ACG2071-Sudano-Exam 2

Cost Behaviour

how costs change as volume changes. It is important to managers to understand cost behaviour because it is used for estimating future costs and decision making

Relevant Range

The range of volume over which costs behave a certain way

Behaviour of increased volume on fixed costs

No change. Costs remain fixed in total

Behaviour of increased volume on variable costs

More volume means more variable cost in direct proportion

Behaviour of increased volume on mixed costs

More volume leads to more costs but not in proportion

Step Costs

costs that are fixed over a small range of activity and then jump to a different level.

Curvilinear costs

costs that are not linear.

Methods to determine how costs behave?

Account analysis or classification and historical cost and volume data

Account Analysis or classification

managers use judgement to classify each cost as variable, fixed, or mixed.

Historical cost and volume data

Scatter plot, high-low method, and regression analysis

Scatter Plot

Also known as visual fit method. Draw a line between scatter plot points and determine a slope equation. Very subjective it is basically eyeballing

High Low Method

Choose two points on a scatter plot graph based off of ACTIVITY not cost and see the highest and lowest points. We then draw a line between the highest and lowest points, then we need to find a cost equation for the line

Cost Equation Formula

Change in Cost/Change in Activity= change per activity. This represents the variable cost per case.

Find intercept as in fixed cost

Plug in change per activity cost to the formula y=(v)x+f and solve for F

Using equation to predict energy costs

Now that we have an equation we can predict costs by replacing variables and plugging them in.

Example of High-Low Method

November produced 123k cases and used 84k energy. February produced 63k cases and used 66.6k energy. We find the slope of the high and the low. 84k-66.6k/123k-63k= .29 per case or .29x Now we replace the numbers of our high or our low into our equation y=mx+b. We will use the high setting it equal to COST but even if we use low the number will be the same. This is mixed costs- variable cost. 84k=.29(123k)+f. Solve for F= 48,330. So we write our equation y=.29x+48,330. If we wanted to find the cost of producing an X amount of units we would replace X by the number in our equation

Regression Analysis

A cost equation is created based on a scatter plot where outliers are ignored. We need to look at R squared which determines the relationship between the points on the line. A higher R squared is good. We want an R squared of more than .8 Without outliers R squared increases.

What is absorption costing

Costing we normally use. It is all manufacturing costs being absorbed into the product cost. Also called full costing, it is required by GAAP and the IRS. Sales Rev-Cogs= Gross Profit-Operating Expenses= Operating Income

What is variable Costing

Only variable manufacturing costs are treated as inventoriable product costs. Fixed costs are treated as period costs and are expensed in their total in the period they are incurred along with fixed and variable operating expenses. It is only for internal use only. Sales Revenue-DM-DLM-Variable MOH-Variable Op Expenses=Contribution Margin-Fixed MOH-Fixed Op. Expense=Operating Income

What is the difference between both forms of costing?

Fixed MOH is expensed in income statement and not passed through inventory in balance sheet. As in, in variable costing, all of fixed MOH is expensed immediately in the income statement while in absorption costing, based on units, fixed overhead is passed through balance sheet and then the income statement

Using absorption and variable costing and not selling all units

Variable costing will take into account the fixed overhead of all units that were made, but absorption costing will only take into account the fixed overhead of units that were sold. This means that using absorption costing results in having costs sitting in the balance sheet. Only when inventory levels are the same will absorption and variable costing be the same

What happens when inventory levels are increasing

Absorption costing will have more fixed overhead cost in the balance sheet and less in the income statement which means it will have higher operating income than variable costing.

Under absorption costing managers can

manipulate operating income by increasing inventory levels thus increasing the Balance Sheet cost and decreasing the income statement cost.

Can managers manipulate operating income using variable costing

no because all fixed overhead is expensed when it is incurred.

Why is variable costing preferable?

It shows marginal cost, and managers can manipulate it.

Cost Volume Profit Analysis

Relationship between cost, volume, and profit. Allows companies to determine sales volume to break even or to earn a target profit. It allows companies to see how changes affect profit.

Contribution Margin

Amount every unit contributes towards paying for FC and generating profit. Calculated by Sales Price-Variable Costs.

Gross Profit

Sales Price- COGS. COGS is DM, DL and MOH

Which is better, Gross Profit or CM

CM because it considers all variable costs not just the ones within COGS. It included variable operating expense costs.

Contribution margin Percentage

CM per unit/Sales Price per unit= percentage. If percentage is 25% this means that for every 1 dollar of sales, 75% pays variable costs and 25% pays fixed costs and profit.

Contribution Margin income Statement

Sales Revenue-Variable Expenses= Contribution Margin-Fixed Costs= Op Income. Can only be used internally.

