ACCT

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Define variable, fixed, and mixed costs and sketch graphs to show their behavior both in total and per unit of activity. Variable costs are the costs that change in total as the production changes or some other activity changes. Examples: DM, DL and Indirect Materials. For us gasoline, clothes, entertainment costs and food. But variable costs per unit is constant. Fixed costs are the costs that stay the same in total regardless in changes in activity or production. Example: property taxes, straight line depreciation, salaries of supervisors. For us it is Rent and car insurance. Fixed cost per unit is decreased as more is produced as that cost is spread over. Mixed costs are the costs that have variable and mixed components. Example: electricity and water etc. **Work S6-6, Discuss Accounting in the Headlines - Amazon** What is the relevant range and why is it important to managers? Range of activity or production where you normally expect to operate. Bond of volume or activity where the total fixed costs are constant and variable costs per unit is constant. Outside the relevant rang- total fixed costs can change and variable cost per unit can change. Describe step costs and curvilinear costs. Step costs are the costs which are broken down in steps. Curvilinear costs are the costs which is graphed as a curve and not as a straight line. LO 2: Use cost equations to express and predict costs. Total variable cost = Variable cost per unit of activity (v) × Volume of activity (x) Total fixed cost = Fixed amount over a period of time (f) Total mixed cost = vx + f **Work E6-23A** LO 3: Use account analysis and scatterplots to analyze cost behavior. How can a scatterplot help managers understand cost behavior? Scatter plot: graph that shows each point of data cost (y-axis) and the activity volume (x-axis). It helps us identify: How the strong the relationship is between the cost and the activity (approximation of the straight line strong relationship) Outliers Cost is variable, mixed or fixed. strong- there is a pattern. Easily identifies the outliers and approximate the line. weak- no pattern Hard to identify outliers hard to approximate line. Try to identify a different activity to explain the cost. LO 4: Use the high-low method to analyze cost behavior. What is the purpose of the high-low method? What is the key limitation of this method? Rough estimate of the cost equation. We use 2 data points to estimate the equation. Th scan be influenced by the outliers. Quick estimate. Three Steps to the High-Low Method Find slope of the mixed cost line USING HIGHEST AND LOWEST VOLUME POINTS (this is the variable cost component) Variable cost per unit. Slope=Variable cost per unit (v)= (cost (high)-cost (low))/(volume (high)-volume (low)) Find the vertical intercept - where line intersects the y-axis (this is the fixed cost component). Use data from either the high or the low month to solve for fixed cost amount. This means the fixed cost. Total mixed cost (low)=[v ×volume (low)]+ Fixed cost (f), OR Total mixed cost (high)=[v ×volume (high)]+ Fixed cost (f) Write the cost equation using the costs determined in Steps 1-2 Total mixed cost=vx+f **Work E6-34A** LO 5: Use regression analysis to analyze cost behavior. How does regression analysis differ from the high-low method? Regression is going to consider every data point. This gives a much more accurate cost equation. Define the terms "independent variable" and "dependent variable" as used in regression analysis. (x) Independent variable: Cost deliver activity what we expect to drive variable costs. (y) Dependent Variable: total cost is what we are trying to explain. What are the key pieces of information to look for in an Excel regression analysis output? Intercept: where we cross the y-axis: that is the Fixed Cost Slope: variable cost per unit: name of the independent variable, or x variable. R-Squared: how accurate our cost equation is. Range is from 0 to 1. Values of 0.80 or higher indicate reliable cost equation. 80% of the variability in the data is explained by the cost equation. **Work E6-52B** LO 6: Describe variable costing and prepare a contribution margin income statement. A company uses absorption costing for financial statements that are reported externally, but variable costing for internal financial statements. What is the format of these two income statements, and when will the amount of operating income reported differ between them? Absorption costing means traditional income statement. Revenue - COGS = Gross Profit - Operating Expenses = Operating Income. Product costs are DM+DL+ MFG OH Variable Costing Revenue - Variable costs (DM, DL, Var. OH, Var. Operating expenses) = Contribution Margin (less) Fixed Costs (Fixed OH and Expenses) = Operating Income Product costs are DM+DL+Variable OH For Service and merchandisers, the operating income is the same for both these types of income