MAS Cost Concepts and Analysis

San Sebastian College – Recoletos Canlubang Campus

Management Advisory Services Costs and Cost Concepts Cost – a measurement, in monetary terms, of the amount of resources used for some purpose. When notified by a term that defines the purpose, cost becomes operational, e.g., selling cpst, acquisition cost, variable cost, etc. Cost Pool – an account in which a variety of similar costs are accumulated prior to allocation to cost objects. It is a group of costs associated with an activity. Example: overhead account. Cost object – the intermediate and final disposition of cost pools. Example: product, job, process Cost driver – a factor that causes a change in the cost pool for a particular activity. It is used as a basis for cost allocation; any factor or activity that has a direct cause-effect relationship Activity – any event, action, transaction, or work sequence that incurs costs when producing a product or providing a service. COST BEHAVIOR – describes how a cost behaves or changes as the amount of cost driver changes. Types of Costs as to Behavior: 1. Fixed Cost – in total: constant within the relevant range as activity output changes; per unit: changes as activity level changes 2. Variable Cost – in total: varies in direct proportion to changes in activity output; per unit: remains constant 3. Mixed Cost – has both fixed and variable components.

Cost Behavior Assumptions: 1. Relevant Range Assumption Relevant range refers to the band of activity within which the identifies cost behavior patterns are valid. Any level of activity outside this range may have a different cost behavior pattern. 2. Time Period Assumption The cost behavior patterns identified are true only over a specified period of time. Beyond this, the cost may show a different behavior. Segregation of Fixed and Variable Elements of Mixed Costs: 1. High-Low Points Method – the fixed and variable elements of the mixed costs are computed from two data points (periods)—the high and low periods as to activity level or cost driver. 2. Statistical Scattergraph Method – various costs (the dependent variable) are plotted on a vertical line (y-axis) and measurement figures (cost drivers or activity levels) are plotted on a horizontal line (x-axis). A straight line is drawn through the points and, using this line, the rate of variability and the fixed cost are computed. 3. Method of Least Squares (Regression Analysis) – mathematically determines a line of best fit or a linear regression line through a set of plotted points so that the sum of the squared deviations of each actual plotted points so that the sum of the squared deviations of each actual plotted point from the point directly above or below it on regression line is at minimum.

This method uses the following equations in computing for the values of unit variable cost and fixed cost: Equation 1: Equation 2:

∑Y = na + b∑x ∑x y = a∑x + b∑𝑥 2

COSTFORMULA: y=a+bx Where:

“y” denotes total cost. It is called the dependent variable because it is dependent on the value of another variable, the activity level x. “a” is an estimate of the fixed cost “b” s an estimate of the variable cost per unit of activity.

EXERCISES:

1. Cost drivers and functions. The list of representative cost drivers in the right column of this table are randomized with respect to the list of functions in the left column. That is, they do not match. Function

Representative Cost Driver

1. Accounting 2. Human resources 3. Data processing 4.Research and development 5. Purchasing 6. Distribution 7. Billing

A. Number of invoices sent B. Number of purchase orders C. Number of research scientists D. Hours of computer processing unit (CPU) E. Number of employees F. Number of transactions processed G. Number of deliveries made

REQUIRED: Match each function with its representative cost driver.

2. The following data have been collected for four different cost items. Cost Item W X Y Z

Cost at 100 units P6,000 P3,000 P3,000 P4,030

Cost at 120 units P6,200 P3,000 P3,600 P4,800

Which of the following classifications of these cost items by cost behavior is correct?

a. b. c. d.

Cost W

Cost X

Cost Y

Cost Z

variable mixed variable mixed

fixed fixed fixed fixed

mixed variable variable variable

variable mixed variable variable

3. Variable costs, fixed costs, relevant range. Sweetmonaman Candies manufactures tooth-breaker candies in a fully automated process. The machine that produces candies was purchased recently and can make 4,100 per month. The machine costs P9,000 and is depreciated using straight line depreciation over 10 years assuming zero residual value. Rent for the factory space and warehouse, and other fixed manufacturing overhead costs total P1,200 per month. Sweetmonman currently makes and sells 3,800 tooth-breakers per month. Sweetmonaman buys just enough materials each month to make the tooth-breakers it needs to sell. Materials cost 30 cents per toothbreaker.

