Solution manual managerial accounting by cabrera 2010 chapter 09 answer

Variable cost: A variable cost is one that remains constant on a per unit basis, but which changes in total in direct relationship to changes in volume.. Fixed cost: A fixed cost is one

CHAPTER 9 COST BEHAVIOR: ANALYSIS AND USE

I Questions

1 a Variable cost: A variable cost is one that remains constant on a

per unit basis, but which changes in total in direct relationship to

changes in volume

b Fixed cost: A fixed cost is one that remains constant in total

amount, but which changes, if expressed on a per unit basis, inversely with changes in volume

c Mixed cost: A mixed cost is a cost that contains both variable and

fixed cost elements

2 a Unit fixed costs will decrease as volume increases

b Unit variable costs will remain constant as volume increases

c Total fixed costs will remain constant as volume increases

d Total variable costs will increase as volume increases

3 a Cost behavior: Cost behavior can be defined as the way in which

costs change or respond to changes in some underlying activity, such as sales volume, production volume, or orders processed

b Relevant range: The relevant range can be defined as that range

of activity within which assumptions relative to variable and fixed cost behavior are valid

4 Although the accountant recognizes that many costs are not linear in relationship to volume at some points, he concentrates on their behavior within narrow bands of activity known as the relevant range The relevant range can be defined as that range of activity within which assumptions as relative to variable and fixed cost behavior are valid Generally, within this range an assumption of strict linearity can

be used with insignificant loss of accuracy

5 The high-low method, the scattergraph method, and the least-squares regression method are used to analyze mixed costs The least-squares

derives the fixed and variable elements of a mixed cost by means of statistical analysis The scattergraph method derives these elements by visual inspection only, and the high-low method utilizes only two points in doing a cost analysis, making it the least accurate of the three methods

6 The fixed cost element is represented by the point where the regression line intersects the vertical axis on the graph The variable cost per unit

is represented by the slope of the line

7 The two assumptions are:

1 A linear cost function usually approximates cost behavior within the relevant range of the cost driver

2 Changes in the total costs of a cost object are traceable to variations or changes in a single cost driver

8 No High correlation merely implies that the two variables move together in the data examined Without economic plausibility for a relationship, it is less likely that a high level of correlation observed in one set of data will be found similarly in another set of data

9 Refer to page 312 of the textbook

10 The relevant range is the range of the cost driver in which a specific relationship between cost and cost driver is valid This concept enables the use of linear cost functions when examining CVP relationships as long as the volume levels are within that relevant range

11 A unit cost is computed by dividing some amount of total costs (the numerator) by the related number of units (the denominator) In many cases, the numerator will include a fixed cost that will not change despite changes in the denominator It is erroneous in those cases to multiply the unit cost by activity or volume change to predict changes

in total costs at different activity or volume levels

12 Cost estimation is the process of developing a well-defined relationship between a cost object and its cost driver for the purpose of predicting the cost The cost predictions are used in each of the management functions:

Strategic Management: Cost estimation is used to predict costs of alternative activities, predict financial impacts of alternative strategic

choices, and to predict the costs of alternative implementation strategies

Planning and Decision Making: Cost estimation is used to predict costs

so that management can determine the desirability of alternative options and to budget expenditures, profits, and cash flows

Management and Operational Control: Cost estimation is used to develop cost standards, as a basis for evaluating performance

Product and Service Costing: Cost estimation is used to allocate costs

to products and services or to charge users for jointly incurred costs

13 The five methods of cost estimation are:

a Account Classification Advantages: simplicity and ease of use Disadvantages: subjectivity of method and some costs are a mix of both variable and fixed

b Visual fit The visual fit method is easy to use, and requires only that the data is graphed Disadvantages are that the scale of the graph may limit ability to estimate costs accurately and in both graphical and tabular form, significant perceptual errors are common

c High-Low Because of the precision in the development of the equation, it provides a more consistent estimate than the visual fit and is not difficult to use Disadvantages: uses only two selected data points and is, therefore, subjective

d Work Measurement The advantage is accurate estimates through detailed study of the different operations in the product process, but like regression, it is more complex

e Regression Quantitative, objective measures of the precision and accuracy and reliability of the model are the advantages of this model; disadvantages are its complexity: the effort, expense, and expertise necessary to utilize this method

