CHAPTER LEARNING OBJECTIVES

Chapter 2 Cost Behavior and Cost Estimation Summary of Questions by Objectives and Bloom’s Taxonomy

CHAPTER LEARNING OBJECTIVES

• Identify basic cost behavior patterns and explain how changes in activity

level affect total cost and unit cost. (Unit 2.1) The two basic cost behavior patterns are variable and fixed. Costs that are a combination of these two basic patterns are referred to as mixed. The following table shows how these costs change with changes in activity.

As Activity Increases As Activity Decreases Cost Behavior Total Cost Cost per Unit Total Cost Cost per Unit Variable Increases Remains constant Decreases Remains constant Fixed Remains constant Decreases Remains constant Increases Mixed increases decreases decreases increases

• Estimate a cost equation from a set of cost data and predict future total

cost from that equation. (Unit 2.2) Total cost can be expressed in the form y=mx+b, where y is the total cost, m is the variable cost per unit, x is the number of units, and b is the total fixed cost. Given a set of costs and activity levels, you can estimate a cost equation using one of the following

methods: scattergraph, high-low, or regression.

• Prepare a contribution format income statement. (Unit 2.3)

A contribution format income statement is an income statement that categorizes

expenses by their behavior. It follows the structure:

Sales revenue – variable expenses = contribution margin Contribution margin – Fixed Expenses = Operating income

Besides showing total sales revenue and expenses, the contribution format statement should also show per unit amounts for sales revenue, variable expenses, and contribution margin.

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Chapter 2 – Cost Behavior and Cost Estimation

TRUE-FALSE STATEMENTS

• A variable cost is one that varies in proportion to a business activity.

Unit 2-1 – True LO: 1, Bloom: K, Unit: 2-1, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and

Decision Making, IMA: Cost Management

• With a variable cost, as the level of activity decreases, the total cost remains the same.

Unit 2-1 – False – With a variable cost, as the level of activity decreases, the total cost decreases by the same proportion.LO: 1, Bloom: C, Unit: 2-1, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving

and Decision Making, IMA: Cost Management

• A fixed cost is a cost that does not change in total with the activity level.

Unit 2-1 – True LO: 1, Bloom: K, Unit: 2-1, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and

Decision Making, IMA: Cost Management

• With a fixed cost, the cost per unit varies proportionately with changes in the level of activity.

Unit 2-1 – False – With a fixed cost, the cost per unit varies inversely with changes in the level of activity.LO: 1, Bloom: C, Unit: 2-1, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving

and Decision Making, IMA: Cost Management

• Discretionary fixed costs are fixed costs that cannot be changed over the short run.

Unit 2-1 – False – Discretionary fixed costs are fixed costs that can be changed over the short run.LO: 1, Bloom: K, Unit: 2-1, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and

Decision Making, IMA: Cost Management

• An example of a committed fixed cost is when a company signs a 10-year lease on an office building.

Unit 2-1 – True LO: 1, Bloom: AP, Unit: 2-1, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and

Decision Making, IMA: Cost Management

• A committed fixed cost is one that cannot be changed over the short run.

Unit 2-1 – True LO: 1, Bloom: K, Unit: 2-1, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and

Decision Making, IMA: Cost Management

• Companies should reduce fixed costs whenever possible during times of falling profits.

Unit 2-1 – False – Companies should be careful about reducing their discretionary fixed costs during times of falling profits. For example, reducing advertising is likely to reduce sales further, exacerbating the problem of falling profits.LO: 1, Bloom: C, Unit: 2-1, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving

and Decision Making, IMA: Cost Management

• Step costs are fixed over only a small range of activity.

Unit 2-1 – True LO: 1, Bloom: K, Unit: 2-1, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and

Decision Making, IMA: Cost Management

• All costs are either fixed or variable. That is, a cost cannot have a fixed and a variable component.

Unit 2-1 – False – Some costs have both a fixed and a variable component. These costs are referred to as a mixed cost.LO: 1, Bloom: C, Unit: 2-1, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving

and Decision Making, IMA: Cost Management

• Since a mixed cost has both a fixed and a variable component, both the total cost and the unit cost

will vary with changes in the level of activity.Unit 2-1 – True LO: 1, Bloom: K, Unit: 2-1, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and

Decision Making, IMA: Cost Management

• An example of a step cost is the natural gas bill you receive for heating your apartment.

