Question

Describe three different ways in which managers determine cost behavior, which do you think is most accurate? How can you visualize cost behavior and why is this important?

Answer 1

Cost behavior analysis is the study of how certain costs behave in a business. ... The activity index identifies the activity that causes changes in the behavior of costs. This allows managers to make decisions to further control costs. There are three types of costs: variable, fixed, and mixed.

A variable cost describes a cost that varies in total with changes in volume of activit.However, the activity can take many different forms depending on the organization. The two most common variable costs are direct materials and direct labor

A fixed cost describes a cost that is fixed (does not change) in total with changes in volume of activity.

The term mixed cost describes a cost that has a mix of fixed and variable costs.

A problem arises when a cost contain features of both fixed and variable costs. Some costs do not have a clear pattern of behavior in relation to the cost driver.

Several cost segregation methods are employed to separate fixed costs and variable costs. The commonly used segregation methods include the high-low method, the scatter graph method, and the least squares method.

The high-low method considers the highest and lowest points of activity only. The scatter graph considers all data, hence provides more reliable results. The scatter graph method is done graphically and visually. The least squares method provides the most accurate results through a series of mathematical computations.

As the variable costs change with activity level variable cost tend to be more accurate.

These patterns are important because knowledge of them can enable predictions of future cost amounts and also the use of decision-making techniques like cost-volume-profit analysis and flexible budgeting. When there are semi-variable (or mixed) costs we need to be able to determine how much of each one is fixed and how much is variable. We also need to know how the variable component of such a cost will change in response to changes in the principal cost driver.

Importance of cost behaviours can be pointed as below.

1)For the purposes of determining the cost

2)For the purposes of planning and decisions

3)For the purposes of control

To estimate cost behavior, the following must be assumed:

• The number of units produced is equal to the number of units sold. In other words, there is no change in inventory levels.

• Costs behave in a linear manner.

• The level of activity (sales and production) occurs within the relevant range.