© Costs and expenses = Technically, costs are those incurred in producing or obtaining resources. These expenditures relate to the transaction between the company and its suppliers. = Expenses are those incurred in administering and selling goods and services. These expenditures relate to the transaction between the company and its customers and those incurred in the administrative services. = Costs and expenses give benefits to the firm while losses do not. = In this chapter, the term cost includes costs and expenses. © Costs classification = Relevant and irrelevant costs. Relevant costs are those used in decision- making. To be relevant, a cost should be differential and deals with the future. Past costs, or sunk costs, are always irrelevant. = Controllable. and non-controliable. costs. Controllable costs are those. which incurrence or non-incurrence is influenced or controlled by a given manager. = Direct product costs. and non-product costs. Direct product costs are those physically identified with the finished product (e.g., direct materials) or where the incurrence of the costs could be operationally identified while the product is undergoing the conversion process (e.g., direct labor). Factory overhead, both variable and fixed, are indirect product costs. = Direct departmental and indirect departmental costs. Direct department casts are those that could be operationally identified with the department. That is, when the department is closed, the cost is avoided. indirect department costs are not operationally identified with a department, and are sometimes referred to as allocated costs or unavaidable costs. = Opportunity and imputed costs. Opportunity costs are those benefits sacrificed in favor of the alternative chosen. Imputed costs are those avoided costs in favor of the alternative chosen. Both are theoretical, not recorded in the accounting books, but are relevant in making decisions. = Qut-of-pocket and non-cash costs. Out-of-pocket costs (or out-of-pocket ). are those that need to be paid in cash. = Sunk and future costs. Sunk costs are those past, histori irrelevant costs. Future costs are estimated, Prema, ae budgeted, or applied costs. Future costs are not always relevant. : * Common and joint costs. Common costs are those incurred by ail organizational departments or segments. Joint costs are those incurredthe same time and in producing goods or services in the same process ee. Cciflcoue are which cannot be individually identified with t aie allocated among the products for costing purp i “incremental cone = Incremental, decremental and marginal costs. tienes in cost per unit total increases in costs while marginal cost is an int Decremental costs are total decreases in costs. = Variable costs and fixed costs © Variable and fixed costs = Variable costs 4 © Total variable-costs change in direct and perfect relation to i change in units. It does not change in relation to a change in unit sal e8 price. © Unit variable cost remains constant regardless of a change in units and unit sales price. = Examples of variable costs aré direct materials, direct labor (if paid by the. hour or unit), variable overhead (such as indirect materials, indirect labor, factory supplies, repairs, etc.), and variable expenses (such as delivery expense, salesmen’s commissions, gas and oil, etc.). =» Fixed costs = The fixed costs referred to here are the committed fixed costs. © Total fixed costs do not change in relation to a change in units and unit sales price. © Unit fixed cost changes inversely in relation to a change in units. Unit fixed costs decreases as units increase, and it increases as units decreases. Unit fixed cost does not change in relation to unit sales price. © Examples of fixed costs are depreciation (computed on a straight-line basis), rent, insurance, interest, executive salaries, advertising, research, and executive training. © Relevant range and learning curve theory = The behavior of costs is predictable within a relevant range. = Relevant range is a band of activity (or stretch of activities) where the behavior of costs, expenses and revenues is valid. That is, total fixed Cost is constant and total variable cost changes. : - oa range is short-term in nature. conomists and management practitioners know i really behave linearly in the long-run that sales and costs do 'e long run, sales inch up slowly until it break: i : Ss ti el are ere ary up in the succeeding ean el c as inspired by a well-fuelled promotional activitie ight ere ae Later on, sales decline as the product roaches tha level m acceptance and maturity (e.g., law of diminishing return).Now comes the importance of technology and innovations to repackage the product and spur an upswing trend in sales (e.g., creative and innovative management). And the process continues, sales go up, mature, decline or move up anew. . = The behavior of total costs is affected by the learning curve theory. This theory states that total costs increase dramatically in the initial years of business or product operations where people, systems, and processes perform inefficiently during which time people and processes gain knowledge and experience. in these initial and learning years, the average cost is comparatively high. As years move on and experience is gained, efficiency pays off and productivity heightens. This means lower cost per unit of output, and a competitive advantage. As production continues people get tired, machines need more maintenance, and new technology learned and adapted, total costs start to move up once more. And the cost per unit increases. However, the virtue of learning comes in and will curb down costs anew. And so the process continues. = The learning curve theory is related to the 80-20 rule or Pareto's law. Applied in business, It says that productivity rate increases by an average of 20% each time an activity is performed twice. In general, productivity fate improves in the vicinity of 65% - 85% as production volume doubles until such time that the best performance is attained. = The learning curve resembles that of the “law of diminishing returns” and “product life cycle”. © Classification of mixed costs = Mixed costs are those that contain both the fixed and variable elements. = Mixed costs may be classified as semi-variable costs, semi-fixed costs, and step costs. = Examples of mixed costs are electricity, inspection, inter-department services, water and sewages, maintenance and repairs, employer contributions to government agencies, and industrial relations expenses. © Costs segregation techniques = Mixed costs may be segregated using the following techniques adopted from the field of statistics: © High-low method (e., two-point analysis, or range analysis) © Scattergraph method (or regression line analysis) © Least-squares method © High-low method = This method is based on the premise that a change in costs is attributed to the change in variable cost, fixed costs being assumed to be constant. = In segregating the costs, the variable cost rate and total fixed costs are of importance, and are determined as follows:An Costs / A in Sales ® Variable cost ratio = Coats / 4 in Unit base = Ain where: = hours, A = change : ine hours, direct labor hours, Unit base = may Ddtobad pres bases of estimating variable lirect lat a costs = le costs Fixed costs = Total costs — Variabl a . whore: Variable costs = Variable cost rate x Ba! © Scattergraph method : i Ituses the regression equation Y = a+ bx, wi f A Y = dependent variable, the value of which is to be determined a = constant, or point of intercept b = constant coefficient of x, orthe slope a x = independent variable, the value of which is normally available * This equation is a perfect resemblance of total costs where: tee = a+ bx Then: FC + VC TC = FC + (UCM) Units sold Relating, we have: Y = Total cost a = Fixed cost b = variable cost rate = no. of units sold (or other basis) In using this model in segregating fixed and variable elements of costs, the following steps are followed: a. Draw the x (horizontal) and y (vertical) axes in the graph. Scale the axes. b. Plot the observed data on the graph. ©. Determine the behavior of the plotted observations on the graph. d. Draw a straight line in the middle of the Plotted observation following i depicted relationship between “x” and “y’, where the differences of @ points above the line is equal to the diff y i beeuineie ferences of the points @. The point of origin (or Point of intercept) is the f OF i value of “a”, Compute “b" by choosing two “y “ values as Y' and Y? Get the : corresponding values of X’ and X?, ; "he value of “b" equals the diffe i “y" divi thefiserce hina Z shall in the values of “y" divided by h. Assign the computed a equation, puted values of “a” and “py in the regression