Solution manual managerial accounting concept and applications by cabrera 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 fixedcost behavior are valid

4 Although the accountant recognizes that many costs are not linear inrelationship to volume at some points, he concentrates on theirbehavior within narrow bands of activity known as the relevant range.The relevant range can be defined as that range of activity withinwhich assumptions as relative to variable and fixed cost behavior arevalid 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-squaresregression method are used to analyze mixed costs The least-squaresregression method is generally considered to be most accurate, since it

derives the fixed and variable elements of a mixed cost by means ofstatistical analysis The scattergraph method derives these elements byvisual inspection only, and the high-low method utilizes only twopoints in doing a cost analysis, making it the least accurate of the threemethods.

6 The fixed cost element is represented by the point where the regressionline 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 withinthe relevant range of the cost driver

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

8 No High correlation merely implies that the two variables movetogether in the data examined Without economic plausibility for arelationship, it is less likely that a high level of correlation observed inone 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 specificrelationship between cost and cost driver is valid This concept enablesthe use of linear cost functions when examining CVP relationships aslong as the volume levels are within that relevant range

11 A unit cost is computed by dividing some amount of total costs (thenumerator) by the related number of units (the denominator) In manycases, the numerator will include a fixed cost that will not changedespite changes in the denominator It is erroneous in those cases tomultiply 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 relationshipbetween a cost object and its cost driver for the purpose of predictingthe cost The cost predictions are used in each of the managementfunctions:

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

choices, and to predict the costs of alternative implementationstrategies.

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

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

Management and Operational Control: Cost estimation is used todevelop 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 ofboth variable and fixed

b Visual fit The visual fit method is easy to use, and requires onlythat the data is graphed Disadvantages are that the scale of thegraph may limit ability to estimate costs accurately and in bothgraphical and tabular form, significant perceptual errors arecommon

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

d Work Measurement The advantage is accurate estimates throughdetailed study of the different operations in the product process, butlike regression, it is more complex

e Regression Quantitative, objective measures of the precision andaccuracy and reliability of the model are the advantages of thismodel; disadvantages are its complexity: the effort, expense, andexpertise 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 ineach observation

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

so that the underlying relationship between the cost driver and the

variable to be estimated is difficult to isolate from the numerousvariables and events occurring in that period of time; alternativelythe 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 orseasonality

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

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

15 The dependent variable is the cost object of interest in the costestimation An important issue in selecting a dependent variable is thelevel 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 costestimation, data availability, reliability, and cost/benefit considerations

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

16 Nonlinear cost relationships are cost relationships that are notadequately explained by a single linear relationship for the costdriver(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 thedriver, the number of years Similarly, sales which fluctuate according

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

an inherently nonlinear relationship For example, payroll costs as adependent variable estimated by hours worked and wage rates isnonlinear, since the relationship is multiplicative and therefore not theadditive 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) tothe data

b provides measures of goodness of fit and of the reliability of themodel 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 occurtogether It is a measure of the degree of association between the twovariables Because correlation is determined from a sample of values,there is no assurance that it measures or describes a cause and effectrelationship between the variables

19 An activity base is a measure of whatever causes the incurrence of avariable cost Examples of activity bases include units produced, unitssold, letters typed, beds in a hospital, meals served in a cafe, servicecalls made, etc

20 (a) Variable cost: A variable cost remains constant on a per unit basis,

but increases or decreases in total in direct relation to changes in

21 The linear assumption is reasonably valid providing that the costformula is used only within the relevant range.

22 A discretionary fixed cost has a fairly short planning horizon—usually

a year Such costs arise from annual decisions by management to spend

on certain fixed cost items, such as advertising, research, andmanagement development A committed fixed cost has a long planninghorizon—generally many years Such costs relate to a company’sinvestment in facilities, equipment, and basic organization Once suchcosts have been incurred, they are “locked in” for many years

25 The term “least-squares regression” means that the sum of the squares

of the deviations from the plotted points on a graph to the regressionline is smaller than could be obtained from any other line that could befitted to the data

26 Ordinary single least-squares regression analysis is used when avariable cost is a function of only a single factor If a cost is a function

of more than one factor, multiple regression analysis should be used toanalyze the behavior of the cost.