14 Implementation problems with cost estimation include:

a cost estimates outside of the relevant range may not be reliable

b sufficient and reliable data may not be available

c cost drivers may not be matched to dependent variables properly in each observation

d the length of the time period for each observation may be too long,

variable to be estimated is difficult to isolate from the numerous variables and events occurring in that period of time; alternatively the period may be too short, so that the data is likely to be affected

by accounting errors in which transactions are not properly posted

in the period in which they occurred

e dependent variables and cost drivers may be affected by trend or seasonality

f when extreme observations (outliers) are used the reliability of the results will be diminished

g when there is a shift in the data, as, for example, a new product is introduced or when there is a work stoppage, the data will be unreliable for future estimates

15 The dependent variable is the cost object of interest in the cost estimation An important issue in selecting a dependent variable is the level of aggregation in the variable For example, the company, plant,

or department may all be possible levels of data for the cost object The choice of aggregation level depends on the objectives for the cost estimation, data availability, reliability, and cost/benefit considerations

If a key objective is accuracy, then a detailed level of analysis is often preferred The detail cost estimates can then be aggregated if desired

16 Nonlinear cost relationships are cost relationships that are not adequately explained by a single linear relationship for the cost driver(s) In accounting data, a common type of nonlinear relationship

is trend and seasonality For a trend example, if sales increase by 8% each year, the plot of the data for sales with not be linear with the driver, the number of years Similarly, sales which fluctuate according

to a seasonal pattern will have a nonlinear behavior A different type of nonlinearity is where the cost driver and the dependent variable have

an inherently nonlinear relationship For example, payroll costs as a dependent variable estimated by hours worked and wage rates is nonlinear, since the relationship is multiplicative and therefore not the additive linear model assumed in regression analysis

17 The advantages of using regression analysis include that it:

a provides an estimation model with best fit (least squared error) to the data

b provides measures of goodness of fit and of the reliability of the model which can be used to assess the usefulness of the specific

model, in contrast to the other estimation methods which provide

no means of self-evaluation

c can incorporate multiple independent variables

d can be adapted to handle non-linear relationships in the data, including trends, shifts and other discontinuities, seasonality, etc

e results in a model that is unique for a given set of data

18 High correlation exists when the changes in two variables occur together It is a measure of the degree of association between the two variables Because correlation is determined from a sample of values, there is no assurance that it measures or describes a cause and effect relationship between the variables

II Exercises

Exercise 1 (Cost Classification)

1 b

2 f

3 e

4 i

5 e

6 h

7 l

8 a

9 j

10 k

11 c or d

12 g

Exercise 2 (Cost Estimation; High-Low Method)

Requirement (1)

Cost equation using square fee as the cost driver:

Variable costs:

P4,700 – P2,800 4,050 – 2,375 = P1.134

Fixed costs:

P4,700 = Fixed Cost + P1.134 x 4,050

Fixed Cost = P107

Equation One: Total Cost = P107 + P1.134 x square feet

There are two choices for the High-Low points when using openings for the cost driver At 11 openings there is a cost of P2,800 and at 10 openings there is a cost of P2,875

Cost equation using 11 openings as the cost driver:

Variable costs:

Fixed costs:

P4,700 = Fixed Cost + P237.50 x 19

Fixed Cost = P187.50

Equation Two: Total Cost = P187.50 + P237.50 x openings

Cost equation using 10 openings as the cost driver:

Variable costs:

Fixed costs:

P4,700 = Fixed Cost + P202.78 x 19

Fixed Cost = P847.18

Equation Three: Total Cost = P847.18 + P202.78 x openings

P4,700 – P2,800

19 – 11 = P237.50

P4,700 – P2,875

19 – 10 = P202.78

Predicted total cost for a 3,200 square foot house with 14 openings using equation one:

P107 + P1.134 x 3,200 = P3,735.80

Predicted total cost for a 3,200 square foot house with 14 openings using equation two:

P187.50 + P237.50 x 14 = P3,512.50

Predicted total cost for a 3,200 square foot house with 14 openings using equation three:

