Managerial Accounting Chapter 5

Transcription

1 Managerial Accounting Chapter 5

2 It s really Economics Except we analyze entries to do the calculations

3 Cost Behavior Analysis The study of how specific costs respond to changes in the level of business activity Helps us plan operations, decide which course of action is better

4 We Measure Key Business Activities Can use more than one measurement (machine hours for manufacturing; sales revenue for selling expenses) Activity Index identifies what causes changes in the behavior of costs Use activity index to classify costs as variable, fixed, or mixed

5 Variable Costs Vary in total, directly and proportionately, with changes in activity level Also remain the same PER UNIT at every level of activity If activity level goes up 10%, total variable costs go up 10% Ex: items direct materials and direct labor; COGS; sales commission

6 Say we make computers that have a $10 camera in them

7 Fixed Costs Stay the same in total regardless of changes in activity level Things like rent, property tax, depreciation, supervisor s salaries Fixed costs, in total, stay the same so fixed costs on a per-unit basis change inversely with activity The more we make, the less in fixed costs per unit; the fewer we make, the more in fixed costs per unit

8 Ex: Rent for the computer facility is $10,000 per month

9 As we automate more, fixed costs increase Depreciation; lease charges on manufacturing equipment are both fixed costs Factory manufacturing labor is a variable cost

10 Relevant Range The range over which a company expects to operate during the year Unrealistic to expect to operate at 1% capacity for the entire year, or 100% capacity for the entire year Relevant range is usually between 40-80%

11 Within this relevant range Straight line relationship generally exists for both fixed and variable costs Outside relevant range, it s curvilinear

12 Mixed Costs Contain both variable and fixed cost element Change in total but not proportionately with changes in activity level Ex renting a u-haul truck: cost is $50 per day plus $1 per mile Daily cost is fixed; mileage cost is variable

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14 So what do we do with these mixed costs? We could figure out variable and fixed components each and every time a mixed cost is incurred Very time consuming Not cost effective

15 Instead We gather info on the behavior of mixed costs at different activity levels Analyze this info to separate into fixed and variable cost components We ll learn the High-Low method

16 High-Low Method Look at total costs at high and low activity levels Use data to classify fixed and variable components Difference between high and low level = variable costs since only variable costs can change as activity levels change

17 First Calculate Variable Cost Per Unit

18 Here s the data for Cupcake Cuties Delivery Fleet What s the Variable Cost Per Unit?

19 Next Calculate fixed costs By subtracting total variable costs from the total costs (at either high or low activity level)

20 We use this analysis to answer these types of questions Ford Motor Co wants to pay its workers more. What impact will this have on profit levels? What can Ford do to maintain current profit levels? Higher wages = higher variable costs so in order to maintain present profit levels Ford will have to cut other variable costs or increase the price of its cars

21 United Steel Corp will modernize its plant by purchasing a significant amount of equipment. The equipment will replace 50% of the human labor force. What will be the effect on the cost of producing one ton of steel? This changes the proportion of fixed and variable costs. Fixed costs go up because of higher depreciation costs; variable costs go down due to reduction in the number of steelworkers

22 Kellog s increases its advertising expenses for Frosted Flakes (They re Grrrreat!) but can t raise its prices because of competitive pressure. How can Kellogg s cover these extra fixed costs?

23 CVP Analysis Cost-Volume-Profit Analysis: the study of effects of changes in costs and volume on a company s profits Used to make decisions like setting selling prices, determining the product mix, and maximizing production facilities

24 CVP looks at: The relationship between volume or level of activity; unit selling price; variable costs per unit; total fixed costs; and sales mix.

25 We have to make assumptions Behavior of both costs and revenues is linear throughout relevant range Costs can be accurately classified as variable or fixed Changes in activity are the only factors that affect costs All units produced are sold Sales mix remains constant (10% cakes and 90% cupcakes)

26 CVP Income Statement Used to calculate a contribution margin amount of revenue remaining after deducting variable costs Usually stated as a total and also on a per-unit basis

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28 Unit Contribution Margin Contribution Margin is available to cover fixed costs and contribute to income Another way of putting it: For every sale, how much of the sale price goes towards fixed costs (or income, once fixed costs are covered)

29 Break Even Point When total contribution margin exactly equals fixed costs This means Total Costs (variable plus fixed) equals Total Revenue No profit, but also no loss

30 Contribution Margin Ratio Shows the percentage of each sales dollar available to apply toward fixed costs and profits.

31 How do managers use Contribution Margin Ratio? It s a quick way to see how net income is effected by a change in sales Assuming fixed costs are met, if sales go up $100,000 then net income goes up by Additional Sales x Contrib Margin Ratio

32 Break Even Analysis Calculating the Break Even Point Can be done three ways: Mathematical Equation Contribution Margin Technique Graphic Presentation

33 Mathematical Equation Remember that for Break Even, Net Income = $0

34 Contribution Margin Technique

35 Graphic Presentation

36 Managers Don t Want To Just Break Even They usually set a target net income that they d like to achieve Then calculate the sales necessary to achieve this income Use either Mathematical Equation, Contribution Margin Technique, or Graphic Presentation to calculate this

37 If using Mathematical Equation, Substitute Target Net Income for Break Even $0 If using Contribution Margin Technique, add Target Net Income to Fixed Costs in each equation On the graph just find the point where Net Income is the desired amount, and trace it to the appropriate number of units or total sales

38 Safety Margin a Financial Cushion The difference between actual or expected sales and sales at the break even point Tells how far sales could fall before company begins operating at a loss. Can be in $$$ or a %

39 Margin of Safety in $$$ = Margin of Safety Ratio Actual (expected) sales The higher the $$ or %, the greater the margin of safety

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