Learning Objective 2-7 Understand the importance of identifying an organization’s
cost increases by 20 percent also. For example, the cost of sheet metal used by Chrysler will increase by approximately 5 percent if automobile production increases by 5 percent.
The cost of napkins and other paper products used at a Chipotle Mexican Grill will increase by roughly 10 percent if the number of guests increases by 10 percent.
At Comet Computer Company, the cost management team identified direct material as a variable cost. One purchased component, a high-definition LCD display screen, costs
$100 per laptop computer manufactured. The cost behavior for this direct material cost is graphed and tabulated in Exhibit 2–9.
Panel A of Exhibit 2–9 displays a graph of this variable cost. As this graph shows, total variable cost increases proportionately with activity. When activity doubles, from 10 to 20 laptops, total variable cost doubles, from $1,000 to $2,000. However, the vari- able cost per unit remains the same as activity changes. The variable cost associated with each unit of activity is $100, whether it is the first unit, the fourth, or the eighteenth. The table in panel B of Exhibit 2–9 illustrates this point.
To summarize, as activity changes, total variable cost increases or decreases propor- tionately with the activity change, but unit variable cost remains the same.
Fixed Costs A fixed cost remains unchanged in total as the level of activity (or cost driver) varies. If activity increases or decreases by 20 percent, total fixed cost remains the same. Examples of fixed costs include depreciation of plant and equipment at a Starbucks coffee roasting facility, the cost of property taxes at a Hyatt hotel, and the salary of a sub- way train operator employed by the New York City Transit Authority.
Comet Computer Company’s cost management team identified the salary of the manager of Internet sales operations as a fixed cost. Her $150,000 annual salary does not vary with the number of units produced or sold.
This fixed cost is graphed in panel A of Exhibit 2–10.
B. Tabulation of Variable Cost
Exhibit 2–9 Variable Cost Total variable cost (LCD displays)
$3,000
$2,000
$1,000
10 20 30
Activity (or cost driver):
laptop units produced A. Graph of Total Variable Cost
Activity (or cost driver)
Variable Cost per Unit Total Variable Cost 1 ... $100 ... $ 100 4 ... 100 ... 400 18 ... 100 ... 1,800 30 ... 100 ... 3,000
C. Graph of Unit Fixed Cost Fixed cost per unit
$150,000
$100,000
$ 50,000
Activity (or cost driver):
laptop units produced
10 20 30
Exhibit 2–10 Fixed Cost
Activity (or cost driver) Variable Cost per Unit Total Fixed Cost 1 ...$150,000 ... $150,000 2 ... 75,000 ... 150,000 5 ... 30,000 ... 150,000 10 ... 15,000 ... 150,000 20 ... 7,500 ... 150,000 30 ... 5,000 ... 150,000
A. Graph of Total Fixed Cost Total fixed cost (Internet sales manager’s salary)
10 20 30
Activity (or cost driver):
laptop units produced
$150,000
B. Tabulation of Fixed Cost
From the graph in panel A of Exhibit 2–10, it is apparent that total fixed cost remains unchanged as activity changes. When activity triples, from 10 to 30 units, total fixed cost remains constant at $150,000. However, the fixed cost per unit does change as activity changes. If the activity level is only 1 unit, then the fixed cost per unit is $150,000 per unit ($150,000 ÷ 1). If the activity level is 10 units, then the fixed cost per unit declines
to $15,000 per unit ($150,000 ÷ 10). The behavior of total fixed cost and unit fixed cost is illustrated by the table in panel B of Exhibit 2–10.
Another way of viewing the change in unit fixed cost as activity changes is in a graph, as shown in panel C of Exhibit 2–10. Unit fixed cost declines steadily as activ- ity increases. Notice that the decrease in unit fixed cost when activity changes from 1 to 10 units is much larger than the decrease in unit fixed cost when activity changes from 10 to 20 units, which in turn is somewhat larger than the decrease from 20 to 30 units. Thus, the amount of the change in unit fixed cost declines as the activity level increases.
To summarize, as the activity level increases, total fixed cost remains constant but unit fixed cost declines. As you will see in subsequent chapters, it is vital in managerial account- ing to thoroughly understand the behavior of both total fixed costs and unit fixed costs.
MANAGING HEALTH CARE COSTS THROUGH COST BEHAVIOR
Health care costs occupy an ever-greater share of U.S. GDP, so an understanding of these costs takes on greater and greater importance. One area of misunderstanding is the cost behavior of health care costs: which of these costs are variable and which ones are largely fixed? According to two leading cost experts, it is a myth that most health care costs are fixed. “Many health care system participants, including economists and accountants, believe that most costs in health care are fixed because so much care is delivered using shared staff, space and equipment. The result of this misguided thinking is that cost reduc- tion efforts tend to focus on only the small fraction of costs seen as variable.” But a focus only on the costs that are clearly variable, such as drugs and supplies, cannot make enough headway in solving the overall cost management problem in health care.
A careful analysis of costs reveals that personnel costs, which account for at least 50 percent of health care costs, are only fixed in the short run and might be more produc- tively viewed as variable over a longer term of management. “Hospital executives can set the quantity, mix and compensation of their employees each year. Personnel costs are fixed only when executives allow them to be.” Another prominent health care cost is space, and according to these two cost experts space costs also are fixed only over a short to medium horizon. “If demand for space is reduced, units can be consolidated into smaller space, and excess space can be repurposed, sold, or subleased. Similarly, equipment costs can be avoided if changes in processes, treatment protocols, or patient mix eliminate the demand for the resources.”6
The controversial Affordable Care Act (ACA), which has as its goal to extend the reach of health care in the United States while reducing its total cost and improving outcomes, includes many elements intended to shift cost behavior. For example, the ACA originally mandated that everyone have some form of private health insurance, either through employer-provided insurance or by buying individual insurance. One purpose of that requirement was to reduce emergency room visits by individuals lacking health insurance, shifting high-cost-per-visit emergency room treatment to less-costly office visits, a reduc- tion in unit variable cost. However, the so-called “individual mandate” was repealed by Con- gress as part of the Tax Cuts and Jobs Act of 2017.
The ACA also includes an initiative called Bundled Payments for Care Improvement wherein all of the various treatments related to a particular episode of care are paid for at a flat payment rate. Today, if an athlete hurts his knee, there are separate bills for orthope- dists, anesthesiologists, nurses, physical therapists, and so forth. Under bundled payments,
6Robert S. Kaplan and Michael E. Porter, “How to Solve the Crisis in Health Care,” Harvard Business Review, September 2011, p. 60.
(continues) e t y e
, g - s h
The Ongoing Debate Over the Affordable Care Act
anagement ccounting ractice
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