ACTG 6310
Chapter 2 – The Nature of Costs
What is a cost?
• “A resource sacrificed or forgone to achieve a specific objective
• Not necessarily an expense; could go to asset first then be expensed. Example: inventory
• Actual outlays - resources have been sacrificed• Examples: average cost, common cost, full
cost, historical cost, joint cost, marginal cost, period cost, product cost, standard cost, fixed cost, opportunity cost, sunk cost, variable cost
Opportunity Costs
• Benefit forgone by choosing one course of action over another.
• This is not recorded in the accounting records.
• Sometimes the alternatives are easy to determine, other times not.
• There is always something else you can do with your money, time, space, etc.
Opportunity Costs
• Forward looking – not historical costs
• Not sunk, past costs– Inventory– Depreciation – Includes interest
Cost Variation
• Cost behavior– Variable– Fixed– Mixed (semivariable)– Step costs
• Relevant Range• Choice of Cost Driver• Marginal costs – cost of producing one more unit• Average cost – Total costs/units produced• Marginal cost DOES NOT equal average cost.
Cost-Volume-Profit Analysis
• Procedure that examines changes in costs -- variable and fixed-- and volume levels and the resulting effects on net income.
• Used for planning -- to determine effects of anticipated changes in revenues, variable costs, fixed costs and volume
• Used for controlling -- what happens to net income when changes occur
Contribution Margin
• Sales - Variable Costs
• Per unit – Sales Price per unit - var. costs per unit– Tells us how much in $ is contributed to firm
• Ratio– CM per unit/Sales price per unit– Tells us what % of each dollar is contributed
to the firm
Example of Contribution Margin
• Billy Bob’s Bicycles (Sales of 200 bikes)
• Sales Revenues $100,000
• Var. Costs 40,000
• Contr. Margin 60,000
• Less Fixed costs 30,000
• Net Income $30,000
Contribution Margin
• CM in total = $60,000• CM per unit =
– $100,000/200 bikes = $500 sales price per bike– $ 40,000/200 bikes = $200 var.costs per bike– $ 60,000/200 bikes = $300 CM per bike
• CM Ratio =– $300/$500 = 60% OR– $60,000/$100,000 = 60%
Break-even Analysis
• Algebraic equation method:
• Sales = Var. Costs + Fixed Costs
• $500x = $200x + $30,000
• $300x = $30,000• x = 100 bikes
• Check• Sales $50,000
(100 x $500) • Var. Costs 20,000
(100 x $200)• CM $30,000• - Fixed 30,000 • Net Income -0-
Equation MethodBreak-even in sales dollars
• Sales = 100% x
• Variable costs = VC/SP = 200/500 = 40%x
• Fixed costs are the same for all sales levels
• Therefore, equation :
• 1X = .40X + $30,000
• .60X = $30,000
• x = $50,000 Break-even in sales dollars
Break-even Analysis
• Contribution Margin Method
• 1) Determine the CM per unit
• $500 - $200 = $300
• 2) Calculate how many units must be sold to break even by the following formula:
• Fixed costs $30,000 = 100 bikes
• CM per unit $300
Break-even Analysis
• In Sales Dollars
• B.E. in units x Sales price per unit
• OR
• Fixed Costs
• CM ratio
• = $30,000/.60 = $50,000
Target Profit AnalysisAdd desired profit to fixed costs
Before-Tax
• Equation Method• $500x = $200x +
$30,000 fixed + $60,000 Desired profit
• $300x = $90,000• x = 300 bikes
• Contribution Margin Approach
• $30,000 + $60,000• $300 • = $90,000/300 =• 300 bikes
Target Net Profit Analysis(After-tax)
• Desired After-Tax Profit
• 100% - Tax rate
• = Before-tax profit
• Example for after-tax profit of $36,000:
• $36,000/1-.40
• =$36,000/.60
• =$60,000 Before tax profit
C-V-P in a Multiproduct Environment
• Sales Mix - more than one product sold– Ratio of each product sold to total– Example: Pizza Hut sells pizza, breadsticks,
etc.– How many pizzas sold per breadsticks?– Assume four pizzas to one breadstick– Sales mix = 4P + 1B– This equation is called a “basket” of goods
C-V-P in a Multiproduct Environment
• Breakeven/Target Profit analysis for multiproducts - use the CM per basket of goods
• Example: Assume the CM for pizzas is $4 and the CM for breadsticks is $2, equation would be:
• 4P ($4) + 1B ($2) = $18 CM per basket of goods
• Proceed as usual with break-even analysis
C-V-P for MultiproductsBasket of Goods Approach
• Example: Fixed costs = $90,000
• Break-even point = $90,000/18 CM
• = 5,000 baskets of goods
• 1 basket = 4 P + 1B, therefore
• Break-even is 4 x 5000 = 20,000 pizzas and 1 x 5000 = 5,000 breadsticks
• All analysis is based on baskets of goods!!!
C-V-P for Multiproducts Weighted Average Approach
• Can weight the basket of goods to get a weighted average CM per unit
• (4/5 x $4) + (1/5 x $2) = $3.60
• $90,000/ $3.60 = 25,000 baskets of goods
• 25,000 x 4/5 = 20,000 pizzas
• 25,000 x 1/5 = 5,000 breadsticks
Cost Structure- what portions of costs are fixed or variable
• Company 1 - Pizza Pizza
• Sales$200,000• -Var. costs 150,000• CM 50,000• -Fixed costs 20,000• Net income 30,000
• Company 2 - Pizza oven manufacturers
• Sales$200,000• -Var. costs 50,000• CM 150,000• -Fix. costs 120,000• Net income 30,000
Cost Structure
• What is CM ratio for each company?
• Company 1 = 50,000/200,000
• Company 2 = 150,000/200,000
• Which company is riskier?
• Operating Leverage = Contribution Margin Net Income
• Higher operating leverage, more risky company
Product/Period Costs
• Product costs– Included in inventory until sold
• Manufacturing Costs– Direct material (DM)– Direct labor (DL)– Manufacturing overhead (OH)
• Prime costs – DM and DL– Conversion costs – DL and OH
• Period costs – Entire amount is expensed in period incurred– Selling, marketing and administrative costs
Direct/Indirect Costs
• Direct - costs directly related to cost object– Always direct materials and direct labor
• Indirect - costs not specifically associated with the cost object; varies based on cost object
• Cost objects: 1 Nissan truck, the Nissan truck division, the Smyrna Nissan plant
Problems/Cases
• P2-4 Silky Smooth Lotions
• P2-8 Taylor Chemicals
• P2-34 Candice Company
• ALL DUE NEXT WEDNESDAY, JANUARY 28