Why do managers like the CM income statement?

Managers can see what is going to change when volume changes. Sales Rev, Cm or Variable Expenses. In a contribution margin income statement, nothing changes except volume so it is easy to just replace volume and find numbers.

When to use CM percentage

When operating income is written down as sales instead of units.

Cost volume profit analysis usage

Sales-VC-Fc=Operating Income. Sales-VC= CM therefore CM-FC=Op Income. CM*Units=FC+Op Income. Units= (FC+OP INCOME)/CM. The Cm can be on a per unit basis or a percentage basis

How to find Breakeven point

Use Cost Volume Price equation and set it to 0

Changes in Contribution Margin due to changes in Variable costs

If Variable costs increase, CM will decrease. If VC decreases, CM will increase. If CM decreases, we need to sell more units, and if CM increases, we need to sell less units to break even.

Changes in Fixed Expenses

Increases in fixed expenses leads to selling more, and decreases in fixed expenses leads to selling less.

Changes in Sales Price Per unit

If sales price increases, CM increases so we need to sell less to break even. If sales price decreases, CM decreases so we need to sell more to break even.

What to do if we have sales units

Just make the equation and plug it in!

Margin of Safety and Operating Leverage

Ways to measure riskiness of a business

Margin of Safety

How far a company's sales can drop before the company is in a loss position. It can be calculated in dollars, units, or as a percentage

Margin of Safety Calculation

For sales= Current Sales-Break Even sales. For dollars. Current Dollars-Breakeven Dollars. In Percentage= Margin of Safety/Current Sales or Current Dollars. It doesn't matter if you get the percentage from sales or dollars it will be the same

Operating Leverage

Relative Degree of fixed and variable costs in a company's cost structure. Focuses on operating income

High Leverage

More fixed costs, less variable costs. Large CM, and if volume is low it is very risky, if volume is high it is very rewarding and the operating leverage factor is high. If sales are low it is risky because there is a lot of Fixed costs and the reward is high if volume is high because CM is large.

Low Leverage

Less fixed costs but higher variable costs. Low CM. If volume is low it is less risky because there is no large fixed cost, and if volume is high there is small reward because CM is small.

Operating Leverage Factor Calculation

CM/Operating Income. The number is a multiplier that determines how sensitive operating income is to sales volume

Example of Operating Leverage Factor

We have a factor or 2 and we see an increase of 10% in sales. What is the effect on operating income? It will increase by 10%*2=20%

At what level of sales will business be indifferent two options?

Set the cost equations to equal themselves to find volume

Multiproduct CVP analysis

Calculate weighted average of CM of all units by multiplying the CM of each unit by the quantity of that unit. And dividing that number by the total amount of both units.

Relevant Information

Information that has to be future data, and must differ among alternatives

Quantitative vs Qualitative

you can measure quantity but not quality (feling)

Rule of thumb

be careful about using unit cost ata unless it is purely variable cost. And analyze fixed and variable costs separately.

Special Order Decision

Asks if we have capacity, is the price enough to cover VC and any additional FC, as in, is it worth doing the order. We are looking at the impact on our operating income. We take the Sales Revenue of making the order and subtract the cost of the order. If it is positive we accept, if it is negative we don't take it. However, when looking at the cost of the order we do not include Irrelevant costs, as in, do not include FC

Pricing Decisions

Using the two different price decisions, find sales price, cost, or profit.

Price Takers

Competitive, generic products/commodities. Little to no control over price. Use target costing by using market sales price-cost= profit where cost is unknown

Price Setter

less competition, unique product, and branded. Lots of control over price. Cost plus pricing. Uses sales price- cost= profit. Where price is unknown.

How do price takers gain control over pricing?

branding and differentiation.

Discontinuing products, departments, or stores

does the segment have a positive Cm or cover its VC, can any FC be avoided, what can we do with freed up capacity, and will sales of other products be affected. Look at the additions and subtractions of discontinuing something ignoring unavoidable costs since they are dispersed through other areas.

Product Mix Decisions

Is there a constraint of what we can sell, will the product mix affect FC? Take the CM of whatever you are producing and divide it by the time it takes to produce to determine optimal product, then multiply actual Cm by quantity of product to find revenue.

What are the effects of changing FC on product mix?

It doesnt change in the short run

What are the benefits of outsourcing?

buy expertise, lower costs, and focuses on core competencies

What are the drawbacks of outsourcing?

Loss of control, and need for dedicated staff to manage relationships

Outsourcing

Cost of making product in both options but taking into account relevant costs

How to find the maximum cost a company would pay to outsource

VC+FC= VC+FC. Cost to buy= cost to make