statements. For Manufacturers, if the units produced = units sold, the operating income is the same under both methods. If the units produced > units sold, operating income is higher in Absorption costing If units produced < units sold, operating income is higher in variable costing What are two reasons managers prefer variable costing? Variable costing shows the additional cost producing 1 more unit. Operating income cannot be manipulated by building excess inventory. S6-18 a. An s shaped curve would represent a Curvilinear b. a cost equation resulting from using regression analysis is described as the line of best fit c. Account analysis is a method for determining cost behavior that is based on a managers judgment d. the vertical intercept of a variable cost is 0 e. The R square value is referred to as the goodness of fit statistic f. Step cost are a type of cost behavior that is fixed over a small range of activity and then jumps to a different fixed level with moderate changes in volume g. as the activity level rises and falls Free cost remains constant in total h. committed fixed cost are fixed costs that management has little to no control over in the short run i. the total mixed cost line increases as the volume of activity increases but the line does not begin at the origin k. the high low method uses two data points to arrive at a cost equation to describe a mixed cost l. the free cost per unit is inversely related to the volume of activity m. Total cost = variable + fixed cost

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Learning Objective (LO) 1: Describe and identify information relevant to short-term business decisions. How do managers make decisions? 1. PLANNING - Define business goals - knowing what we are working towards 2. PLANNING - Identify alternative courses of action 3. PLANNING - Gather and analyze relevant information: compare alternatives 4. DIRECTING - Choose the best alternative - recommend from a financial standpoint 5. DIRECTING - Implement decision - managers decide which course of action to take 6. CONTROLLING - Follow-up: Compare actual results with anticipated results What makes information relevant? Information that differs between the alternatives and occurs or pertains to the future What factors would be relevant to a restaurant that is considering whether to make its own dinner rolls or to purchase dinner rolls from a local bakery? Relevant to making dinner rolls- Cost of labor Cooking ingredients Larger cooking space and utensils Relevant to purchasing dinner rolls- Purchase price Transportation price What are some keys to analyzing business decisions? 1.Use Incremental Analysis - we want to determine how operating income differs between alternatives 2.Focus on the relevant revenues and relevant costs 3.Focus on the contribution margin income statements (fixed vs variable) **Discuss Accounting in the Headlines - New England Patriots** Cross out the charges that are both same in type AND value 1. Costs of chartering aircraft - Fuel Chartering costs Staff Cleaning Insurance Airport fees 2. Costs of owning the planes - Maintenance Purchase price of the planes Depreciation Fuel Staff Logos and design Storage and Hangars Cleaning Airport fees LO 2: Describe and apply different approaches to pricing. Key Pricing Considerations • What is your target profit? Desired Profits • How much are customers willing to pay? • Are we a price-taker or price setter? Explain the differences between a price-taker and a price-setter. Price Taker : Generic brand Heavy competition Similar products to competitors Target costing Price Setter : Specific brands Less competition Unique products Cost-Plus pricing Target Costing Follow Market Price Subtract Target Profit Realize what Target Cost they need to charge for said profit What can the company do if actual total costs are more than target total costs? Try to differentiate the product or improve upon it Reduce costs Adjust your desired profit Cost-plus Pricing Total costs Add Target Profit Cost plus Price Desired Profit examples - % of total or variable costs % of return on investment on assets **Work E8-19A** 1. Target Costing - Fierce competition, cookie cutter houses 2. Target Profit - 14% of variable costs Total variable costs = $183000 Target profit = 14% * 183000 = $25620 Market Price = 202000 - Target Price = 25620 Target Cost = 176380 Actual Cost = 183000 Shortfall or loss = $6620 3. Current Variable Costs 183000 +Upgrade cost 20000 Total Costs 203000 +Target Profit (14% of 203000) 28420 =Cost Plus Price 231420 In comparison to the Expected Price 202000 + 35000 = 237000 Should differentiate the prices as they are charging even more than the Cost Plus Price we calculated LO 3: Decide whether to accept a special order. What is a special order? One time order that is charged at a reduced sales price for a one time customer that is purchasing it at a very large volume Key Considerations for a Special Order • Do we have excess capacity to fill this order? • Will the reduced sales price be high enough to cover the order's incremental costs? • Will the special order affect regular sales in the long run? How do you make a special order decision? Two alternatives Either accept the special order Or Reject it Examine relevant costs and revenues Decision Rule : Relevant operating income from special order is positive, accept it If relevant operating income from special order is negative, reject it **Work E8-20A** 1. Accept or reject the special order Relevant Revenue ($25 * 10000) = 250000 -Costs Relevant Variable costs ($30 * 10000) = (300000) Loss = $50000 So REJECT 2. Accept or reject the special order Relevant Revenue ($40 * 10000) = 400000 -Costs Relevant Variable cost (30*10000) = (300000) Relevant Fixed costs = (15000) Profit = $85000 So ACCEPT **Watch and Discuss PWC Pricing Video** https://www.youtube.com/watch?v=Y6mOPVqlQPs LO 4: Decide whether to discontinue a product, department, or store. Key Considerations for Discontinuing Products, Departments, or Stores • Does the product/dept/store provide a positive contribution margin? • Are there any fixed costs that can be avoided if we discontinue the product/dept/store? • Will discontinuing the product/dept/store affect the sales of any other products? • What can we do with freed capacity? OPPORTUNITY COST How do you make a decision about dropping a product/dept/store? Alternatives: Drop the Product Keep the Product Analysis purposes: Relevant revenues, costs, sales impacts on other products, sales or costs from freed up space and other use of those assets **Work E8-23A** 1. Drop or Keep Decrease in Revenue (128000) Decrease in Variable cost 82000 = Decrease in Operating income (46000) So DROP 2. Decrease in Operating income (46000) Decrease in Fixed cost 32000 = Decrease in Operating income (14000) 3. Decrease in Operating income (46000) Decrease in Fixed cost 74000 Decrease in Wood Sales Revenue (15000) = Increase in Operating Income 13000 LO 5: Factor resource constraints into product mix decisions. What is product mix? Constraint- limits production of a product or service, examples would be materials, machine or labor hours, floor space, display space How much of your Sales come from each product and service you provide Key Considerations for Product Mix • What constraint stops us from make (or displaying) all of the units we can sell? • Which products offer the highest contribution margin per unit of the constraint? • Would emphasizing one product over another affect fixed costs or sales of other products? How do you make a decision about product mix? Identifying any products or services we can sell Identify constraints Calculate Contribution Margin per unit of constraint per product or service Decision Rule If there is a constraint, then we should focus on the product with the highest Contribution Margin per unit of the constrained resource If there is no constraint, then we focus on the product with the highest Contribution Margin per unit of the product itself **Work P8-57B** 1. Machine Hours is the constraint We need the Contribution Margin per Machine Hour 2. Deluxe: CM per Unit - 73 Number of Units per hour - 25 CM per Machine hour - 1825 Standard: CM per Unit - 34 Number of Units per hour - 65 CM per Machine Hour = 2240 RECOMMEND STANDARD as it has a higher CM per machine hour Calculate the number of units you can produce of the product you chose to emphasize: 4000 * 65 = 260000 Standard units LO 6: Analyze outsourcing (make-or-buy) decisions. What is the difference between outsourcing and offshoring? Outsourcing - Having someone else produce your product or purchase your service. Domestic or outside the US Offshoring - Having the product made or the service performed overseas. May be done by the company itself or an outsourcer What are benefits and drawbacks of outsourcing? Benefits: Allows the company to focus on the competency, lets us take advantage of company's expertise, reduces investment in equipment or labor Drawbacks: Lose control over the quality of the outsourced product. We lose control over production schedule for the outsourced item and delays in delivery could impact our production times. Reputational consequences to interacting with poor outsourcers who treat employees unfairly. Key Considerations for Outsourcing • How do variable costs per unit compare to outsourcing cost per unit? • Are any fixed costs avoidable if we outsource? • What could we do with the freed capacity? • What volume do we need? How do you make an outsourcing decision? Alternatives Continue to make the product or outsource the product Analyzing the relevant costs and opportunity costs of the decision. Don't focus much on revenue as it would remain constant regardless Decision based on the alternative with the lowest cost How can you determine the maximum acceptable outsourcing price? Indifference point - Point where the cost is the same in