Thursday, December 07, 2006

Management accounting - chapter 3

Measurement of cost behavior -- understanding and quantifying how activities of an organization affect its levels of costs
linear cost behavior -- activity that can be graphed with a straight line because costs are soon to be either fixed or variable
step costs -- costs that changed abruptly at intervals of activity because the resources and their cost come in indivisible chunks
mixed costs -- cost that contained elements of both fixed and variable cost behavior
capacity costs -- the fixed costs of being able to achieve a desired level of production or to provide a desired level of service while maintaining product or service attributes, such as quality
committed fixed costs -- costs arising from possession of facilities, equipment, and a basic organization
discretionary fixed costs -- cost determined by management as part of the periodic planning process in order to meet the organization's goals. They have no obvious relationship with levels of capacity or output activity
cost measurement -- estimating or predicting costs as a function of appropriate cost drivers
cost function -- an algebraic equation used by managers to describe the relationship between a cost and its drivers
activity analysis -- the process of identifying appropriate cost drivers and their effects on the costs of making a product or providing a service
engineering analysis -- the systematic review of materials, supplies, labor, support services, and facilities needed for products and services; measuring cost behavior according to what costs should be, not by what costs have been
account analysis -- selecting a plausible cost driver and classifying each account as a variable cost or as a fixed costs
high-low method -- a simple method for measuring a linear cost function from past cost data, focusing on the highest activity and lowest activity points and fitting a line through these two points
visual fit method -- a method in which the cost analyst visually fits a straight line through a plot of all the available data
least squares regression (regression analysis) -- measuring a cost function objectively by using statistics to fit a cost function to all the data
coefficient of determination -- a measurement of how much of the fluctuation of a cost is explained by changes in the cost driver

Step and mixed cost behaviors.
Cost behavior refers to how cost changed as levels of an organization's activities change. Costs can behave as the fixed, variable, step, or mixed costs. Step and mixed costs both combine aspects of variable and fixed cost behavior. Step costs for graphs that look like stats. Costs will remain fixed within a given range of activity or cost driver level, but then will rise or fall abruptly when the cost driver level is outside this range. Mixed costs involved a fixed element and a variable element of cost behavior. Unlike step costs, mix costs have a single fixed costs at all levels of activity, and in addition have a variable cost element that increases proportionately with activity.

Management influences on cost behavior.
Managers can affect the costs and cost behavior patterns of their companies through the decisions they make. Decisions on product and service features, capacity, technology, and cost control incentives, for example, can all affect cost behavior.

Cost functions, prediction costs.
The first step in estimating or predicting costs is measuring cost behavior. This is done by finding a cost function. This is an algebraic equation that describes the relationship between a cost in its drivers. To be useful for decision-making purposes, cost functions should be plausible and reliable.

Activity analysis for measuring cost functions.
Activity analysis is the process of identifying the best cost drivers to use for cost estimation and prediction in determining how they affect the costs of making a product or service. This is an essential step in understanding and predicting costs.

Once analysts have identified cost drivers, they can use one of several methods to determine the cost function. Engineering analysis focuses on what the costs should be by systematically reviewing the materials, supplies, labor, support services, and facilities needed for a given level of production. Account analysis involves examining all accounts in terms of an appropriate cost driver and classifying each account as either fixed or variable with respect to the driver. The cost function consists of the variable cost per cost driver unit multiplied by the amount of the cost driver plus the total fixed cost. The high-low, visual-fit, and least-squares methods all use historical costs to determine cost functions. Of these three methods, high-low is the easiest, although least-squares is the most reliable.