On the Internet, access the SEC home page, via the chapter web links at the Interac- tive Study Center at http://www.thomsonedu.com/accounting/hansen. Next, access the EDGAR database. Obtain copies of financial statements for a manufacturing firm and a service firm (e.g., Texas InstrumentsandChase Manhattan Bank). Write a memo discussing the differences and similarities of the two statements.
Interview an accountant who works for a manufacturing or service firm (preferably one who works in cost accounting). Ask that person the following questions, and write up his or her responses:
a. What product(s) does your firm produce?
b. What costs are assigned to the product(s) produced?
c. For a particular product, what direct materials are used?
d. What percentage of total manufacturing costs is direct labor? Direct materials?
Overhead?
e. How is overhead assigned to the products?
f. Do you now use or plan to use an activity-based management system? Why or why not?
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Cybercase LO1, LO2, LO3
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Research Assignment LO1, LO2, LO4
PART 2
Activity-Based Accounting
Chapter 3: Activity Cost Behavior
Chapter 4: Activity-Based Product Costing
Chapter 5: Activity-Based Management
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Activity Cost Behavior
l e a r n i n g o b j e c t i v e s
After studying this chapter, you should be able to:
1. Define cost behavior for fixed, variable, and mixed costs.
2. Explain the role of the resource usage model in understanding cost behavior.
3. Separate mixed costs into their fixed and variable components using the high-low method, the scatterplot method, and the method of least squares.
4. Evaluate the reliability of a cost equation.
5. Discuss the role of multiple regression in assessing cost behavior.
6. Describe the use of managerial judgment in determining cost behavior.
chapter 3
Scenario
1 Activity-based accounting promises a better understanding of costs, increased accuracy in costing assignments, and an increase in economic efficiency. How these promises can be realized is explored in the next three chapters.
Reddy Heaters, a producer of insert heaters for coffeepots, had recently begun the imple- mentation of an activity-based costing system.
Jamie Weathers, CEO, appointed Rick Ander- son to head up a team to examine the feasi- bility of simultaneously implementing an activity-based budgeting (ABB) system. Rick Anderson began searching for experiences of others who had experimented with ABB and came across an article discussing the experi- ence of Scottish Courage Brewing.1He first discovered that Scottish Courage Brewing was a pioneer of ABB in the United Kingdom.
Next, he noted that a key factor in the devel- opment of the ABB system was the identifica- tion of activities, resources, and the relation- ship between activities and resources as the volume of activity changed. Scottish Courage Brewingassumedthat a linear relationship existed between measures of activity con- sumption and resources. Based on this assump- tion, the ABB model predicted that activity cost would change as the activity volume changed. In reality, many activity costs did not follow a linear relationship but instead fol- lowed a stepped path. Consequently, Scottish Courage Brewing had significant difficulties with managing costs because the underlying actual cost behavior was more complicated than the simple assumed variable relationship.
After reading of this experience, Rick real- ized that managing costs and improving effi- ciency required an understanding of how the costs of activities change as activity output changes. To drive this home to the members of his team, he had the team carefully study the cost behavior of a rework activity. They discovered that when a bad product is detected, it is analyzed to determine the problem and then reworked so that the product functions as it should. Some costs, such as depreciation on the equipment used and supervision, do
not change as the number of reworked prod- ucts increases. Other costs, such as materials and power, do increase with the number of units reworked. However, some costs will change only with fairly large changes in activ- ity output.
Rick began to realize that knowing how cost behaves was vital information. If, for example, some costs of the rework activity vary with the number of units reworked, then these costs can be managed by reducing the number of reworked units. Finding ways to reduce the number of defective units will allow the cost of the rework activity to decrease, increasing overall efficiency. On the other hand, some rework costs may be more fixed in nature and reduction of these costs may only follow step reductions in the number of units reworked.
Q u e s t i o n s t o T h i n k A b o u t
1. Suppose that the division reduces the demand for the rework activity. Will resource spending be reduced by the same proportion for this activity? Is there a dif- ference between resource spending and resource usage?
2. Suppose the total cost of rework activity and the total number of units reworked are known. Given this information, is it possible to determine how much of this total cost is variable? How much is fixed?
Is knowing fixed- and variable-cost behav- ior important?
3. What role does management play in deter- mining cost behavior?
4. Can you think of reasons other than those suggested by the scenario that make it important for managers to understand cost behavior?