cost behaviour in accountiwork full.pptx

Cost behavior

1. COST BEHAVIOUR

2. COST BEHAVIOUR It means the pattern of change in cost as a result of change in level of activity or production. This is also the ways in which costs react or do not react to changes in the level of activity of an organisation. The type of activity normally varies according to the work that is done in of organisation and also the nature of items.

3. PREDICTING COST BEHAVIOUR 1. VARIABLE COST This is the cost which varies with the measure of activities. In other words it is cost which tends to follow the level of activity. Variable cost behavior is subdivided into linear and non-linear. a. Linear variable cost It is a relationship between variable cost and output and this can be shown in a straight line. A linear relationship can be expressed as cost = bx

4. Where x = volume of output in units b = a constant representing the variable cost per unit

5. EXAMPLE Materials used for production of product Z are 3 brackets @ $1.25 50 screws @ $0.025 6 pulleys @ $1.5   What is the expected cost of producing 40 units of product Z?

6. SOLUTION 3 x 1.25 = 3.75 50 x 0.025 = 1.25 6 x 1.5 = 9 ( 3.75+1.25+9 = 14 ) Therefore variable cost is 14 x 40 = $560

7. b. Non linear variable cost or curvilinear variable cost This is a relationship between variable cost and output and it can be shown as a curved line on a graph. There are two main types of curves which show a non-linear relationship.

8. A convex is where the extra units of output causes a less than proportionate increase in cost. A concave is where the extra units of output causes a more than proportionate increase in cost. The cost is represented as {cost = bx + cx ² + dx 3 +……….+ zx n } Where x is the volume of output in the unit b, c, d,……z are constants representing the variable cost per unit

9. EXAMPLE Analysis of cost and activity reports for a product are expressed by the following equation Cost = bx + cx² + dx 3 ; where b = 8, c = 0.6 and d = 0.04 Calculate Variable cost when production is 100 units Variable cost when production is 150 units Determine if the function is convex or concave

10. SOLUTION Cost for 100 units = (8 x 100) + (0.6 x 100 2 ) + (0.04 x 100 3 ) = 800 + 6,000 + 40,000 = 46,800   Cost for 150 units = (8 x 150) + (0.6 x 150 2 ) + (0.04 x 150 3 ) = 1,200 + 13,500 + 135,000 = 149,700 The function is concave because cost increases as output increases    

11. 2. FIXED/PERIOD COST A fixed cost is a cost that does not change with an increase or decrease in output in the short run. Fixed cost can be expressed as cost = a

12. 2. SEMI-VARIABLE COST This is the cost that contains both the fixed and variable components which is partly affected by the change in the level of activities. Semi-variable costs can be shown by the following graphs

13. ESTABLISHING COST CHARACTERISTICS There are three methods of establishing cost characteristics i.e. High/low method or the comparison method Least squares method Scatter graph

14. HIGH/LOW METHOD OR THE COMPARISON METHOD In this method, costs of two periods or two activity levels are compared. The difference in these costs is considered as variable costs because it is assumed that the fixed cost of two periods or activity levels is the same.

15. EXAMPLE The Western Company presents the production and cost data for the first six months of the 2018. Required: Determine the estimated variable cost rate and fixed cost using high-low point method. Also determine the cost function on the basis of data given above.   MONTH UNITS PRODUCED COST JANUARY 15,000 45,000 FERBUARY 18,000 56,000 MARCH 22,000 42,000 APRIL 16,000 48,000 MAY 29,000 66,000 JUNE 26,000 62,000

16. SOLUTION: Variable cost = Variable cost = = $1.5 per unit Based on highest activity TC = VC + FC 66,000 = (1.5 x 29,000) + FC FC = 66,000 – 43,500 FC = 22,500  

17. Based on lowest activity TC = VC + FC 45,000 = (1.5 x 15,000) + FC FC = 45,000 – 22,500 FC = 22,500   y = 22,500 +1.5x  

18. LEAST SQUARES METHOD   This is a statistical approach for calculating the line of best fit and it can be used in establishing the cost function. The linear cost function can be represented by y = a + bx Where y = cost a and b are constants that need to be solved simultaneously To find the values of constants ‘a’ and ‘b’ the following two simultaneous equations are to be solved: Ƹ y = an + b Ƹx Ƹxy = aƸx + bƸx 2 Where n is the number of pairs of cost and activity levels  

19. EXAMPLE   The following data is given for a period Use the equations in the previous slide  

20. SOLUTION: Ƹ y = an + b Ƹx Ƹxy = aƸx + bƸx 2 n is the number of output

21. SCATTER GRAPH     A graph is plotted that is units of output against cost. The pattern of the graph plotted will determine if it is fixed, variable and or semi variable.   Using the same example above under the least square method, plot a scatter graph.

22. END OF TOPIC 2