Semester 1 Week 1b PP (Cost Behaviour and Decision Making) Flashcards
How is activity measured?
Activity or volume measured in terms of:
Units of productions or sales
Value of items sold
Number of invoices issued
Numbers of units of electricity consumed
Hours worked
Miles travelled
Patients seen
Students enrolled
Or any other appropriate measure of the activity of an organisation.
What is the classification of costs based on cost behaviour?
Variable costs vary in direct proportion with activity.
Fixed costs remain constant over wide ranges of activity. Not affected by changed in activity.
Semi-fixed costs are fixed within specified activity levels (and for a specified period), but they eventually increase or decrease by some constant amount at critical activity levels.
Semi-variable costs include both a fixed and a variable component (e.g., telephone charges).
Note that the classification of costs depends on the time period involved. In the short term some costs are fixed, but in the long term all costs are variable.
How do you calculate total variable cost?
What would the graph of total variable costs and unit variable costs look like?
What would the graphs of total and unit fixed costs look like?
What would the graph of step or semi-fixed costs look like?
What would the semi-variable costs graph look like?
How to Create and Use a Cost Formula
What is the High-Low method of the seperation of variable and fixed costs?
Assume that the relationship between volume and total costs is linear.
Use only the highest and lowest observed values of the cost driver within the relevant range and their respective costs to estimate the slope coefficients and the constant of the cost function.
Calculate the high-low estimate of the cost function.
How to Use the High-Low Method to Calculate Fixed Cost and the Variable Rate and to Construct a Cost Formula.
What are irrelevant and relevant costs?
Relevant costs and revenues are those future costs and revenues that will be changed by a decision, whereas irrelevant costs and revenues will not be changed by a decision.
Simple Example: How should I go to the AG219 class at 15:00 each Tuesday ?
Two Options: By car or public transport.
Irrelevant costs: Car tax + insurance costs.
Relevant Costs: fuels costs for the car or bus tickets.
What are avoidable and unavoidable costs?
Avoidable costs are those costs that can be saved by not adopting a given alternative, whereas unavoidable costs cannot be saved.
Avoidable/unavoidable costs are alternative terms sometimes used to describe relevant/irrelevant costs.
Only avoidable costs are relevant for decision making.
Material costs of € 100 -> unavoidable + irrelevant
Conversion costs of € 200 -> avoidable + relevant
Decision Rule: Accept those alternatives that generate greater revenues in excess of the avoidable costs (i.e., reduce unavoidable costs).
What are sunk costs?
Sunk costs are the costs of resources already acquired and are unaffected by the choice between the various alternatives (e.g., depreciation).
Sunk costs are always the outcome of past decisions + cannot be changed by future decisions.
Expenditure of 100 on materials -> Sunk cost
Sunk costs are irrelevant for decision-making, but not all irrelevant costs are sunk costs.
Why? Consider two machines with future identical direct material costs. (irrelevant but not sunk).
What are opportunity costs?
A cost that measures the opportunity that is lost or sacrificed when the choice of one course of action requires that an alternative course of action be given up.
Example: To produce product X requires that an order that yields € 1 000 contribution to profits is rejected. The lost contribution of € 1 000 represents the opportunity cost of producing product X.
No alternative uses => Zero opportunity cost.
