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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
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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 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%
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- Break-even Analysis
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
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 Profit AnalysisAdd desired profit to fixed costsBefore-Tax
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
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 portions of costs are fixed or variable
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 THURSDAY, JANUARY 23