Unit 2-1 – False – Your natural gas bill would be an example of a mixed cost. The base charge would be fixed and the additional charge per cubic foot of gas would be variable.LO: 1, Bloom: AP, Unit: 2-1, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving

and Decision Making, IMA: Cost Management

• Once you know how a particular cost behaves, estimating the total cost is relatively simple.

Unit 2-2 – True LO: 2, Bloom: K, Unit: 2-2, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and

Decision Making, IMA: Cost Management

• Three methods used for estimating the fixed and variable portions of a cost include: cost-cover

graphs, the high-low method and regression analysis.Unit 2-2 – False – Three methods used for estimating the fixed and variable portions of a cost include scattergraphs, the high-low method and regression analysis.LO: 2, Bloom: K, Unit: 2-2, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving

and Decision Making, IMA: Cost Management

• A scattergraph is simply a graph that shows total costs in relation to volume, or activity level.

Unit 2-2 – True LO: 2, Bloom: K, Unit: 2-2, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and

Decision Making, IMA: Cost Management

• The high-low method of estimating the fixed and variable components of a mixed cost is a precise

approach that uses a statistical technique.Unit 2-2 – False – The high-low method is a “quick and dirty” method. It does not use a statistical technique.LO: 2, Bloom: C, Unit: 2-2, Difficulty: Difficult, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and

Decision Making, IMA: Cost Management

• Unlike the scattergraph, the high-low method requires only two data points – the lowest point of

activity and the highest point of activity.Unit 2-2 – True LO: 2, Bloom: K, Unit: 2-2, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving

and Decision Making, IMA: Cost Management

• To estimate total cost using the high-low method, identify the highest and lowest level of activity

and compute the slope of the line.Unit 2-2 – True LO: 2, Bloom: C, Unit: 2-2, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving

and Decision Making, IMA: Cost Management

• Regression is a more precise method of estimating the fixed and variable components of a mixed

cost than the high-low method or a scattergraph.Unit 2-2 – True LO: 2, Bloom: C, Unit: 2-2, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving

and Decision Making, IMA: Cost Management

• Like the high-low method of estimating the fixed and variable components of a mixed cost,

regression analysis uses a statistical technique that identifies the line of best fit.Unit 2-2 – False – The high-low method is not a statistical technique.LO: 2, Bloom: C, Unit: 2-2, Difficulty: Difficult, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and

Decision Making, IMA: Cost Management

• Cost behaviors and estimates are valid only within what is referred to as a precision range.

Unit 2-2 – False – Cost behaviors and estimates are valid only within a relevant range.LO: 2, Bloom: K, Unit: 2-2, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving

and Decision Making, IMA: Cost Management

• The relevant range is the normal level of operating activity.

Unit 2-2 – True LO: 2, Bloom: K, Unit: 2-2, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and

Decision Making, IMA: Cost Management

• Operating income = Sales revenue – Variable cost per unit – Total fixed costs.

Unit 2-3 – False – Operating income = Sales revenue – Total variable costs – Total fixed costs.LO: 3, Bloom: K, Unit: 2-3, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving

and Decision Making, IMA: Cost Management

• A basic tool for making business decisions is the contribution margin.

Unit 2-3 – True LO: 3, Bloom: K, Unit: 2-3, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and

Decision Making, IMA: Cost Management

• The contribution margin is the difference between sales and fixed costs.

Unit 2-3 – False – The contribution margin is the difference between sales and variable costs.LO: 3, Bloom: C, Unit: 2-3, Difficulty: Moderate, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving

and Decision Making, IMA: Cost Management

• Contribution margin is the amount of revenue that remains to cover fixed costs and provide a profit.

Unit 2-3 – True LO: 3, Bloom: K, Unit: 2-3, Difficulty: Easy, Min: 1, AACSB: Analytic, AICPA FN: Measurement, AICPA PC: Problem Solving and

Decision Making, IMA: Cost Management