Management accounting theory of cost behavior

However, the exact relationship between total variable cost and volume in practice is not always easy to describe or measure. Variable Cost Behavior and Linearity In management accounting, the relationship between activity and total variable cost is assumed to be linear.

An understanding of fixed costs requires an understanding of the different facets of capacity. On the surface, it would appear that the Management accounting theory of cost behavior and use of fixed costs is fairly simple matter.

As true of all mathematical equations, by assigning different values to Q, the independent variable, the resulting dependent values can be plotted on a graph.

The affect on slope of the line for different values of V is illustrated in Figure 5. Manufacturing Variable Costs Material used Direct labor Manufacturing overhead Utilities for machines Supplies Selling Variable Expenses Commissions Supplies Salesmen travel expense Packaging Travel The ability to identify and measure variable costs from historical cost data is often important.

Line A - C then represents total average cost. In order to 15 Management Accounting 77 understand the consequences of decisions that convert variable costs to fixed costs, a more detailed discussion of capacity is required.

For example, the leasing of additional equipment or the hiring of an additional production supervisor will increase capacity. Fixed costs provide capacity to manufacture or to sell.

For example, sales people compensation can be either fixed or variable. For the short run, profits might be less, but in the long run profits might be greater, if the machine with the greater capacity is purchased.

Because of the complexity of accounting for fixed manufacturing costs, two theories exist, absorption costing and direct costing. Five machines are not in use because of a lack of a supervisor.

The decision to pay workers a salary would make the factory labor compensation a fixed cost in the short- run. However, now only the smaller machine is needed. Privacy Policy Management Accounting Theory of Cost Behavior Management accounting contains a number of decision-making tools that require the conversion of all operating costs and expenses into fixed and variable components.

When significant increases in activity occur, additional staff, equipment, and other resources involving fixed costs must be acquired. Likewise salaries also relate to a period of time such as a month or year.

Since is it highly unlikely that the plotted points will fall in a straight line, the graph is called a scatter graph.

A commission is likely to motivate sales people, but at the same time for an individual inexperienced sales person, the inability to attain sufficient sales may result in discouragement and thus quitting. The greater the expenditure the greater the capacity. In the following section, the importance of average fixed cost will be discussed and illustrated.

Management has the discretionary power to make some costs either variable or fixed. Tabular Presentation - The presentation of fixed costs in a table at different levels of activity is basically unnecessary for the reason that regardless of the level of activity the cost is the same.

A graphical illustration of fixed and step cost is shown in Figure 5. However, the exact relationship between total variable cost and volume in practice is not always easy to describe or measure.

Mathematically, then F may be defined as: It would seem that it is irrelevant which graph is used to portray fixed and variable costs. The cost of a product per unit is highly dependent on volume when the fixed cost in a business represents a major portion of the total cost.

To justify the assumption of non variation of fixed costs as illustrated in Figure 5.

A change in volume has an immediate impact on variable costs. Fixed costs are expenditures that contractually provide services for a defined period of time. Consequently, any increase in the spending for fixed manufacturing costs will normally increase capacity.

Communication of cost behavior from the accountant to management is also critically important. After variable costs have been measured, the remaining costs may be treated as fixed.

A major concern of management is to have a balance or equality among the different ranges of capacity services.

Three methods exists for separating fixed and variable components from mixed expenses. Another example of an cost that is unavoidably variable is direct labor when the method of compensation is a wage rate. If factory workers are paid a wage rate, then factory workers compensation is variable.

Conceptually, no business can report net income until all fixed costs have been covered. At this point, you should keep in mind that all management accounting models requiring fixed and variable cost data assume that the relationship between total cost and volume is direct and proportionate; that is, on a graph the relationship is seen as a straight line.

At the aggregate level, V represents the sum of the individual variable costs rates. The physical material specifications of the table design create a fixed relationship between a unit of product the table and the amount of material used.Cost Accounting.

Accounting is the collection and aggregation of information for decision makers including managers, investors, regulators, lenders, and the public. Accounting systems affect behavior and management and have affects across departments, organizations, and even countries. This paper will give the reader an understanding about cost accounting.

Dec 04,  · Cost behavior is identified by estimating cost functions. Cost function is mathematical relationship between cost and the level of an activity.

Examples of activities used in cost accounting to develop cost functions are units of output, direct manufacturing labor hours, machine hours etc. Apr 1, The subject 'Cost and Management Accounting' is very important and and managemen accounting process and principles, financial, cost and management accounting Pages · · MB · 96 Downloads.

In management accounting theory, the relationship between volume and total variable cost is presented as a continuous linear function; that is. 2 64 CHAPTER FIVE Management Accounting Theory of Cost Behavior In management accounting theory, the relationship between volume and total variable cost is presented as a continuous linear function; that is, a straight line when plotted on a graph.

In economic theory, the relationship is assumed to be curvilinear.

Management Accounting Theory of Cost Behavior

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Management accounting theory of cost behavior
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