Next year Sweetmonaman expects demand to increase by 100%. At this volume of materials purchased, it wilt get a 10% discount on price. Rent and other fixed manufacturing overhead costs will remain the same. REQUIRED: 1. What is Sweetmonaman’s current annual relevant range of output? 2. What is Sweetmonaman’s current annual fixed manufacturing cost within the relevant range? What is the annual variable manufacturing cost? 3. What will Sweetmonaman’s relevant range of output be next year? How if at all, will total annual fixed and variable manufacturing costs change next year? (Assume that if it needs to, Sweetmonaman could buy an identical machine at the same cost as the one it already has.) 4. Estimating a cost function, high-low method. Juan dela Cruz is examining customer- service costs in the southern region of Kuryente Products. Kuryente Products has more than 200 separate electrical products that are sold with a six-month guarantee of full repair or replacement with a new product. When a product is returned by a customer, a service report is prepared. This service report includes details of the problem and the time and cost of resolving the problem. Weekly data for the most recent 9-week period are as follows:

Week

Customer-Service Department Costs

1 2 3 4 5 6 7 8 9

REQUIRED:

Number of Service Reports

P13,700 20,900 13,000 22,000 14,000 21,500 16,900 21,000 120,000

190 275 115 395 265 455 340 305 1,764

Use the high-low method to compute thet function, relating customer-service costs the number of service reports.

5. The controller of Leon Furniture, a retail store, wants to determine the variable and fixed cost components of the company’s costs and expenses. He has prepared income statements for recent months, which he plans to use in conducting cost analysis. Sales Cost of goods sold Gross profit Operating expenses: Selling Administrative Total Profit

P80,000 48,000 P32,000

P90,000 54,000 P36,000

P 8,500 9,200 P17,700 P14,300

P 8,800 9,400 P18,200 P17,800

Required: a. Determine the fixed and variable components of cost of goods sold, selling expenses, and administrative expenses. b. Compute income if sales amount to P100,000. 6. Below is an examination of last year’s financial statements of Mickey Company. Units produced and production costs for the first four (4) months of the year, which are representative for the year, were as follows: Month January

Units 5

Total Production Costs P200

February March April

7 9 6

280 300 250

REQUIRED: 1. Using the least squares method, calculate the monthly fixed and variable components of the total production costs 2. Using the estimates made in Number 1, compute the total cost for 8 units. 7. n analysis of past janitorial costs indicates that the average janitorial cost is P3.00 per machine hour at an activity level of 20,000 machine hours and P2.40 per machine hour at an activity level of 25,000 machine hours. Assuming that this activity is within the relevant range, what is the total expected janitorial cost if the activity level is 23,000 machine hours? 8. The Monstax Company uses the high-low method to estimate the cost function. The information for 2013 is provided below: Machine-hours Highest observation of cost driver Lowest observation of cost driver

Labor Costs

300 160

P7,500 4,000

What is the total cost for 250 hours? 9. Black Forest Clinic contains 600 beds. The average occupancy rate 90% per month. In other words, an average of 90% of the clinic’s beds are occupied by patients. At this level of occupancy, the clinic’s operating costs are P25 per occupied bed per day, assuming a 30-day month. This P25 contains both variable and fixed cost elements. During April, the clinic’s occupancy rate was only 80%. A total of 0600 in operating costs was incurred during the month. REQUIRED: 1. Using the high-low method, estimate the (a ) variable cost per occupied bed on a daily basis and (b) the total fixed operating costs per month. 2. Assume an occupancy rate of 85% per month. What amount of total operating costs would you expect the clinic to incur? 10. Makina Company’s total overhead costs at various levels of activity are presented below: Month April May June July

