Chapter 3 Reading

LO1 Define and describe fixed, variable, and mixed costs Variable costs change in total as activity usage changes - Usually, variable costs increase in total in direct proportion to increases in activity output - Fixed costs don’t change in total as activity output changes - Mixed costs have both a variable and a fixed component - LO2 Explain the use of resources and activities and their relationship to cost behavior Flexible resources are acquired as used and needed Flexible resources have no excess capacity for these resources ○ They're usually considered to be variable costs ○ - Committed resources are acquired in advance of usage May have excess capacity ○ Frequently considered fixed ○ Can be discretionary or nondiscretionary ○ - Step costs are acquired in lumpy amounts Narrow steps approximated by a variable cost function ○ Wide steps approximated as fixed ○ - LO3 Explain how several methods of cost estimation can be used The industrial engineering method uses physical observation and analysis to determine what activities in what amounts are needed to complete a process Time and motion studies may be used ○ Typically expensive and seldom updated ○ - Account analysis requires the accountant to classify accounts as either fixed or variable Frequently used in practice ○ Gives good results if accounts are primarily fixed costs or variable costs ○ Average account values and average driver values are used to calculate fixed costs and variable rates ○ - LO4 Separate mixed costs into their fixed and variable components using the high-low method, the scatterplot method, and the method of least squares High-low method uses the high and the low data points to form a straight line Slope is variable rate ○ Intercept is fixed cost ○ Advantages: objective and easy ○ Disadvantage: nonrepresentative high or low point leads to misestimated cost function ○ - Scatterplot method plots data—two points chosen to determine a line Intercept is fixed cost ○ Slope is variable rate ○ Advantages: identify nonlinearity, outliers, shifts in the cost relationship ○ Disadvantage: subjectivity ○ - OLS (regression) produces a best-fitting line. - LO5 Evaluate the reliability of the cost formula Coefficient of correlation shows degree to which two variables move together Perfect positive correlation is 1.0 ○ Perfect negative correlation is –1.0 ○ - Coefficient of determination shows amount of cost variability explained by driver 0 ≤ R 2 ≤ 1.0 ○ Often multiplied by 100 and used as percent ○ - Smaller standard errors of estimate indicate better goodness of fit. - Chapter 3-9a: Summary of Learning Objectives Saturday, November 4, 2023 10:20 PM Week 1 Page 1