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Cost Behavior Over Time and Relevant Range

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Consider the following:

Within this year your property taxes on your commercial building are not likely to change, and as such they are considered fixed; yet with a simple change in operating periods - to include up to a few years, these are more than likely to flux. (In one year the tax level on the property is a fixed cost, but usually it changes year over year.)

If we were to have the ability to shorten reporting periods, let's say to around a week, or longer, for around five years which would you choose, and why? How would this affect your calculations on items such as break even projections and contribution margin?

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Solution Preview

Because of the variations caused by economic cycles, I think that one week is not representative of a business's true financial condition or operations. For example, the week's activity may present an unusually glum picture of the business because the business may be unusually slow during that week because the company's business is seasonal and that week is not within the selling season (e.g., a surfboard factory in January), or because a holiday falls during that week so most people are not buying the goods or services that company sells. Likewise, the week may represent a high point for the company's sales (e.g., a beachfront resort during Labor Day Weekend), so the week may present an ...

Solution Summary

This solution discusses cost behavior (i.e., fixed or variable) as viewed over time rather than within a relevant range of activity at a specific point of time. It extends that discussion to the effect of time on determining the break-even point and contribution margin.

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See Also This Related BrainMass Solution

Mixed Cost Analysis and the Relevant Range

The Ramon Company is a manufacturer that is interested in developing a cost formula to estimate the fixed and variable components of its monthly manufacturing overhead costs. The company wishes to use machine- hours as its measure of activity and has gathered the data below for this year and last year:
Last Year This Year
Month Machine- Hours Overhead Costs Machine- Hours Overhead Costs
January 21,000 $ 84,000 21,000 $ 86,000
February 25,000 $ 99,000 24,000 $ 93,000
March 22,000 $ 89,500 23,000 $ 93,000
April 23,000 $ 90,000 22,000 $ 87,000
May 20,500 $ 81,500 20,000 $ 80,000
June 19,000 $ 75,500 18,000 $ 76,500
July 14,000 $ 70,500 12,000 $ 67,500
August 10,000 $ 64,500 13,000 $ 71,000
September 12,000 $ 69,000 15,000 $ 73,500
October 17,000 $ 75,000 17,000 $ 72,500
November 16,000 $ 71,500 15,000 $ 71,000
December 19,000 $ 78,000 18,000 $ 75,000

The company leases all of its manufacturing equipment. The lease arrangement calls for a flat monthly fee up to 19,500 machine- hours. If the machine- hours used exceeds 19,500, then the fee becomes strictly variable with respect to the total number of machine- hours consumed during the month. Lease expense is a major element of overhead cost.

Required:
1. Using the high- low method, estimate a manufacturing overhead cost formula.
2. Prepare a scattergraph using all of the data for the two- year period. Fit a straight line or lines to the plotted points using a ruler. Describe the cost behavior pattern revealed by your scattergraph plot.
3. Assume a least- squares regression analysis using all of the given data points estimated the total fixed costs to be $ 40,102 and the variable costs to be $ 2.13 per machine- hour. Do you have any concerns about the accuracy of the high- low estimates that you have computed or the least- squares regression estimates that have been provided?
4. Assume that the company consumes 22,500 machine- hours during a month. Using the high-low method, estimate the total overhead cost that would be incurred at this level of activity. Be sure to consider only the data points contained in the relevant range of activity when performing your computations.
5. Comment on the accuracy of your high- low estimates assuming a least-squares regression analysis using only the data points in the relevant range of activity estimated the total fixed costs to be $ 10,090 and the variable costs to be $ 3.53 per machine- hour.

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