 5000
$ 7400
Change …………………………….. 3000
2400
Variable cost = slope of the line = y2-y1 = change in cost = $2400
x2-x1 change in activity
= $ 0.80 per day
3000
Total cost = Fixed cost + variable cost
Total cost - variable cost = Fixed cost
9800- ($0.80* 8000)
= 3400$ ………………….. (Y= $3400 + $.080X)
3-The least-square Regression Method : the goal is to fit a straight line to the data
that minimize the errors
Traditional & Contribution Format Income Statements
The Traditional Format Income statement prepared primarily for external reporting purposes.
Traditional format (GAAP)
Sales(revenue)
12,000
cost of goods sold*
6,000
Gross margin
6,000
Selling and administration expenses
Selling
3,100
Administrative
1,900
5000
Net operating income
1,000
contribution format
sales
variable expenses:
cost of goods sold
variable selling
variable administrative
contribution margin
fixed expenses:
fixed selling
fixed administrative
Net operating income
Cost of goods sold =( b. inventory + purchase ) – ending inventory
Available for sale
Sales-variable expenses = Contribution margin
12,000
6,000
600
400
2,500
1,500
7,000
5,000
4,000
1,000
Cost classifications for assigning costs to cost objects
A cost object is any thing for which cost data are desired (any thing you try
to figure out accost for) that could be anything products(car/computer),
customers, jobs
Direct costs
. Costs that can be
easily and conveniently
traced to a unit of
product or other cost
object.
.Example: DM&DL
Indirect costs
. Costs that cannot be
easily and conveniently
traced to aspecific unit of
product or other cost
object.‫مشتركة مع منتجات أخرى‬
. Example : manufacturing overhead
Common costs
Indirect costs incurred to support a number of cost objects. Theses costs
cannot be traced to any individual cost object.
cost classification for decision making :
- 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 others should be ignored.
Differential Cost and Revenue
Differential cost : a difference in costs between any two
alternatives.
-Incremental cost :increase cost. (between alternatives)
-Decremental cost : decrease cost. (between alternatives)
Differential revenue : a difference in revenue between any two
alternatives.
- The revenue can be obtained from selling on more unit of product (is called
marginal cost.
Opportunity Cost
- The potential benefit that is given up when one alternative
is selected over another.
- These costs are not usually entered into the accounting
records of an organization. But must be explicitly
considered in all decision.
Sunk cost
Sunk cost have already been incurred and cannot be changed
now or in the future. These costs should be always be
ignored when making decision.
Purpose of cost classification
Preparing external financial statements
cost classification
.product costs (inventoriable)
.direct material
.direct labor
.manufacturing overhand
.period costs(expensed)
.nonmanufacturing costs
. Selling costs
. Administrative costs
Predicting cost behavior in
. Variable cost (proportional to activity)
response to changes in activity
. Fixed cost (constant in total)
.mixed cost(has variable & fixed cost)
Assigning costs to cost objects
. Direct cost (can be easily traced)
(e.g. department or product)
.Indirect cost (cannot be easily traced)
Making decision
.differential cost (differs between alternatives)
.sunk cost (past cost not affected by a decision)
. Opportunity cost (forgone benefit)