Module 2: Cost Concepts, Classification, and Cost Behavior

X Cost Concepts and Classification (FS Preparation, Behavior, Decision Making, Cost Assignment)
X Traditional Format Income Statement versus Contribution Format Income Statement
X Splitting of Mixed Cost (Scattergraph, High-Low Method, Least Squares Method)
X Learning Curve Analysis
Cost Concepts and Classification
For Financial Statement Preparation
Product Cost (inventoriable) Manufacturing Costs: Direct Materials, Direct Labor, Man
Period Cost (expensed) Non-Manufacturing Costs: Selling costs, Administrative co
For Predicting Cost Behavior
Variable proportional to activity
Fixed constant in total
Mixed variable + fixed
For Decision Making
Differential/Relevant Cost differs between alternative
Sunk Cost should be ignored
Opportunity Cost foregone benefit
For Cost Assignment
Direct Cost Traceable to the cost object
Indirect Cost Common, non-traceable to the cost object

Traditional Format Income Statement

Sales - Product Cost = Gross Margin - Period Cost = Net Operating Income
Sales xx
Cost of Goods Sold xx
Gross Margin xx
Selling and Administrative Expenses
Selling xx
Administrative xx xx
Net Operating Income xx

Contribution Format Income Statement

Sales - Variable Cost = Contribution Margin - Fixed Cost = Net Operating Income
Sales xx
Variable Expenses
Cost of Goods Sold xx matic VE sya
Variable Selling xx
Variable Administrative xx xx
Contribution Margin xx
Fixed Expenses
Fixed Selling xx
Fixed Administrative xx xx
Net Operating Income xx

Cost Prediction Models

High-Low Method
Y = a + bX
Variable Cost (b) = Change in Cost / Change in activity
Fixed Cost (a) = Total Cost - Variable Cost element
Least-Squares Regression Method
Y = a + bX

Using Excel:
Variable Cost (b) = SLOPE Function
Fixed Cost (a) = INTERCEPT Function
Goodness of Fit = RSQ Function

Learning Curve Analysis

Formula: Y = aX^b
Y = Labor Hours
a = time for the 1st unit/batch
X = cumulative output
b = learning index (logarithm)
= ln(learning curve rate) / ln(2)
osts: Direct Materials, Direct Labor, Manufacturing Overhead / Prime versus Conversion Cost
ing Costs: Selling costs, Administrative costs

aceable to the cost object

rating Income
 Product Cost
Variable Direct Direct Manufacturing
Cost Fixed Cost Materials Labor Overhead
1. Wood used ($100 per table) X X
2. Labor cost ($40 per table) X X

3. Salary of the factory supervisor ($38,000 per X X

year)
4. Cost of electricity ($2 per machine-hour) X X
5. Depreciation of machines ($10,000 per year) X X

6. Salary of the company president ($100,000 X

per year)
7. Advertising expense ($250,000 per year) X

8. Commissions paid to salespersons ($30 per X

table sold)
9. Rental income forgone on factory space
Period Opportunity
Cost Sunk Cost Cost

X
(1) Schedule of Cost of Goods Manufactured

Klear-Seal Corporation
Schedule of Cost of Goods Manufactured
For the Year Ended December 31

Direct Materials
Raw Materials Inventory, Jan 1 $ 90,000
Add: Purchases of Raw Materials 750,000
Raw Materials Available for Use 840,000
Less: Raw Materials Inventory, Dec 31 60,000
Raw Materials Used in Production $ 780,000 prime cost
Direct Labor 150,000 prime / conversion cost
Manufacturing Overhead 640,000 conversion cost
Total Manufacturing Cost 1,570,000
Add: Work in Process Inventory, Jan 1 180,000
Total Work in Process 1,750,000
Less: Work in Process Inventory, Dec 31 100,000
Cost of Goods Manufactured $ 1,650,000

