Managerial accounting 2nd edition whitecotton solutions manual 1

Chapter 05 - Cost Behavior

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Chapter 5 Cost Behavior ANSWERS TO QUESTIONS 1. Variable costs are those that change, in total, in direct proportion to the activity level. Direct materials are an example of a variable cost.

Fixed costs are constant, in total, regardless of activity level. Factory rent is a fixed cost.

Step costs are fixed across a range of activity, then increase in a step-like fashion when a capacity constraint is reached. An example would be the cost of a machine that can produce a limited number of units per day. To produce more units, an additional machine must be leased or purchased, which will increase fixed costs by a lump sum amount.

Mixed costs have a fixed component that will be incurred regardless of activity, plus a variable cost that increases with activity. An example would be a phone bill that has a fixed amount per month, plus a per minute charge based on usage.

5-1 © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 05 - Cost Behavior

2. When activity level decreases: a. Total fixed costs remain the same. b. Total variable costs decrease proportionately. c. Total mixed costs decease. d. Fixed cost per unit increase. e. Variable cost per unit remains the same. f. Mixed cost per unit increases.

3. The relevant range is the range of activity over which assumptions about cost behavior are expected to hold true. It is important to understand the relevant range because our assumptions and conclusions may not hold outside of that range, which may lead to faulty decisions.

4. y represents total cost. a represents total fixed costs. b represents the variable cost per unit of X. x represents the activity driver.

5. A scattergraph shows the relationship between total cost and a measure of activity.

It allows one to determine if the linear assumption is valid and whether there are any unusual patterns in the data, such as outliers. It also can give the user information about the appropriateness of the relevant range that’s been set.

5-2 © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 05 - Cost Behavior

6. There are three linear approaches to analyzing mixed costs: • •

•

A scattergraph is very easy to prepare and gives users a visual image of the relationship between total cost and some activity driver. However, scattergraphs do not provide precise estimates of the relationship between cost and activity.

The high-low method is relatively easy to compute and only requires two data points. However, the resulting cost equation may not be representative of the true relationship between cost and activity, and can be easily influenced by outliers.

Regression analysis is generally the most accurate method for analyzing mixed costs. It incorporates more data points than the high-low method, and thus may better represent the relationship between cost and activity. However, you must have a basic level of statistical knowledge to interpret and use the regression results.

The three methods are unlikely to provide identical results, although the results may be similar if the linearity assumption is valid and if the high and low data points are representative of the overall relationship between total cost and activity.

7. R-square is a goodness of fit measure that tells managers how much of the variability in the y variable (total cost) is explained by the x variable (customers served). The closer the R-square value is to 1, the more accurate and reliable the analysis.

8. A contribution margin income statement is more useful because it separates costs into fixed and variable components. This allows managers to predict how these costs will change in the future, depending on different decisions that may be made.

It is generally better for making internal managerial decisions than a financial statement aimed at external users.

9. Contribution margin can be calculated in total, per unit, or as a percentage of sales: •

Total contribution margin is calculated as total sales revenue less total variable costs. It indicates the total amount available to cover total fixed costs, with the remainder becoming operating profit.

•

Contribution margin per unit is calculated as the unit sales price less variable cost per unit. It indicates how much each unit contributes toward fixed cost and operating profit.

•

Contribution margin ratio (%) is calculated by dividing total or per unit contribution margin by total or per unit sales revenue. It indicates the percentage of sales revenue that is available to cover fixed costs, with the remainder becoming operating profit.

5-3 © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 05 - Cost Behavior

10. When activity levels increase: a. b. c. d. e.

Contribution margin per unit remains the same.

Contribution margin ratio remains the same.

Total contribution margin increases.

Total fixed cost remains the same.

Profit increases (so long as the contribution margin is positive).

11. Full absorption costing classifies costs based on whether they are related to

manufacturing or non-manufacturing activities, while variable costing separates costs based on whether they are fixed or variable. A variable costing statement is generally more useful for making internal managerial decisions because it allows managers to predict how total costs and profits will change as a result of specific decisions. However, variable costing cannot be used for external reporting (GAAP).

12. The item treated differently is fixed manufacturing overhead. Full absorption costing

(GAAP) requires that all manufacturing costs be treated as product cost, which means that fixed manufacturing overhead cost will be included in either cost of goods sold or inventory, depending on whether the product has been sold. Variable costing deducts all fixed costs, including fixed manufacturing overhead, during the period they are incurred.

13. The two methods will show the same income if a company sells all the units

produced. They will yield different income if ending inventory changes because absorption costing attaches all manufacturing costs, including fixed manufacturing overhead, to the units produced, even if the units are not yet sold.

14. When a company produces more units than it sells (i.e., finished goods inventory

increases), full absorption costing will show a higher profit than variable costing.

When a company produces fewer units than it sells (i.e., finished goods inventory decreases), full absorption costing will show a lower profit than variable costing.

5-4 © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

Chapter 05 - Cost Behavior

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5-5 © 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.

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