both making the product and outsourcing it **Work E8-28A** 1. Make Unit: DM - 8 per unit DL - 1.50 per unit MOH - 1 per unit Purchase price - None Total Cost - 10.50 per unit Buy Unit: DM - None DL - None MOH - None Purchase Price - 8.50 per unit Total Cost - 8.50 per unit CHOOSE TO OUTSOURCE as its relevant costs are lower 2. Make Unit Variable cost per unit - 10.50 per unit Units - 75000 V cost - 787500 Fixed Costs - 455000 Relevant costs - 1 242 500 Buy Unit Variable cost per unit - 8.50 per unit Units - 75000 V Cost - 687500 Fixed Costs (go down by 105000) - 350000 Relevant costs - 987 500 3. Make Units = Buy Units (10.50*75000) + 455000 = (PRICE*75000) + 350000 Price = 11.90 per unit is the price for the indifference point LO 7: Decide whether to sell a product "as is" or process it further. Give examples of products that a company could sell a product as is or process further. Bike Unassembled or Assembled Unfinished furniture or Painted and Constructed Key Considerations for Processing Further • How much revenue will we receive if we sell the product as is? • How much revenue will we receive if we sell the product after processing it further? • How much extra will it cost to process the product further? Irrelevant costs: Costs of the product as is. How do you make a process further decision? Alternatives: Sell the product as is or Process the product further and then sell it Analyze: Relevant revenues and costs If processing further increases operating income we would pick that If processing further decreases operating income we should sell the product as is **Work E8-31A** Sell as is: $8 per gallon $0.16 for packaging Benefit per unit = $7.84 per gallon Units per batch = 7.84 * 540 Operating income = $4234 Process further: $0.56 per individual $0.07 for packaging $0.10 for fruits Benefit per unit = $0.39 per individual Units per batch = 0.39 * 11520 Operating Income = $4493 THEREFORE they should choose to process further as it gives them the higher net operating income. SEGMENT MARGIN INCOME: 1. refers to the result of operating income or loss for each individual product line 2. Unavoidable fixed costs include fixed costs that continue to be incurred even if the product line is discontinued 3. Avoidable fixed costs include costs that may be eliminated as a result of discontinuing the product 4. Contains NO allocation of common fixed costs on the statement.

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What are the four key assumptions of CVP analysis? 1. Sales price is constant in the relevant range 2. We can classify all costs as fixed or variable 3. Inventory levels will not change 4. The sales mix of products remain constant What is contribution margin? Revenue - variable cost = contribution margin Selling Price - variable cost per unit = contribution margin per unit Contribution margin ratio = contribution margin / revenue Or = contribution margin per unit / selling price LO 2: Use CVP analysis to find breakeven points and target profit volumes. What is the breakeven point and why is it important to managers? Break even is when Sales = Total costs or when operating income = 0 managers want to know how much they need to sell to cover their costs Do you agree or disagree with this statement: "Breakeven analysis isn't very useful to a company because companies need to do more than break even to survive in the long run." Break even is a starting point to help managers determine how much to sell to earn profits. How do you calculate the sales needed to breakeven or earn a target profit? Income Statement Approach: Operating income = Sales Revenue - Variable Costs - Fixed Costs = (selling price*number of unites) - (variable cost per unit*number of units) - FC Shortcut using unit contribution margin: Sales in units = (Fixed costs + operating income)/ contribution margin per unit Sales in dollars = (Fixed costs + operating income)/ contribution margin ratio Contribution margin ratio = Contribution Margin / Revenue or = Contribution Margin Per unit / Selling price **Work E7-21A, Discuss Accounting in the Headlines - Zume Pizza** 1. Contribution margin per unit = 2 - 1.20 = $0.80 Contribution margin ratio = .80 / 2 = .4 or 40% 2. Breakeven sales units = (85000 + 0) / 0.80 = 106250 units Breakeven sales dollars = (85000 + 0) / .4 = 212500 dollars Or (units * selling price) = 106250 * 2.00 = 212500 dollars 3. Sales in units = (85000+22000) / .80 = 133750 units. Graphing CVP Relationships Sales Revenue - Straight upward sloping line from the origin Fixed Cost line - Straight horizontal line Total Cost line - Straight upward sloping line from the point of fixed cost intercept Variable Cost - Area between total cost and fixed cost Break Even point - Point where Sales Revenue line and Total cost line intercept Profit or Loss - Area between Sales Revenue and Total cost AFTER the break even point LO 3: Use CVP analysis to measure the impact of changing business conditions. What if life