(2) Cost of Goods Sold

Finished Goods Inventory, Jan 1 $ 260,000
Add: Cost of Goods Manufactured 1,650,000
Goods Available for Sale 1,910,000
Less: Finished Goods Inventory, Dec 31 210,000
Cost of Goods Sold $ 1,700,000

(2) Income Statement

Klear-Seal Corporation
Income Statement
For the Year Ended December 31

Sales $ 2,500,000
Cost of Goods Sold 1,700,000 product cost
Gross Margin 800,000
Selling and administrative expenses
Selling Expenses 140,000 period cost
Administrative Expenses 270,000 410,000 period cost
Net Operating Income $ 390,000
version cost
(1) Contribution Format Income Statement
Sales Volume ($150,000 / $750) 200 units

The Alpine House, Inc.

Contribution Format Income Statement -- Ski Department
For the Quarter Ended March 31

Sales $ 150,000
Variable Cost
Cost of Goods Sold $ 90,000
Selling expenses ($50 x 200) 10,000
Administrative expenses ($10,000 x 20%) 2,000 102,000
Contribution Margin 48,000
Fixed Cost
Selling expenses ($30,000 - 10,000) 20,000
Administrative expenses ($10,000 x 80%) 8,000 28,000
Net Operating Income $ 20,000

(2) Contribution Margin per Unit Sold

= Total Contribution Margin / Sales Volume
= $48,000 / 200 units
= $ 240 contribution for every pair of skis sold
Splitting Mixed Costs: High-Low Method, Scattergraph Analysis, Least Squares Method
(1) High-Low Method
Variable Cost (b) = Change in Cost / Change in activity
= ($2700 - $1,200) / (8 - 2)
= $ 250

Fixed Cost (a) = Total Cost - Variable Cost element

= $2700 - ($250 x 8)
= $ 700

= $1200 - ($250 x 2)
= $ 700

Y = a + bX
Y = $700 + $250X

(2) (a) Scattergraph

Total Shipping
Month Units Shipped Expense
X Y
January 3 $ 1,800
February 6 2,300
March 4 1,700
April 5 2,000
May 7 2,300
June 8 2,700
July 2 1,200

Scattergraph
$3,000

$2,500

$2,000

$1,500

$1,000

$500

$-
1 2 3 4 5 6 7 8 9

(b) Cost Formula

 a = $900

Y = a + bX
$2,000 = $900 + b(5)
b(5) = $1,100
b = $220
Y = $900 + $220X

(3) The cost of shipping units is likely to depend on the weight and size of the units, and the distance traveled.
In addition, higher shipping might be necessary in some situations to meet a deadline (e.g. rush items)

(1) (a) Least-Squares Regression Method

Total Shipping
Units Shipped Expense
Month X Y X^2 XY
January 10,000 $ 119,000 100000000 1190000000
////// 16,000 175,000 256000000 2800000000
March 18,000 190,000 324000000 3420000000
April 15,000 164,000 225000000 2460000000
May 11,000 130,000 121000000 1430000000
June 17,000 185,000 289000000 3145000000
13,000 147,000 169000000 1911000000
July 20,000 210,000 400000000 4200000000
SUM 120000 1,320,000 1884000000 20556000000

Y = a + bX
(8 x 20,556,000) - (120 x 1,320,000)
b =
(8 x 1884) - (120)^2
b = $ 9.00 Using excel (SLOPE) 9.00

1,320,000 - ($9000 x 120)

a =
8
a = $ 30,000 Using excel (INTERCEPT) 30000.00

Y = $30,000 + $9,000 Using excel (RSQ) 100%

(2) Comparison Among Cost Prediction Models

Least-
Quick-and-Dirty High-Low
Squares
(Scattergraph) Method
Regression
Fixed Cost (a) $900 $ 700 $ 30,000
Variable Cost (b) $220 $ 250 $ 9.00
Goodness of Fit
Consider Rayburn Corporation, a radar systems manufacturer. Rayburn has an 80% learning curve.

