Outline
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What are cost behaviour, cost estimation
and cost prediction?
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Cost drivers
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Cost behaviour patterns
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The relevant range
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Engineered, committed and discretionary
costs
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Cost estimation
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Practical issues in cost estimation
Cost Behaviour Patterns
Cost Behaviour Patterns
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•Cost behaviour Cost behaviour
-The relationship between a cost and the The relationship between a cost and the level of activity (or cost driver)level of activity (or cost driver)
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•Cost functions are equations used to describe Cost functions are equations used to describe cost behaviourscost behaviours
Variable Costs
Variable Costs
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•Variable costs Variable costs change in totalchange in total
-In direct proportion to changes in the level of In direct proportion to changes in the level of activityactivity
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•But the variable cost per unit remains constantBut the variable cost per unit remains constant
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•The variable cost function is expressed as:The variable cost function is expressed as:
Y
Y= = aa+ + bXbX
Variable Cost: Direct Material Cost for Wholemeal
Variable Cost: Direct Material Cost for Wholemeal RollsRolls
Fixed Costs
Fixed Costs
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•Fixed costs Fixed costs remain unchanged in total as the remain unchanged in total as the level of activity changeslevel of activity changes
e.g. If FC are $5,000, then if 1,000 units are
e.g. If FC are $5,000, then if 1,000 units are produced, FC per unit is 5,000/1,000 = $5.00produced, FC per unit is 5,000/1,000 = $5.00
If 2,000 units are produced, then FC per unit is
If 2,000 units are produced, then FC per unit is 5,000/2,000 = $2.505,000/2,000 = $2.50
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•But the fixed cost per unit decreases as But the fixed cost per unit decreases as activity levels increaseactivity levels increase
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•In reality very few fixed costs are truly fixedIn reality very few fixed costs are truly fixed
Fixed Cost: Premises Cost
Fixed Cost: Premises Cost
Other Cost Behaviour Patterns
Other Cost Behaviour Patterns
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•StepStep–fixed costsfixed costs
-Remain fixed over a wide range of activity levels Remain fixed over a wide range of activity levels but change outside that rangebut change outside that range
Example
Example: Step: Step–fixed costsfixed costs
If a housekeeping staff can clean no more than 10 rooms each, a
If a housekeeping staff can clean no more than 10 rooms each, a count of 51 occupied rooms would require six staff.count of 51 occupied rooms would require six staff.
If nine more guests arrive to bring the total count to 60, the number
If nine more guests arrive to bring the total count to 60, the number of housekeeping staff needed is still only six. The next guest after of housekeeping staff needed is still only six. The next guest after that will require going to the next “step”, or seven staff.that will require going to the next “step”, or seven staff.
Step
Step–Fixed Cost: Shop Managers’ SalariesFixed Cost: Shop Managers’ Salaries
Other Cost Behaviour Patterns
Other Cost Behaviour Patterns
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•SemivariableSemivariable(or mixed) costs(or mixed) costs
-Have fixed and variable componentsHave fixed and variable components
-The fixed cost element shall be a part of the cost The fixed cost element shall be a part of the cost that needs to be paid irrespective of the level of that needs to be paid irrespective of the level of activity achieved by the entity. activity achieved by the entity.
-On the other hand the variable component of the On the other hand the variable component of the cost is payable proportionate to the level of cost is payable proportionate to the level of activity.activity.
Semivariable
SemivariableCost: Cost of Operating Delivery Cost: Cost of Operating Delivery TrucksTrucks
Other Cost Behaviour Patterns
Other Cost Behaviour Patterns
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•Curvilinear costsCurvilinear costs
-Have a curved cost lineHave a curved cost line
-Activity levels impact the marginal costActivity levels impact the marginal cost
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•At lower levels of activity, there is decreasing At lower levels of activity, there is decreasing marginal costmarginal cost
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•At higher levels of activity, there is increasing At higher levels of activity, there is increasing marginal costmarginal cost
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•Costs that change with volume, but not at a Costs that change with volume, but not at a constant rate constant rate
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•TheThemarginalmarginalcostcostofofananadditionaladditionalunitunitofofoutputoutputisisthethecostcostofofthetheadditionaladditionalinputsinputsneededneededtotoproduceproducethatthatoutputoutput..
Curvilinear Cost: Electricity Cost
Curvilinear Cost: Electricity Cost
Cost Behaviour and the Relevant Range
Cost Behaviour and the Relevant Range
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•The The relevant range relevant range is the range of activity is the range of activity over which a particular cost behaviour pattern over which a particular cost behaviour pattern is assumed to be validis assumed to be valid
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•Outside the relevant range the cost behaviour Outside the relevant range the cost behaviour pattern may not holdpattern may not hold
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•The range of activity that is relevant for a The range of activity that is relevant for a particular cost estimate should be specifiedparticular cost estimate should be specified
Engineered, Committed and Discretionary Costs
Engineered, Committed and Discretionary Costs
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•Engineered costsEngineered costs
-Defined physical relationship to the level of outputDefined physical relationship to the level of output
-When level of activity is known, total cost can be When level of activity is known, total cost can be predictedpredicted
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•Committed costsCommitted costs
-Cost of organisation’s basic structure and facilitiesCost of organisation’s basic structure and facilities
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•Discretionary costsDiscretionary costs
-Management decision to spend moneyManagement decision to spend money
Shifting Cost Structures
Shifting Cost Structures
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•Increasingly, costs do not vary directly with Increasingly, costs do not vary directly with volumevolume
-Automation has led to less reliance on labour and Automation has led to less reliance on labour and more reliance on equipmentmore reliance on equipment
-Equipment costs generally do not vary with Equipment costs generally do not vary with production volumeproduction volume
-Some employee wage agreements specify fixed Some employee wage agreements specify fixed salaries and a stabilised workforcesalaries and a stabilised workforce
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