Professional Documents
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Behavior of Costs
Cost-volume relationships.
Fixed and variable costs.
Step-function costs.
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Variable Costs
Items of cost that vary, in total, directly and
proportionately with volume.
Volume refers to activity level.
Examples:
Material costs varies with units sold.
Electricity costs varies with production hours.
Stationery and postage costs varies with number
of letters written.
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Fixed costs
Non-variable costs = items of cost that, in
total, do not vary with volume.
Examples:
Building rent, property taxes, management salaries.
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TC = TFC +(UVC*X)
TC = total cost;
TFC = total fixed cost (per time period),
UVC = Unit variable cost (per unit of
volume),
X = volume.
Equations for:
Variable cost line: TC = UVC*X
Fixed cost line: TC = TFC
Semivariable cost: TC = TFC + (UVC*X).
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Cost Relations
Average costs = total cost/volume.
Average cost behaves differently than
total cost.
As volume goes up
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Limitations (continued)
Amount of variable costs depends on the
time period over which behavior is
estimated (the relevant time period).
If the time period is one day, few costs are
variable.
Over an extremely long time period, no costs
are fixed.
Sticky Costs
Generally considered variable but fall less
with decreases of activity than they rise
with increases.
Managers tend to increase resources more
quickly than they decrease.
Examples:
Sales commissions with minimum guarantees.
Managers slower to fire employees than to
hire.
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Step-function costs
Some items of costs may vary in steps
Incurred when costs are added in discrete
chunks, e.g. a supervisor for every 10.
Adding the chunk of costs increases capacity.
Height of a stair step (riser) indicates cost of
adding incremental capacity.
Step width (tread) shows how much additional
volume of activity can be serviced by an
additional increment of capacity.
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Measures of volume
Have assumed a single-product.
If multiple products, with different cost
structures, unlikely that units would be a
reliable measure of activity.
Possible common denominators include: labor
hours, labor dollars, machine hours,
homogeneous quantities such as tons or
barrels and sales value.
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Questions to consider in
selecting a volume measure
Input (resources used) or output (goods or
services produced)?
Money or non-monetary quantities?
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Input or output?
Input measures: resources used: labor
hours worked, labor cost, machine hours,
kilowatt hours of electricity, pounds of
material.
Output measures: units or dollars.
Manufacturing costs might use input
measures such as labor or machine hours.
Retail stores might use dollar sales.
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Money or non-monetary
quantities?
A non-monetary measure is not affected by
price changes and therefore may have some
advantages.
If price changes affect all costs equally, use of
labor costs as an activity measure implicitly
allows for price changes.
Best volume measure should be related to
the activity that causes cost.
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Profit-graph
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Contribution Analysis
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Breakeven volume
TR = UP*X
TC = TFC + (UVC*X)
Breakeven: TR = TC
Substituting: UP*X = TFC + (UVC*X)
X = TFC/(UP - UVC)
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Target Profit
Add to breakeven analysis to show units
or dollar of sales to achieve a target (T)
level of profit:
UP*X = TFC + (UVC*X) + T
X = (TFC+T)/(UP - UVC)
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Break-even volume
In units = Fixed costs/unit contribution
In revenue dollars = Fixed costs /
contribution percent
Contribution percent = contribution margin
percentage = contribution as a percent of
revenues = (UP - UVC)/ UP
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Contribution
Unit contribution = unit contribution margin
= marginal income = unit selling price variable cost per unit = UP - UVC.
I = total income = (UP - UVC) * X - TFC.
What is contribution:
First: contribution to cover fixed costs.
Then: contribution toward profit.
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Contribution (Contd..)
Contribution Margin per Unit equals unit selling price less
variable cost per unit
CMu = SP VCu
Margin of safety
The amount or ratio by which current volume
exceeds breakeven volume.
One indicator of risk, the Margin of Safety (MOS)
measures the distance between budgeted sales
and breakeven sales:
MOS = Budgeted Sales BE Sales
Thank You
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