M4 Cost Behavior
DISCUSSION QUESTIONS
4-1. The purpose of this question is to move your students from thinking of fixed costs in the textbook sense to what fixed costs represent in the real world. There are many fixed costs associated with running a fast-food restaurant such as McDonald's, so your students should have no difficulty coming up with two. Some possible fixed costs include: manager's salary, building rent, depreciation on fixtures (if straight-line is used), trash removal, advertising, property taxes, insurance, cost of telephone, cost of lighting for the building, and upkeep on landscaping.
4-2. The purpose of this question is to move your students from thinking of variable costs in the textbook sense to what variable costs represent in the real world. There are many variable costs associated with running a fast-food restaurant such as McDonald's, so your students should have no difficulty coming up with two. Many of the variable costs your students may list will be various ‘raw material’ components of food items that McDonald's sells. In addition to the cost of materials in the food items, the variable costs should include direct labor. Both of these fluctuate based on the number of each item sold. Other examples are: cups, lids and straws (fluctuate based on the number of each drink sold; napkins (fluctuate based on the number of customers served); restroom supplies (fluctuate based on the number of customers); and cash register tape (fluctuate based on the number of orders entered).
NOTE: Some students many include electricity on their lists, reasoning that cooking more burgers uses more electricity and therefore causing more cost. Most of us classify electricity cost as a mixed cost that is not presented until later in the chapter. You may want to take this opportunity to reason with students about whether electricity cost would totally disappear if no burgers were cooked (as a preview of mixed cost analysis).
4-3. Additional costs that relate to the mountain climbing club party could include: decorations, party favors, a piñata, cups and paper goods for the party food, a variety of beverages, invitations, postage on the invitations, cleanup after the party, chaperones, directional signs to show guests directions to the party, and other similar costs. Of these additional costs, those classified as fixed would be decorations, a piñata, cleanup after the party, and directional signs. The costs classified as variable would include party favors, cups and paper goods, beverages, chaperones, invitations, and postage on the invitations. You may find your students categorize the cost of ‘chaperones’ as either fixed or variable costs. With any relevant range, only a certain number of chaperones may be needed. But if the number of additional guests increases, and the activity (number of guests) increases beyond the relevant range appropriate for the selected number of chaperones, more would be needed. Since the concept of relevant range has not been covered at this point in the chapter, only those students that have read ahead may bring up the concept.
4-4. Fixed costs plus variable costs equals total costs. Since the dollar amount of fixed cost is known at $525, and the variable cost per guest is known at $25, an equation can be set up to determine the number of guests that could attend the party.
Total Costs = Fixed Costs + Variable Costs
$5,500 = $525 + (25) X
X = 199 guests
Based on a budget of $5,500, a total of 199 guests could be invited to the party.
4-5. McDonald's may have various mixed costs included in its operations. Some costs are: the cost of utilities such as electricity and water, the consumption of paper towels, toilet paper and hand soap in the restrooms, the cost of labor related to after hours cleanup, cost of water used in the ice machines to make ice, cost of man hours to clean tables in the lobby, cost of uniforms supplied to additional employees needed, and various other similar activities.
4-6. For decision-making purposes, it is useful to identify the fixed and variable components of a mixed cost. This is important because increased activity will increase the total variable costs. The total dollar amount of fixed costs remains the same regardless of whether the activity levels declined or increased. In anticipating future activity levels, a manager must know how much of the cost is fixed and how much is variable in order to determine whether the total cost will increase as a result of the change in activity.
4-7. In order to estimate next year's cost, you would need to know whether the activity level is expected to increase, stay the same, or decrease. Knowing which costs are variable and fixed, i.e. mixed costs, would also help in determining the costs anticipated in the future.
4-8. Because the cost of operating the fleet of delivery vehicles is one of the company's selling costs, the sales manager is undoubtedly responsible for the budgeting and control of this cost along with the other selling costs. A sales manager may also be concerned about the cost of delivery vehicles because it may impact his commission for the period, the calculation of a related bonus, or his future as a manager with a company. The sales manager may also be concerned about whether the selling prices of the products the company sells to customers are enough to recover the costs of the product, selling and administrative expenses, and then leave a contribution to profit for the period.
4-9. Since this is a question about what your students would do personally, there is obviously no right or wrong answer. The important part is how they reason their responses. If they feel they have a solid understanding of the costs and cost behaviors involved in operating the fleet of delivery vehicles, they would likely not enlist the aid of any outside experts to help separate the costs. If, on the other hand, they were unsure of the costs and behaviors, they would seek outside assistance. The engineering approach relies on engineers or other professionals who are familiar with the technical aspects of an activity and the associated cost to analyze the situation and determine which costs are fixed and which are variable. An automotive expert can identify which costs associated with the vehicles will likely increase as a result of usage or remain constant. The expert’s industry experience and evaluations are helpful in separating the fixed and the variable components of a mixed cost. Most accountants would not likely be familiar with the technical aspects of vehicles, so consulting an automotive expert would be advantageous in learning how costs behave for vehicles.
4-10. Some variable costs associated with the cost of operating the fleet of delivery trucks would be: gasoline, oil, transmission and brake fluids, timing and fan belts, the battery, tires, windshield wipers, and certain other maintenance-type items. Some fixed costs associated with the cost of operating a fleet of delivery trucks would include: the cost of the body of the car, its paint job, interior lighting fixtures, components such as doors and windows, the seats, the headliner, and other items of this nature.