ends up being different than you had expected? What if you are told that you are getting a raise? What if your rent increases? Break even sales units = Fixed Cost + 0 / Selling price - variable cost per unit CVP can show managers what happens if selling price, variable costs, or fixed costs change. What if? Effect on Unit Contribution Margin Effect on Breakeven Point Sales price decreases DECREASES INCREASES Sales price increases INCREASES DECREASES Variable cost per unit decreases INCREASES DECREASES Variable cost per unit increases DECREASES INCREASES Total fixed costs decrease NOTHING DECREASES Total fixed costs increase NOTHING INCREASES **Work E7-27A** 1. Break even units = Fixed costs + 0/ Contribution margin = 308000 / 2200-500-160 = 200 units Break even sales dollars = 200 * 2200 = $440 000 2. Operating income = Contribution margin - fixed cost = 260 * 1540 - 308000 = $92400 3. Break even units = 308000 + 70 400 / 2200-500-160+220 = 378400 / 1760 = 215 units Break even sales dollars = 215 * 2200 4. Operating income = Contribution margin - Fixed cost = 260 * 1760 - 378400 = $79200 5. They should not implement software control system as it has a higher break even point and lower operating income LO 4: Find breakeven and target profit volumes for multiproduct companies. What is different about the breakeven formula for a company that sells more than one product? Break even point = (fixed cost + 0) / Weighted average contribution margin per unit Weighted average CM per unit = (number of units * CM product A) + (number of Units* CM B) DIVIDED BY (Product A units + Product B units) Find total break even points and multiply it with the sales mix of each product Why can't all of the product's contribution margin ratios just be added together and averaged? Break even sales Dollars = fixed cost + 0 / weighted average CM ratio Weighted average CM ratio = (number of units * CM product A) + (number of Units* CM B) DIVIDED BY (Product A Sales + Product B Sales) ** Work E7-32A** Standard CM = 55 - 45 = $10 per unit Deluxe CM = 85 - 65 = $20 per unit Break even units = Total fixed cost + 0 / weighted average contribution margin per unit Weighted average contribution margin = Total CM dollars / Total units = 3 * 10 + 2 * 20 / 5 = $14 per unit Break even units = 11900 + 0 / 14 = 850 units Sales mix = 3/5th Standard and 2/5th Deluxe Standard break even units = 3/5 * 850 = 510 units Deluxe break even units = 2/5 * 850 = 340 units Total units required = 11900 + 7700 / 14 = 1400 units Standard units = 1400 * 3/5 = 840 Deluxe units = 1400 * 2/5 = 560 LO 5: Determine a firm's margin of safety, operating leverage, and most profitable cost structure. How can CVP analysis provide an indication of company's operating risk? 1. How far away from the break even point are we 2. How dependent is the company in fixed vs variable costs What is "margin of safety"? Cushion or buffer How much our sales can drop before we incur a loss Margin of safety units = expected or actual sales units - break even units Margin of safety dollars = expected or actual sales dollars - break even dollars Margin of safety ratio = Margin of safety sales or units / Expected or actual sales or units Smaller margins of safety pose a higher risk What is "operating leverage"? How dependent we are on fixed costs vs variable costs High operating leverage = more dependent on fixed costs (higher risk) Low operating leverage = more dependent on variable costs (lower risk) Operating leverage = Contribution margin dollars / Operating income % Change in Operating Income = Operating Leverage * % Change in Sales **Work E7-34A** 1. Margin of safety = Expected sales dollars - break even sales dollars Breakeven sales = Fixed cost + 0 / CM ratio = 7500 / 0.60 = $12500 Expected sales = 7500 + 30000 / 0.60 = $62500 Margin of safety dollars = 62500 - 12500 = $50000 2. 50000 / 62500 = 0.80 3. Operating leverage = CM / operating income CM = 62500 * 0.60 = 37500 Operating income = 37500 - 7500 = 30000 Operating leverage = 37500/30000 = 1.25 4. (-0.12) * 1.25 = -15% How do managers choose a cost structure (their mix of fixed vs. variable costs)? Indifference point - The point where fixed costs would equal variable costs Based on number of units of activity If expected units are more than the indifference point then managers should choose to have more fixed costs If expected units are less than the indifference point then managers should choose to have more variable costs **Work S7-17** 1. Indifference point fixed costs = variable costs Fixed cost = 2000 Therefore X= number of cupcakes 2000 = 800 + 0.05 (6*X) X = 4000 Option 1: Fixed cost = 2000 Option 2: Variable cost = 800 + 0.05 (6*3400) = 1820 Prefer Option 2 as it is always going to be cheaper as long as less than 4000 cupcakes aka the indifference point is not exceeded 2. Option 1: Fixed cost = 2000 Option 2: Variable cost = 800 + 0.05 (6*5200) = 2360 Prefer Option 1 as the indifference point is crossed.