Question : Cost behaviour; committed and discretionary costs; high–low method: m
ID: 2574593 • Letter: Q
Question
Question : Cost behaviour; committed and discretionary costs; high–low method: mining company
Outback Mining Ltd (OML), which mines ore in Australia's north-west, uses a calendar year for financial reporting purposes. The following selected costs were incurred in December, the low point of activity, when 1400 tonnes of ore were extracted.
Straight-line depreciation $30 000
Charitable contributions* 12 000
Mining labour (including oncosts) 315 000
Royalties 140 000
Trucking and hauling 280 000
Peak activity of 2700 tonnes occurred in June, resulting in mining labour costs (including oncosts) of $607 500, royalties of $224 500, and trucking and haulage costs of $360 000. The trucking and hauling costs exhibit the following behaviour:
Less than 1 500 tonnes $240 000
From 1 500–1 899 tonnes 280 000
From 1 900–2 299 tonnes 320 000
From 2 300–2 699 tonnes 360 000
OML uses the high–low method for analysing cost behaviour.
Required:
1 Assuming that royalties are a semi variable cost, classify each of the other four costs listed above in terms of their behavior as variable, step-variable, committed fixed, discretionary fixed, step-fixed, or semi-variable. Show calculations to support your answers for mining labour costs.
2 Calculate the total cost for next February when 1650 tonnes of ore are expected to be extracted.
3 Comment on the cost effectiveness of hauling 1500 tonnes with respect to OML's trucking/hauling cost. Can the company's cost effectiveness be improved? How?
4 Distinguish between committed and discretionary fixed costs. If OML were to experience severe
Explanation / Answer
Answer 1. Expenses Expenses Type Straight Line Depreciation Committed Fixed Charitable Contributions Discreationary Fixed Mining Labor Variable Royalties Semi-Variable Trucking & Hauling Step-Fixed The per ton cost of Minning Labor is Constant in both Volume level: At 1,400 Tons = $315,000 / 1,400 Tons = $225 per ton At 2,700 Tons = $607,500 / 2,700 Tons = $225 per ton Royalties Cost (Using High Low Method): Variable Portion = ($224,500 - $140,000) / (2,700 Tons - 1,400 Tons) = $65 per ton Fixed Portion = $224,500 - ($65 X 2,700 Tons) = $49,000 Answer 2. Total Cost of 1,650 Tons: Straight Line Depreciation 30,000 Charitable Contributions - Mining Labor - 1,650 tons X $225 371,250 Royalties - $49,000 + (1,650 tons X $65) 156,250 Trucking & Hauling 2,800,000 Total Cost 3,357,500 Answer 3. The hauling of 1,500 tons is not very cost-effective. The company should have decided to haul 1,499 tons in order to decrease their costs by $40,000 since less 1,500 tons only incur a cost of $240,000. The Company’s effectiveness can be improved by operating on the right-most segment of a step. Answer 4. A committed fixed cost results from an entity’s ownership or use of facilities and its basic organizational structure. Examples of such costs include property taxes, depreciation, rent, and management salaries. Discretionary fixed costs, on the other hand, arise from a decision to spend a particular amount of money for a specific purpose. Outlays for research and development, advertising, and charitable contributions fall in this category. In times of severe economic difficulties, a company’s management will often try to cut discretionary fixed costs.