4-11. In order to calculate the expected cost of operating the fleet for the year, you must recall that total costs equal fixed costs plus variable costs. Plugging in the information provided in the example, we get:
Total costs = Fixed costs + Variable costs
X = 8 (3,000) + (.10) (8) (25,000)
X = $24,000 + $20,000
The expected cost of operating the fleet is $44,000. The cost per vehicle is $5,500 ($44,000/8 vehicles).
4-12. The maintenance cost of operating the delivery truck that is expected to be driven 25,000 miles can be calculated using the formula for mixed cost:
Total Mixed Costs=Fixed Cost Element + Variable Cost Element
Based on the example provided in the text, the fixed cost element of the maintenance cost is the point where the Y-axis is intercepted, which is $1,100. The number of miles driven at this point is zero. The variable cost per mile is already calculated at 4.7 cents per mile.
Each vehicle has a fixed cost element of $1,100. The variable cost of each vehicle is determined by multiplying the cost per mile of 4.7 cents times the 25,000 expected miles per year, giving a total of $11,750.
NOTE TO INSTRUCTOR: Should your students select alternate points on the scatter graph, the cost per mile driven will likely be different. This is an opportunity to point out that the relationship between the variables is not linear. If the pattern is identified as random, the information provided in the scatter graph will not be useful for managers to make decisions.
4-13. To determine the cost of operating a fleet of eight delivery trucks, multiply the total vehicle maintenance cost by 8. The total maintenance cost on the fleet of eight trucks is 8 times $12,850, or a total of $102,800. The calculations for the total maintenance cost for one vehicle appears in Discussion Question 4-12.
4-14. The maintenance cost for one truck using the high-low method can be calculated using the cost formula:
Total Mixed Cost = Fixed Cost Element + Variable Cost Element
The high-low method focuses on the mathematical differences between the highest and lowest observations. The example in the text determined that the fixed cost element was $1,050, and the variable cost per mile is 5 cents. Plugging these numbers into the mixed cost formula we get:
Total Mixed Cost = $1,050 + ($0.05 x 25,000) = $2,300
4-15. To determine the maintenance cost of a fleet of eight trucks, multiply 8 times the total maintenance cost of $2,300 per vehicle, for a total of $18,400.
REVIEW THE FACTS
A. Cost behavior is the reaction of costs to changes in the level of business activity.
B. Fixed costs remain constant regardless of the level of activity. As activity increases the fixed cost per unit will decrease.
C. Variable cost changes in total proportionately with changes in the level of activity.
D. Variable cost per unit does not change as the level of activity increases.-
E. The relevant range is the range of activity within which cost behavior assumptions are valid.
F. The relevant range concept applies to both fixed and variable costs.
G. A mixed cost is a cost that contains elements of both fixed and variable costs.
H. The four methods of separating a mixed costs into its fixed and variable components are the:
a. engineering approach
b. high-low method
c. scatter graphing approach
d. regression analysis approach
I. The scatter graphing method plots all of the historical data about activity and costs making it more reliable than the high-low method which uses information for only two levels of activity and cost.
J. The major flaw with the high-low method is that the two points used in the computation may not be representative of the population which will cause the results to be flawed.
K. Another name for regression analysis is the total cost formula.
L. There are computer programs available that will automatically compute and analyze the regression formula making it very easy to generate an accurate formula.
APPLY WHAT YOU HAVE LEARNED
4-16.
1. V _ Direct material
2. V _ Direct labor
3. _F _ Cost of plant security guard
4. F _ Straight-line depreciation on production equipment
5. _M_ Maintenance on production equipment
6. _M_ Maintenance on factory building
7. V _ Cost of cleaning supplies used in the factory
8. _F _ Rent on the factory building
9. _F _ Salary for the two factory supervisors
10. F _ Vice president of manufacturing’s salary
11. M/ V Cost of electricity used in the factory
12. _M_ Cost of production machine lubricants
4-17.
1. _F_ Cost of the car
2. _F_ Insurance cost (or M - Can vary depending upon Insurance Company)
3. M/ V Maintenance cost
4. _V_ Cost of gasoline
5. _F_ The cost of a college parking permit
6. _F_ AAA membership
4-18.
1. F Rent for the party hall
2. F Cost of the band
3. V Cost of cold drinks
4. V Cost of food
5. F Cost of party decorations
6. F or M Cost of renting tables and chairs
4-19.
1. F Cost of the new office building
2. V or M Basic telephone service
3. V Cost of attorney salaries
4. F Cost of the receptionist’s wages
4-20.
1. F Cost of store rent. (or M if the store has entered into a bonus rent situation)
2. F Basic telephone service
3. F Cost of salaries for the two salespeople
4. F or M Cost of advertising
5. F Cost of store displays
6. M or V Cost of electricity
7. V Cost of merchandise sold
4-21.
The accounting department finds it difficult to use the scatter diagram because this diagram does not present a very linear pattern. Without a clear linear pattern, the cost estimates used might bear little correlation to the actual cost behavior of the truck maintenance. The accounting department could derive precise calculations of the cost behavior for truck maintenance with a regression analysis. Because no one knows how to accomplish this, the accountants can use the high-low method which approximates the results obtained with regression analysis. The high-low method is a quick, easy, and low-cost method to approximate the fixed and variable cost of truck maintenance.