BUS105 Study Guide
Unit 4: Cost Behavior Patterns
4a. Identify typical cost behavior patterns
- What are the different types of cost behavior patterns?
- What type of cost behavior does total costs have?
- What do you call a cost that has both a fixed component as well as a variable one?
Costs that increase in total with total production are called variable costs. These costs are constant on a per-unit basis. Fixed costs are costs that are constant, in total, regardless of the level of production. However, on a per-unit basis, these costs decrease as production increases. Fixed costs that can be easily changed are called discretionary fixed costs. If a fixed cost can not be easily changed, it is called a committed fixed cost. A mixed cost consists of a fixed component as well as a variable component. Total costs, which include both fixed and variable costs, are an example of mixed costs.
The range of activity for which cost behavior patterns are likely to be accurate is referred to as the relevant range. Outside that range, cost estimates and behaviors are not necessarily accurate and need to be reevaluated.
Review Cost Behavior Patterns.
4b. Estimate costs using account analysis, the high-low method, the scattergraph method, and regression analysis
- What are the four common methods used to estimate costs?
- What are the four steps used in the high-low method?
- What are the five steps used in the scattergraph method?
- Which method will provide the most accurate cost estimates?
There are four ways to estimate fixed variable costs. All four methods attempt to define the equation:
Y = f + vX
Where Y = total costs, f = fixed costs, v = variable costs and X = level of output.
In account analysis employees review the applicable accounts to determine whether costs are fixed, variable, or mixed. The high-low method consists of four steps and uses the highest and lowest output levels with their related costs to estimate fixed and variable costs. The scattergraph method has five steps and involves plotting all points on a graph and fitting a line through the points. Regression analysis is a mathematical method that fits a line through the data points.
The choice of a method will usually depend on the situation. While account analysis and the high-low method are easier and less costly, a scattergraph or regression analysis are more accurate, but may require the use of computer software. Many times, two or more methods will be used simultaneously.
Review Cost Estimation Methods.
4c. Prepare a contribution margin income statement
- What differentiates the contribution margin income statement from a traditional income statement?
- Why is it useful to separate fixed and variable costs in an income statement?
- How is the contribution margin useful in cost analysis?
A contribution margin income statement breaks down cost information into fixed and variable components Revenue is shown followed by variable costs. Revenue less variable costs equals the contribution margin. Fixed costs are then subtracted from the contribution margin to reach operating profit. This statement is able to provide a clearer idea of cost behavior when there are changes in levels of activity.
The contribution margin is very important in analyzing cost behavior. It equals revenue from sales left over after deducting variable costs and represents how much revenue remains to cover fixed costs. The higher the contribution margin, the more each sale will help offset fixed costs.
4d. Provide for nonlinear costs that occur outside of a predetermined relevant range for linear costs
- What are two assumptions always made in estimating costs?
- What happens to cost behavior if production is at a level outside of the relevant range?
- How do nonlinear costs affect cost behavior?
All cost behavior estimates assume that the production activity level is within a given relevant range. Additionally, within that range, it is assumed that costs are linear and not nonlinear. If costs are outside this range, cost behavior may change. For example, if production increases by a large amount, a new plant may be needed, increasing fixed costs. Additionally, if within the relevant range, costs are nonlinear, cost estimates will be distorted.
Although cost estimates are not perfect, companies generally clearly define a relevant range and assume that costs are linear within that given range. These assumptions usually lead to reasonably good cost estimations.
Unit 4 Vocabulary
This vocabulary list includes terms you will need to know to successfully complete the final exam.
- account analysis
- committed fixed cost
- contribution margin
- contribution margin income statement
- discretionary fixed cost
- fixed costs
- high-low method
- linear costs
- mixed cost
- nonlinear costs
- regression analysis
- relevant range
- scattergraph method
- total costs
- variable costs