CHAPTER 11: but it is also referred to as a cost

driver.
COST BEHAVIOR

➢ how a cost will react as changes take place 2. FIXED COST

in the level of business activity. ➢ cost that remains constant in total
regardless of changes in the level of
IMPORTANCE OF UNDERSTANDING COST activity.
BEHAVIOR

PLANNING TYPES OF FIXED COST

a) Committed Fixed cost
o requires that management make ➢ costs relate to the investment in
decisions based in part on expectations facilities, equipment, and basic
as to the future. organizational structure of the
o failure in this activity could mean firm.
displacement cost to to unexpected b) Discretionary Fixed Cost
events ➢ often referred to as managed
CONTROL fixed cost
➢ arise from annual decision by
o the process of using feedback management to spend in certain
information for comparison with fixed cost areas.
expectations and the implementation of c) Fixed Cost and the Relevant Range
actions on the basis for comparison ➢ levels of discretionary fixed cost
are typically decided at the
COST ANALYSIS
beginning of the year. and
➢ integral part of planning and control depend on the support needs of
function. planned programs.
➢ key to effective cost prediction lies in an
understanding of cost behavior patterns 3. MIXED COST
➢ one that contains variable and fixed
TYPES OF COST BEHAVIOR PATTERNS
cost elements.
1. VARIABLE COST ➢ also known as the semi-variable cost
➢ those cost that change in total as the
level of activity changes in the short
COST ESTIMATION:
run and within the relevant range.
➢ short run – tie period long enough to THE ANALYSIS OF MIXED COST
allow management to change the
➢ fixed portion of mixed cost represents
level of production.
the basic, minimum cost of just having a
➢ relevant range – range activity within
service ready and available for use.
which assumption relative to variable
➢ variable portion represents the cost
cost and fixed cost behavior are valid.
incurred for the actual consumption of
➢ for a cost to be variable, it must be
the service.
variable with respect to activity base.
➢ activity base – measure of whatever
causes the incurrence of variable cost
DIFFERENT METHODS: CORRELATION ANALYSIS

1. Account Analysis Method ➢ In the process of estimating and

➢ provides a detailed expert analysis of controlling costs, management must
the cost behavior in each account evaluate whether or not the factor
➢ subjective selected for estimating cost behavior is
2. Engineering Method suitable for that purpose.
➢ based on studies of what future cost
THE LEARNING CURVE THEORY
should be rather than what past costs
have been ➢ One assumption in estimating cost
➢ not particularly useful when the behavior is that the cost of each input is
physical relation between inputs and a linear function of the quantity
outputs is indirect assigned. However, the costs and
3. High-low Method independent variables is not always
➢ simple to apply linear.
➢ uses only two data points which may
not produce accurate results Some of the Uses of Learning Curves are as
4. Scatter graph method follows:
➢ uses all the observations of the cost 1. Preparing cost estimates for bidding
data purposes
➢ relatively easy to understand and 2. Setting standards and budget allowances
apply 3. Scheduling labor requirements
➢ the fitting of the line to the 4. Evaluating performance by comparing
observations is subjective progress reports with the
➢ difficult to do where several accomplishments anticipated under the
independent variables are to be used. learning curve
5. Least square regression Method 5. Setting incentive wage rates with due
➢ Uses all of the observations of cost consideration for the fact that labor times
data. will normally be reduced as the workman
➢ The line is statistically fit to the becomes more experienced.
observations.
➢ A measure of the goodness of fit of In solving learning curve problems, the following
the line to the observations is steps may be followed:
provided. 1. Double the cumulative quantity
➢ Relatively easy to use with computers 2. Multiply the cumulative average by the
and sophisticated calculators. learning curve percentage
➢ The regression model requires that 3. Multiply the cumulative average by the
several relatively strict assumptions cumulative quantity
be satisfied for the results to be valid