Machine Hours 140,000 120,000 160,000 180,000

Total Overhead Cost P198,000 174,000 222,000 246,000

Assume that the total overhead costs above consist of utilities, supervisory salaries, and maintenance. The breakdown of these costs at the 120,000 machine-hour level of activity is: Utilities (V) Supervisory salaries (F) Maintenance (M) Total overhead costs V = variable; F = fixed; M = mixed

P 48,000 21,000 105,000 P174,000

Makina Company’s management wants to break down the maintenance cost into its basic variable and fixed cost elements. REQUIRED: 1. As shown above overhead costs in July amounted to P246,000. Determine how much of this consisted of maintenance cost. 2. By means of the high-low method, estimate a cost formula for maintenance. 3. Express the company’s total overhead costs in the linear equation form Y = a +bX. 4. What total overhead costs would you expect to be incurred at an operating activity level of 150,000 machine-hours?

11. The chief statistician of Aloha Company has developed the following cost formula: Y = P50,000+ 2L + 3M Where:

Y = total monthly manufacturing overhead cost L = labor hours M = machine hours

The measure of goodness of fit is good and no evidence of multicolinearity exists. The company will use 10,000 labor hours and 3,000 machine hours next month.

REQUIRED: 1. Determine the total manufacturing overhead costs that Aloha should incur next month. 2. Aloha makes a product that has P6.00 in materials costs. It requires two hours of labor time and 30 minutes of machine time. Laborers earn P10 per hour. What is the product’s per unit variable manufacturing cost? 3. Suppose that Aloha could reduce the labor time for the product described in requirement 2 by 30 minutes, to 1.50 hours. Machine time will remain the same. By how much would the per unit variable manufacturing cost fall? 12. M. Munda Company produces and sells rattan baskets. The number of units produced and the corresponding total production costs for six months, which are representatives for the year, are as follows: Month April May June July August September

Units Produced 500 700 900 600 800 550

12a. The cost function derived by the simple least squares method a. is linear. b. is curvilinear. c. is parabolic. d. must be tested for minimum and maximum points.

Production Costs P4,000 8,000 6,000 7,500 8,500 7,250

12b. Using the least squares method, the variable production cost per unit is approximately a. P 5. b. P10.

c. P0.27. d. P3.74.

12c. Using the least squares method, the monthly fixed production cost is approximately a. P 1,500. b. P18,000.

c. P 4,350. d. P52,200.

12d. If the high-low points method is used, the results when compared with those under the method of least squares, are Variable Cost Per Unit Total Fixed Costs a. Equal Equal b. Higher by P1.26 Lower by P2,850 c. Lower by P1.26 Higher by P2,850 d. Higher by P5 Lower by P1,500 13. Meemon Company manufactures and sells a single product. A partially completed schedule of the company’s total and per unit costs over the relevant range of 30,000 to 50,000 units produced and sold annually is given below: Units produced and sold Total costs: Variable costs Fixed costs Total Cost per unit: Variable Fixed cost Total

30,000

40,000

50,000

P180,000 300,000 P480,000

? ? ?

? ? ?

? ? ?

? ? ?

? ? ?

Required: a. Complete the schedule of the company’s total and unit costs above. b. Compute income, assuming that the company produces and sells 45,000 units during a year at a selling price of P16 per unit. 14. A company makes prestige high-end watches in small lots. The company has been in operation since 1990. One of the company’s products, a platinum diving watch, goes through an etching process. The company has observed etching costs as follows over the last six weeks: Week Units Total Etching Costs 1 4 P18 2 3 17 3 8 25 4 6 20 5 7 24 6 2 16 30 P120 For planning purposes, management would like to know the amount of variable etching cost per unit and the total fixed etching cost per week. Required: 1. Using the least squares regression method, estimate the variable and fixed elements of etching costs. 2. Express the cost data in (1) above in the form Y = a + bX. 3. If the company processes five (5) units next week, what would be the expected total etching cost? ***END***