Understanding Depreciation, Fixed, and

Variable Costs

Next Generation Science / Common Core Standards Addressed!

CCSS. Math Content HSSIC.B.5 - Use data from a randomized experiment to compare two treatments; use simulations to decide if differences between parameters are significant.CCSS Math Content HSSIC B.6 - Evaluate reports based on data.

Bell Work / Student Learning Objectives

Distinguish between fixed and variable costs.Calculate depreciation using the straight-line method.Calculate depreciation using the sum-of-the-digits method.Calculate depreciation using the double-declining method.

Terms

Average fixed costAverage total costAverage variable costBreak-even quantityDepreciationDouble-declining method

Terms

Fixed costsMarginal costStraight-line methodSum-of-the-digits methodTotal costVariable costs

Interest Approach

How do you decide if a new enterprise for your SAE is feasible?Why does a new vehicle goes down by thousands of dollars in value as soon as it leaves the lot?

Expenditures

A business has numerous production expenditures that are called costs.

Fixed Costs

Fixed costs are those costs that are constant regardless of level of production.Examples

DepreciationInteresttaxes.

Fixed Costs

Fixed costs per unit of production decreases as more product is produced.

Variable CostsVariable costs are those costs that change as production levels change.Examples:

FertilizerSeedFeedFuelHired labor

Variable CostsTotal variable costs increase as production increases.

Total Cost

Total cost is variable costs plus fixed costs. Total cost increases as variable costs increase.

Average Costs

Average variable cost Average fixed cost Average total cost

Average Variable Cost

Average variable cost is figured by dividing total variable costs by total output at any given point.

Average Fixed CostsAverage fixed cost equals total fixed costs divided by total output at any given point.

AFC = TFC

Average Total Cost

Average total cost equals total cost divided by total output at any given point.

Marginal CostMarginal cost equals change in the total cost divided by the change in output. The cost of producing one additional unit of product.The level of production that maximizes profits is where marginal costs equal the price received for the product.

Break-even Quantity

Break-even quantity equals the total fixed costs divided by the price per unit minus the direct costs per unit.

Depreciation

Depreciation is the decline in value of an asset due to use and age.

Straight-line Method

The straight-line method provides equal depreciation during each year of the asset’s useful life.

This method is the easiest and probably most widely used.

Straight-line Formulas

The formula for determining straight-line depreciation is: OC – SV divided by u

OC = original cost of the assetSV = salvage valueU = useful life in years

Straight-Line Example

A new air seeder for a commercial greenhouse with a cost of $10,000 to be used for 10 years, with a salvage value of $1,000 would depreciate $900 per year.

10,000.00 – 1,000.00 (salvage value) = 9,000.009000.00 / 10 yrs. = 900.00 depreciation/yr.

Sum-of-the-digits Method

The sum-of-the-digits method is a way of calculating depreciation in which the rate of annual depreciation declines as an asset becomes older.

FormulaThe formula for determining depreciation using the sum-of-the-digits method is;

(acquisition cost – salvage value) X remaining useful life sum of the years digits

U = useful life remainingOC = original costSV = salvage value

Example

A new air seeder for a commercial greenhouse with a cost of $10,000 to be used for 10 years, with a salvage value of $1,000 would depreciate $1636.36 the first year.

This is figured as follows:

10 divided by (10+9+8+7+6+5+4+3+2+1)

Multiply the sum by (10,000 -1,000)

10 X 9,000.00 = 1,636.36 55

Double Declining Method

The double-declining method allows for fastest depreciation with a declining amount of depreciation each year. Allows for accelerated depreciation of long lived assests.

Formula

2 divided by N multiplied by R

U = useful lifeR = remaining book value at the beginning of the year.Salvage value is disregarded

Double Declining Method

An example: A new skid steer for a commercial landscaper with a cost of $30,000 will be used for 10 years, with a salvage value of $3,000 we would depreciate 20 % the first year.

This is figured as followsYear 1 - $ 30,000.00 – $ 3,000.00 = $ 27,000.00

$ 27,000.00 X .20 (20 %) = $ 5,400.00 $ 27,000.00 - $ 5,400.00 = $ 21,600.00

Year 2 - $ 21,600.00 X .20 (20 %) = $ 4,320.00$ 21,600.00 – 4,320.00 = $ 17,280.00

Review/SummaryDistinguish between fixed and variable costs.Calculate depreciation using the straight-line method.Calculate depreciation using the sum-of-the-digits method.Calculate depreciation using the double-declining method.

The End!