Chapter 3, Problem 1DQ

To determine

Explain the importance of cost behavior for managerial decision making with an example.

Explanation of Solution

Cost Behavior:

Cost behavior determines the effect of changes in organizational activities on the cost associated with them. In other words, cost behavior is determined by the manager to analyze the changes in cost due to changes in output level within the organization.

Analyzing cost behavior is important for managerial decision making purpose due to following reasons:

• Managers would be able to reduce total cost incurred on activities.
• Cost behavior helps manager make decisions to increase profitability.
• Cost is compared with the predetermined standards to check the cost efficiency in the organization. Controlling measures could be taken by the managers if any deviation is found.
• Cost behavior helps the manager to attain economies of scale by increasing the production volume.

There are various cost associated within the organizational operations such as advertising cost, production cost, material cost and labor cost. Cost can be classified into variable and fixed costs.

For instance, if raw material cost is reduced in the market then manager can purchase it now for future use depending on the nature of raw material. This will reduce its cost of production and increases its profitability. At the same time, inventory storage and maintenance cost will be increased. The decisions related with cost can be taken by the manager after analyzing the cost behavior.