ACG 2071 Exam 2 (FSU Sudano)

Fixed costs

Costs that don't change as we produce more units or activity level increases

Variable costs

Costs that do change as we produce more units or activity level increases

Mixed costs

Fixed costs + variable costs

They do change in total as we produce more units or activity level increases

Relevant Range

The typical range of activity

To find a fixed cost...

Turn the numbers into a total per unit

(ex: divide per unit number by amount of units)

To find a variable or mixed cost...

First divide the change in cost by the change in activity. Then, multiply that number by a given activity level

(if the multiplied numbers equal the given total, it is a variable cost; if they do not equal, it is a mixed cost)

Variable cost equation

Variable cost * x

Mixed cost equation

(Variable cost * x) +y

A firms estimate for their fixed cost is the...

(in terms of the cost and volume graph)

Y-intercept

A firms estimate for their variable cost is the...

(in terms of the cost and volume graph)

Slope

The accounting equation for variable and mixed costs...

TC = VC(activity level) + FC

(mirrors Y = mx + b)

Three objective (math) methods to calculate a firms mixed costs

1) Scatter graph/plot - visual fit where we place trend line where we think it should go

2) High/low method - connect a trend line between highest and lowest points of activity levels (what we will use for class) (does not take outliers into account...)

3) Least squares regression analysis - software such as excel uses data points to find best fit

Two subjective (non-math) methods to calculate a firms mixed costs

1) Account analysis/classification - someone looks at the graph and estimates what is going on

2) Engineering approach - someone looks at the materials used, labor incurred, product specifications, etc. and estimates what SHOULD be going on

Contribution margin

Difference between a product's selling price and its variable cost

Contribution margin per unit formula

Price per unit - variable cost per unit

Total contribution margin formula

Total revenue - total variable costs

Contribution margin ratio

Contribution margin / price (or revenue or sales)

CVP (cost-volume-profit) analysis

Used to determine the units, revenues, etc. to break even

(break even point is when revenues = total expenses or when operating income = $0)

# of units needed formula

(Fixed cost + target operating income) / CM per unit

Sales revenue ($) needed formula

(Fixed cost +target operating income) / CM ratio

What-if analysis

What moves a break-even point up or down

If fixed costs increase, break-even point will...

Increase

If fixed costs decrease, break-even point will...

Decrease

If variable costs per unit increase, break-even point will...

Increase

If variable costs per unit decrease, break-even point will...

Decrease

If selling price increases, break-even point will...

Decrease

If selling point decreases, break-even point will...

Increase

If CM per unit increases, break-even point will...

Decrease

If CM per unit decreases, break-even point will...

Increase

Multi-product CVP analysis (3 steps)

1) Compute firms weighted average CM = sum of (% sales)(CM)

2) Plug WACM into formula: # of units needed = (fixed cost + target op income)/WACM

3) Distribute answer from step 2 according to the sales mix

Margin of safety formula

Target sales or units - break-even sales or units

Operating leverage formula

Contribution margin / operating income

Firms with a high operating leverage degree are...

Risky and have more fixed costs than variable costs

Firms with a low operating leverage degree are...

Less risky and have more variable costs than fixed costs

Absorption (full) costing

Product costs = DM + DL + VOH + FOH

(required by GAAP and will always appear MORE expensive)

Variable costing (CM method)

Product costs = DM + DL + VOH

(used only internally and will always appear LESS expensive)

If # produced = # sold...

Income with full costing = income with variable costing.. inv levels are constant

If # produced > # sold...

Income with full costing > income with variable costing.. inv levels are rising

If # produced < # sold...

Income with full costing < income with variable costing.. inv levels are falling

Difference in operating incomes:

(FOH/unit produced) * (difference in # of units produced vs sold)

Traceable fixed costs

Direct or avoidable

Fixed costs that can be directly attributed to a division or segment of a company

Common fixed costs

Indirect or unavoidable

Fixed costs that cannot be directly attributed to a division or segment of a company (more "general" fixed costs)

Segment margin

Method used to evaluate segments or divisions of a company

(positive segment margin means the company is covering it's own costs.. negative segment margin means the company is NOT covering it's own costs)

Segment magin formulas

1) contribution margin - traceable (direct) fixed costs

2) revenues - var costs - traceable (direct) fixed costs

For info to be relevant...

1) must be an expected future rev or cost

2) must be different from the other alternatives

Are variable costs relevant or irrelevant?

Unless told otherwise, all variable costs are unavoidable, meaning they DO matter and are relevant

Are fixed costs relevant or irrelevant?

Unless told otherwise, all fixed costs are avoidable, meaning they DON'T matter and are irrelevant

Differential cost

The difference in costs between two alternatives

How to solve for special orders:

Create a column for Additional (incremental) Revenues and Additional Costs. Write down the change in revenue and cost that would result if the special order is accepted, ignoring unavoidable (fixed) costs. If additional revenue > additional cost, accept the special order. If additional revenue < additional cost, do not accept the special order.

How to solve for the "make vs. buy" decision:

Create two columns labeled Make and Buy. Below them, write the relevant costs associated with making and buying the product. The column with the LOWER cost is the one that should be picked and the answer is usually in terms of the difference between the two numbers.

How to solve for the "allocation of constrained resources" decision:

Compute the contribution margin of each product. If there are no constraints, product with the higher total CM is better. If there are constraints, the product with the higher CM per constraint is better. optimize the highest cm/constraint product, and then with the leftover constraint (time, raw materials, etc), move onto optimizing the next highest cm/constraint product.

How to solve for the "keep or eliminate a segment" decision:

Compute the segment margin (CM - direct (avoidable) fixed costs). If SM is positive, keep it. If SM is negative, ditch it. When expanding to another segment, compute increase in CM associated with that segment's expansion, then compare this additional CM to the segment margin to see if we should eliminate the segment or not.

How to solve the "sell vs process further" decision:

Create an additional (incremental) revenue column and an additional (incremental) cost column. Write down the relevant change in revenues and costs that would occur from processing the item further. If additional rev > additional cos, process further. If additional rev < additional cost, do not process further.

Note: When several products are produced together, they are called joint products (until the split-off point). Joint products are always irrelevant. Costs associated with processing further are called separable costs and are always relevant.

Cost-plus pricing

When a firm has control over it's prices

Price = cost + profit

Target costing

When a firm has no control over the price, they aim for a cost they want

Target cost = revenue at market price - profit