P847.18 + P202.78 x 14 = P3,686.10

There is no simple method to determine which prediction is best when using the High-Low method In contrast, regression provides quantitative measures (R-squared, standard error, t-values,…) to help asses which regression equation is best

Predicted cost for a 2,400 square foot house with 8 openings, using equation one:

P107 + P1.134 x 2,400 = P2,828.60

We cannot predict with equation 2 or equation 3 since 8 openings are outside the relevant range, the range for which the high-low equation was developed

Requirement 2

Figure 9-A shows that the relationship between costs and square feet is relatively linear without outliers, while Figure 9-B shows a similar result

for the relationship between costs and number of openings From this perspective, both variables are good cost drivers

Figure 9-A

Figure 9-B

Exercise 3 (Cost Estimation; Account Classification)

Requirement 1

Fixed Costs:

Variable Costs:

Shopping Bags 180

Variable Costs Per Unit = P84,730 / 8,900

= P95.20

Cost Function Equation: y = P31,800 + P95.20 x (CD’s sold)

Requirement 2

New Sales = 8,900 x 1.25

= 11,125 units = round to 11,130 Total Costs = P31,800 + P95.20 x (11,130)

= P137,760 Per Unit Total Costs = P137,760 / 11,130

= P123.80 Add P1 profit per disc: P123.80 + P10 = P133.80

Requirement 3

Adjusted New Sales = 8,900 x 11.50

= 10,240 units Revenue = P133.80 x (10,240)

= P137,010

Total Cost = P31,800 + P95.20 x (10,240)

= P129,280

Cost Per Disc = P129,280 / 10,240 = P126.30

Profit Per Disk = P133.80 – P126.30

= P7.50

Exercise 4 (Cost Estimation Using Graphs; Service)

Requirement 1

Requirement 2

There seems to be a positive linear relationship for the data between P2,500 and P4,000 of advertising expense Llanes’ analysis is correct within this relevant range but not outside of it Notice that the relationship between advertising expense and sales changes at P4,000 of expense

III Problems

Problem 1

Driven

Total Annual Cost*

High level of activity 120,000 P13,920 Low level of activity 80,000 10,880 Difference 40,000 P 3,040

* 120,000 miles x P0.116 = P13,920

80,000 miles x P0.136 = P10,880

Variable cost per mile:

Change in cost, P3,040

Fixed cost per year:

Total cost at 120,000 miles P13,920

Less variable cost element: 120,000 x P0.076 9,120

Fixed cost per year P 4,800

Requirement (b)

Y = P4,800 + P0.076X

Requirement (c)

Fixed cost P 4,800

Variable cost: 100,000 miles x P0.076 7,600

Total annual cost P12,400

Problem 2

Requirement 1

Cost of goods sold Variable Shipping expense Mixed

Advertising expense Fixed

Salaries and commissions Mixed

Insurance expense Fixed

Depreciation expense Fixed

Requirement 2

Analysis of the mixed expenses:

Units Shipping Expense

Salaries and Comm Expense

High level of activity 4,500 P56,000 P143,000 Low level of activity 3,000 44,000 107,000 Difference 1,500 P12,000 P 36,000 Variable cost element:

Change in cost

Change in activity

Shipping expense:

Salaries and comm expense:

= Variable rate P12,000 1,500 units = P8 per unit

P36,000 1,500 units = P24 per unit

Fixed cost element:

Shipping Expense Salaries and Comm.

Expense

Cost at high level of activity P56,000 P143,000 Less variable cost element:

4,500 units x P8 36,000

4,500 units x P24

108,000 Fixed cost element P20,000 P 35,000 The cost elements are:

Shipping expense: P20,000 per month plus P8 per unit or Y = P20,000 + P8X

Salaries and comm expense: P35,000 per month plus P24 per unit

or Y = P35,000 + P24X

Requirement 3

LILY COMPANY Income Statement For the Month Ended June 30 Sales in units 4,500 Sales revenues P630,000 Less variable expenses:

Cost of goods sold (@P56) P252,000

Shipping expense (@P8) 36,000

Salaries and commission expense

(@P24) 108,000 396,000 Contribution margin 234,000

Less fixed expense:

Shipping expense 20,000

Advertising 70,000

Salaries and commissions 35,000

Insurance 9,000

Depreciation 42,000 176,000 Net income P 58,000