1. Provide an example of how a company may change its processes to make its manu
ID: 2725789 • Letter: 1
Question
1. Provide an example of how a company may change its processes to make its manufacturing more efficient or environmentally sustainable. How will the company benefit?
2. Justify why you think this production process would dictate the use of a process costing system.
3. How does process costing differ between a first processing department and a second or later processing department?
4. Describe a situation when a manager in that organization could use cost behavior information and how the manager could use the information.
Explanation / Answer
Solution.
4.
Cost behavior refers to how costs change in relation to volume (units of output) or activity. Some costs vary with volume or operating activity; others remain fixed as volume changes. Some costs exhibit characteristics between these two extremes. Understanding cost behavior is useful as managers move through the planning, executing, reviewing, and reporting stages of the management cycle. Managers use their knowledge of cost behavior to estimate future costs and impact of operational changes (such as changing output volume) on future profitability. Managers use assumptions about cost behavior in almost every decision they make. They must understand cost behavior patterns to anticipate cost ramifications of alternatives in order to decide correctly.
Identify specific types of variable and fixed cost behavior, and discuss how operating capacity and relevant range relate to cost behavior.
Total costs that change in direct proportion to changes in productive output (or other volume measures such as hours worked) are called variable costs. On a per unit basis, however, variable costs remain constant as volume changes. Examples of variable costs are direct materials, direct and indirect labor (hourly), operating supplies, sales commissions, and the cost of merchandise.
Capacity can be expressed in several ways, including total labor hours, total machine hours, and total units of output. Operating capacity is the upper limit of an organization’s productive output capability, given its existing resources. To increase operating capacity, an organization must acquire additional buildings, machinery, personnel, and operations. Cost behavior patterns can change when additional operating capacity is added. In discussing cost behavior, we assume that volume does not exceed operating capacity.
Theoretical capacity, or ideal capacity, is the maximum productive output possible over a given period of time. Practical capacity is theoretical capacity reduced by normal and anticipated work stoppages. Normal capacity is the average annual operating capacity needed to satisfy expected sales demand. Excess capacity refers to extra machinery and equipment kept on standby.
Each variable cost should be related to an appropriate measure of capacity, but often more than one measure of capacity applies. Management accountants must aggregate variable costs that have the same activity base to facilitate estimation of future costs. The traditional definition of variable costs assumes a linear relationship exists between costs and the measure of capacity chosen.
Many costs vary with operating activity in a nonlinear fashion. Examples of nonlinear variable costs are the costs of computer usage and power consumption. Here, cost behavior can be approximated within the relevant range using a linear approximation technique. The relevant range is the volume range within which actual operations are likely to occur.
Fixed costs are costs that remain constant within a relevant range of volume or activity. Examples of fixed costs are depreciation, rent, supervisory salaries, and property taxes. Unit fixed costs vary inversely with changes in volume.
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