line© Least-squares method : = The least squares method extends the analysis of the basic regression equation by finding the SY and IXY . This brings us to two more regression equations, as follows: Equation 1. Y= a +bx Equation 2. LY na + byx Equation 3. =XY = Dxa + bx? = To compute for “b", the unknown variable “a” should first be eliminated using the second and third equations. ~ Once, the value of “b” is determined, the value of “a” is computed next by the process of substitution. STRAIGHT PROBLEMS 1. High-low method. The Lamesa Corporation builds tabletop replicas of some of the most famous resorts in the Philippines. The company is highly automated, and thus, maintenance cost is a significant organizational expense. The company’s owner has decided to use machine hours as a basis of predicting maintenance costs and has gathered the following data from the prior 8 weeks of operations: Number of — Maintenance Number of Maintenance Week machine hours costs Week machine hours costs 1 3,000 P 9,800 5 9,000 24,800 2 4,500 12,900 6 3,500 10,400 3 8,000 18,100 7 5,500 13,000 4 6,000 13,500 8 7,000 16,000 Required: a. Variable cost rate. b. Total fixed costs. c. If the company expects to use 8,200 machine hours next month, how much is the estimated maintenance costs. SOLUTION GUIDE a_ The highest value is found in week no. 5 while the lowest value is registered in week no. 1. The highest and lowest observation are tabulated below and their differences taken as follows Machine hours Costs Highest 9,000 P24,800 Lowest 3,000 9,800 Change §,000 15,000 Variable cost rate = P15,000/ 6,000 MH = P2.50/MHoe b. Computation of fixea costs Highest Lowest 24,800 ; 0 x P2.59) Total costs P24, 7 (3,000 x - ‘Variable costs (P9,000 x P2.50)_22,500 aoe Fixed costs P.2,300 P c. Total variable costs (8,200 MH x P2.50) ee Fixed costs 43 Total costs 2t 8,200 MH 22,800 2. Scattergraph. Lorelai Delivers, Inc., manufactures a Hee eua ee commercial operations. The firm has encountered a probl lem Bhai ft expense. The expense is apparently a mixed cost and varies mo: ly machine hours. The following data have been gathered from recent operations and may help you describe the relationship. Machine Utilities Machine Utilities Month Hours Expense ‘Month Hours Expense January 1,500 P 9,000 June 1,000 P 7,000 February 1,750 9,500 July 2,000 13,000 March 2,000 11,000 August >.500 12,000 April 1,500 10,000 Sept 2,000 10,000 May 2,500 14,000 October 2,250 12,000 Required: Using the Scattergraph method, a. + Plot the observations on the graph wh 'ere the vertical line denotes t is and the horizontal line denotes the units. ea, * Draw the fegression line at the middie of the points lotted depicting the relationship of utilities expense and machine aie sreen * Determine the total fixed costs. * Calculate the Utilities expen; bd. ifthe company i : nates the number of machine hours What is the estimated total utlities costs? "© Feach 2,200 next month, variable cost per unit usi 2 Per unit using the P8,000 and 12,000 levels of2. SOLUTION GUIDE (graph in thousands) (a) Amount Y=ar+bx ry AY 0 X% X AX The equation Y = a + bx may be interpreted as TC = FC + VC, where a = FC, b = VCrate, and X as the activity driver. From the graph, we could discern that a= 3,750. To solve for “b’, we have: a Y; = P12,000 X, = 2,600 Y2 = P 8,000 X2 = 1,300 b = AY/AX = (P12,000 — P8,000) / (2,600 - 1,300) b = P4,000/ 1,300 b = 3.08 Therefore: Y’ = a +bx Y' = 3,750 + 3.08X 3,750 + 3.08X 3,750 + (3.08) 2,200 10,526Units: Totat Units Total Produced Cost Quarters Produced © Cost Quarters. FTO P 19,000 ot 800 —P27,000 coo 24,000 02 500 20.000 05 900 29,000 03 4,000 31,000 Harel ate the variable cost rate and the tota fixed costs elements of the glazing process. ; b. Express the cost data in “a” a Phe form Y= nae quarter, how much.is ©. Assume, the company processes 1,120 units in the the expected glazing cost? 3. SOLUTION GUIDE a x Y 800 P27,000 500 20,000 1,000 31,000 400 19,000 600 24,000 200 29,000 4.200 10,000 n=6 Factor to eliminate “a” = 4,200/6 = 700 or -700 LY = na + brx { 150,000 = 6a + b4,200 } -700 IXY = dxa + bd? ee 110,700,000 = 4,; + 63,220,000 105, 000 = me 5,700,000 = +b 280,000 b = 2036 To-compute for the value of “a”: 150,000 = 6a + b4,200 150,000 = Ga + (20.36) 4,200 150,000 = 6a + 85,512 a = 64,488/6 a = 10,748 ib. Y = 10,748 + 20.36x | % Total costs = 710,748 + 20.36 (1,120) = paa.s51