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

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

Cost equation using 11 openings as the cost driver:

P4,700 – P2,8004,050 – 2,375 = P1.134

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:

There is no simple method to determine which prediction is best whenusing the High-Low method In contrast, regression provides quantitativemeasures (R-squared, standard error, t-values,…) to help asses whichregression equation is best.

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

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

We cannot predict with equation 2 or equation 3 since 8 openings areoutside the relevant range, the range for which the high-low equation wasdeveloped

Figure 9-B

Exercise 3 (Cost Estimation; Account Classification)

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 11,130Total Costs = P31,800 + P95.20 x (11,130)

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

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

Requirement 3

Adjusted New Sales = 8,900 x 11.50

= 10,240 unitsRevenue = 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 betweenP2,500 and P4,000 of advertising expense Llanes’ analysis is correctwithin this relevant range but not outside of it Notice that the relationshipbetween advertising expense and sales changes at P4,000 of expense

Exercise 5 (Fixed and Variable Cost Behavior)

* Total cost ÷ cups of coffee served in a week

Requirement (2)

The average cost of a cup of coffee declines as the number of cups of coffeeserved increases because the fixed cost is spread over more cups of coffee

Exercise 6 (Scattergraph Analysis)

Requirement (1)

The completed scattergraph is presented below:

02,000

Requirement (2)

(Students’ answers will vary considerably due to the inherent imprecisionand subjectivity of the quick-and-dirty scattergraph method of estimatingvariable and fixed costs.)

The approximate monthly fixed cost is P6,000—the point where thestraight line intersects the cost axis

The variable cost per unit processed can be estimated as follows using the8,000-unit level of activity, which falls on the straight line:

Total cost at the 8,000-unit level of activity P14,000Less fixed costs 6,000Variable costs at the 8,000-unit level of activity P  8,000P8,000 ÷ 8,000 units = P1 per unit

Observe from the scattergraph that if the company used the high-lowmethod to determine the slope of the line, the line would be too steep Thiswould result in underestimating the fixed cost and overestimating thevariable cost per unit

Exercise 7 (High-Low Method)

Requirement (1)

Electrical Costs

High activity level (August) 3,608 P8,111Low activity level (October) 186 1,712Change 3,422 P6,399Variable cost = Change in cost ÷ Change in activity

= P6,399 ÷ 3,422 occupancy-days

= P1.87 per occupancy-dayTotal cost (August) P8,111Variable cost element

(P1.87 per occupancy-day × 3,608 occupancy-days) 6,747Fixed cost element P1,364

Requirement (2)

Electrical costs may reflect seasonal factors other than just the variation in

occupancy days For example, common areas such as the reception areamust be lighted for longer periods during the winter This will result inseasonal effects on the fixed electrical costs.

Additionally, fixed costs will be affected by how many days are in a month

In other words, costs like the costs of lighting common areas are variablewith respect to the number of days in the month, but are fixed with respect

to how many rooms are occupied during the month

Other, less systematic, factors may also affect electrical costs such as thefrugality of individual guests Some guests will turn off lights when theyleave a room Others will not

Exercise 8 (Least-Squares Regression)

The least-squares regression estimates of fixed and variable costs can becomputed using any of a variety of statistical and mathematical softwarepackages or even by hand

January 2,310 P10,113February 2,453 P12,691March 2,641 P10,905April 2,874 P12,949May 3,540 P15,334June 4,861 P21,455July 5,432 P21,270August 5,268 P19,930September 4,628 P21,860October 3,720 P18,383November 2,106 P 9,830December 2,495 P11,081

Y = P2,296 + P3.74X