Cumulative Average-Time Individual Unit-Time Learnin

Cumulative Input (i.e. Labor Learning Model Model
Formula: Y = aX^b
Output Hours)
Cumulative Individual Unit Cumulative
Total Time Time Total Time
1 100.00 100.00 100.00 100.00
2 80.00 (100 hours x 80%) 160.00 60.00 180.00
3 70.21 [100 hours x 3^(-0.32193)] 210.63 50.63 250.21
4 64.00 (80 hours x 80%) 256.00 45.37 314.21
5 59.56 [100 hours x 5^(-0.32193)] 297.82 41.82 373.77
6 56.17 337.01 39.19 429.94
7 53.45 374.14 37.13 483.39
8 51.20 (64 hours x 80%) 409.60 35.46 534.59
9 49.29 443.65 34.05 583.89
10 47.65 476.51 32.86 631.54
11 46.21 508.32 31.81 677.75
12 44.93 539.22 30.89 722.68
13 43.79 569.29 30.07 766.47
14 42.76 598.63 29.34 809.23
15 41.82 627.30 28.67 851.05
16 40.96 (51.2 hours x 80%) 655.36 28.06 892.01
ividual Unit-Time Learning
Model
Individual Unit
Time Formula: Y = aX^b
100.00 Y Labor Hours
80.00 a time for the 1st unit/batch
70.21 X cumulative output
64.00 b learning index (logarithm)
59.56 ln(learning curve rate) / ln(2)
56.17
53.45 b ln(80%)/ln(2)
51.20 -0.32193
49.29
47.65
46.21
44.93
43.79
42.76
41.82
40.96
(a) 90% Cumulative Average-Time Learning Curve

Cumulative Average-Time Individual Unit-Time Learni

Input (i.e. Learning Model Model
Cumulative
Labor Formula: Y = aX^b
Output
Hours) Cumulative Individual Unit Cumulative
Total Time Time Total Time
1 15,000 15,000 15,000 15,000
2 13,500 (15000 hours x 90%) 27,000 12,000 28,500
3 12,693 [15000 x 3^(-0.152)] 38,079 11,079 41,193
4 12,150 (13500 hours x 90%) 48,600 10,521 53,343
5 11,745 [15000 x 5^(-0.152)] 58,725 10,125 65,088
6 11,424 [15000 x 6^(-0.152)] 68,544 9,819 76,512
7 11,159 [15000 x 7^(-0.152)] 78,113 9,569 87,671
63,113

b = ln(90%)/ln(2) -0.152

Production Costs:
Direct material ($200,000 x 6 boats) $ 1,200,000
Direct manufacturing labor (DML) (63,113 hours x$40) 2,524,520
Variable manufacturing overhead (63,113 hours x $25) 1,577,825
Other manufacturing overhead (20% of DML) 504,904
Total costs of the next 6 boats $ 5,807,249

(b) No Learning; Linear

Production Costs:
Direct material ($200,000 x 6 boats) $ 1,200,000
Direct manufacturing labor (DML) (15,000 hrs x 6 boats x $40) 3,600,000
Variable manufacturing overhead (15,000 hrs x 6 boats x $25) 2,250,000
Other manufacturing overhead (20% of DML) 720,000
Total costs of the next 6 boats $ 7,770,000

Difference $ 1,962,751

(c) 90% Individual Unit-Time Learning Curve

Production Costs:
Direct material ($200,000 x 6 boats) $ 1,200,000
Direct manufacturing labor (DML) (72,671 hours xn$40) 2,906,840
Variable manufacturing overhead (72,671 hours x $25) 1,816,775
Other manufacturing overhead (20% of DML) 581,368
Total costs of the next 6 boats $ 6,504,983
ividual Unit-Time Learning
Model
Individual Unit
Time
15,000
13,500
12,693
12,150
11,745
11,424
11,159
72,671