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Cost Structure

Cost Structure. UAA - ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee. Introduction . Cost structure is defined as the relationship between a firm’s fixed and variable costs. Cost Structure. Labor-Intensive = High Variable Costs. Cost Structure.

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Cost Structure

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  1. Cost Structure UAA - ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee

  2. Introduction • Cost structure is defined as the relationship between a firm’s fixed and variable costs. ACCT202 Principles of Managerial Accounting

  3. Cost Structure Labor-Intensive = High Variable Costs Cost Structure Machine-Intensive = High Fixed Costs ACCT202 Principles of Managerial Accounting

  4. Abacus Computers • Performs computer services for other firms: • Owns 2 computers • Employs two people • Bulk of costs are . . . • Rent Expense; and • Depreciation (S/L) ACCT202 Principles of Managerial Accounting

  5. Sales $500,000 100% Variable Costs 100,000 20% Contribution Margin $400,000 80% Fixed Costs 300,000 Net Income $100,000 Abacus Computers Income Statement For Year Ended December 31, 2003 ACCT202 Principles of Managerial Accounting

  6. Tailor Made Company • Manufactures custom made men’s suits • Owns one sewing machine • Employs six people • Bulk of costs are . . . • Materials; and • Labor ACCT202 Principles of Managerial Accounting

  7. Sales $500,000 100% Variable Costs 300,000 60% Contribution Margin $200,000 40% Fixed Costs 100,000 Net Income $100,000 Tailor Made Company Income Statement For Year Ended December 31, 2003 ACCT202 Principles of Managerial Accounting

  8. Abacus Sales $500 Sales $500 VC 300 VC 300 CM $200 CM $200 FC 100 FC 100 NI $100 NI $100 Abacus and Tailor Made Company Income Statement Comparison For Year Ended December 31, 2003 • Tailor Made ACCT202 Principles of Managerial Accounting

  9. Sales $500,000 100% Variable Costs 100,000 20% Contribution Margin $400,000 80% Fixed Costs 300,000 Net Income $100,000 Abacus Computers Income Statement For Year Ended December 31, 2003 Abacus Computers will increase its profits by $0.80 for each additional dollar of sales. ACCT202 Principles of Managerial Accounting

  10. Sales $500,000 100% Variable Costs 300,000 60% Contribution Margin $200,000 40% Fixed Costs 100,000 Net Income $100,000 Tailor Made Company Income Statement For Year Ended December 31, 2003 Tailor-Made Company will increase its profits by $0.40 for each additional dollar of sales. ACCT202 Principles of Managerial Accounting

  11. Periods of Decreased Activity . . . • Assuming no change in selling prices, unit VC and FC . . . • Abacus Computers will reduce its profits by $0.80 for each additional dollar of sales. • Tailor Made Company will reduce its profits by $0.40 for each additional dollar of sales. ACCT202 Principles of Managerial Accounting

  12. Periods of Increased Activity . . . • Assuming no change in selling prices, unit VC and FC . . . • Abacus Computers will increase its profits by $0.80 for each additional dollar of sales. • Tailor Made Company will increase its profits by $0.40 for each additional dollar of sales. ACCT202 Principles of Managerial Accounting

  13. Leverage . . . • To the scientist . . . • Leverage explains how one is able to move a large object with a small force. ACCT202 Principles of Managerial Accounting

  14. Operating Leverage • Is a measure of the extent to which fixed costs are being used in an organization. ACCT202 Principles of Managerial Accounting

  15. Financial Leverage • Financial leverage is the financing of a portion of the firm’s assets with securities bearing a fixed (limited) rate of return. ACCT202 Principles of Managerial Accounting

  16. Consider this . . . Labor-Intensive Firms % FC:TC Machine-Intensive Firms % FC:TC Therefore, machine-intensive firms use more operating leverage than labor-intensive firms. ACCT202 Principles of Managerial Accounting

  17. Consider two firms . . . Firm A Labor-Intensive Firm B Machine-Intensive Both increase sales by 20%. Which one will have the larger increase in profits? Why? ACCT202 Principles of Managerial Accounting

  18. Degree of Operating Leverage • The DOL is the measure of how a percentage change in sales volume at a given level of sales activity will affect profits. • A measure of how sensitive net operating income is to percentage changes in sales. ACCT202 Principles of Managerial Accounting

  19. Degree of Operating Leverage • The Formula . . . Contribution Margin ------------------------------------ = DOL Net Income ACCT202 Principles of Managerial Accounting

  20. Abacus Sales $500 Sales $500 VC 300 VC 300 CM $200 CM $200 FC 100 FC 100 NI $100 NI $100 Abacus and Tailor Made Company Income Statement Comparison For Year Ended December 31, 2003 • Tailor Made ACCT202 Principles of Managerial Accounting

  21. Degree of Operating Leverage • For Abacus Computers . . . $400,000 DOL = ------------------------- = 4 $100,000 ACCT202 Principles of Managerial Accounting

  22. Degree of Operating Leverage • For Tailor Made Company $200,000 DOL = ------------------------- = 2 $100,000 ACCT202 Principles of Managerial Accounting

  23. The Change in Net Income Abacus Computers $100,000 x 20% x 4 = $80,000 Tailor Made Company $100,000 x 20% x 2 = $40,000 ACCT202 Principles of Managerial Accounting

  24. Observations on DOL • The DOL varies at different levels of sales activity . . . • Highest near the breakeven point • Undefined at breakeven point • Lessens with increased sales volume ACCT202 Principles of Managerial Accounting

  25. The Margin of Safety • Excess of budgeted (or actual) sales over the break-even volume of sales. The amount by which sales can drop before losses begin to be incurred. Margin of safety = Total sales - Break-even sales ACCT202 Principles of Managerial Accounting

  26. The Margin of Safety Exhaustion Unlimited has a break-even point of $200,000. If actual sales are $250,000, the margin of safety is $50,000 or 100 exercise bikes. ACCT202 Principles of Managerial Accounting

  27. The Margin of Safety The margin of safety can be expressed as 20%of sales.($50,000 ÷ $250,000) ACCT202 Principles of Managerial Accounting

  28. Sales Mix • Sales mix is the relative proportions in which a company’s products are sold. • Different products have different selling prices, cost structures, and contribution margins. ACCT202 Principles of Managerial Accounting

  29. Multi-product break-even analysis Wind Bicycle Co. provides the following information: $265,000 $550,000 = 48.2% (rounded) ACCT202 Principles of Managerial Accounting

  30. Fixed expenses CM Ratio Break-even sales = $170,000 0.482 = = $352,697 Rounding error Multi-product break-even analysis ACCT202 Principles of Managerial Accounting

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