1 / 24

The Behavior of Costs

16. The Behavior of Costs. Behavior of Costs. Cost-volume relationships : Fixed and variable costs Step-function costs. Relation of costs to volume. Higher volume causes higher costs : Variable costs = items of cost that vary, in total, directly and proportionately with volume

holmes-pate
Download Presentation

The Behavior of Costs

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. 16 The Behavior of Costs

  2. Behavior of Costs • Cost-volume relationships: • Fixed and variable costs • Step-function costs

  3. Relation of costs to volume • Higher volume causes higher costs: • Variable costs = items of cost that vary, in total, directly and proportionately with volume • Fixed costs = non-variable costs = items of cost that, in total, do not vary with volume • Semivariable costs = semifixed costs = partly variable costs = mixed costs = costs that include a combination of variable and fixed cost items

  4. Variable Costs • Items of cost that vary, in total, directly and proportionately with volume: • Volume refers to activity level • Examples: • Material costs varies with units sold • Electricity costs varies with production hours • Stationery and postage costs varies with number of letters written

  5. Fixed costs • Non-variable costs = items of cost that, in total, do not vary with volume: • Examples: • Building rent, property taxes, management salaries • Fixed cost per unit of activity decreases as the level of activity increases • Fixed costs are fixed for a range of activity and a limited period of time • Fixed costs may change for reasons such as a deliberate management decision to change them

  6. Cost-volume (C-V) diagram • Y or vertical axis reflects total cost • X or horizontal axis reflects volume • y = mx + b • y is the cost at a volume of x • m is the rate of cost change per unit of volume change, or the slope (variable costs) • b is the vertical intercept, which represents the fixed cost component

  7. TC = TFC +(UVC*X) • TC = total cost • TFC = total fixed cost (per time period) • UVC = Unit variable cost (per unit of volume) • X = volume • Equations for: • Variable cost line: TC = UVC*X • Fixed cost line: TC = TFC • Semivariable cost: TC = TFC + (UVC*X)

  8. Cost Relations • Average costs = total cost/volume • Average cost behaves differently than total cost • As volume goes up: • Total fixed cost remains constant, total variable costs goes up, per unit variable costs stays the same, per unit fixed cost goes down, per unit total cost goes down • As volume increases without limit, unit cost approaches variable unit cost and fixed cost per unit approaches zero

  9. Limitations of C-V Relations • A straight line approximates cost behavior only within a certain range of volume, the relevant range: • When volume approaches zero, management takes steps to reduce fixed costs • When volume exceeds relevant range, fixed costs increase

  10. Limitations (continued) • Amount of variable costs depends on the time period over which behavior is estimated (the relevant time period): • If the time period is one day, few costs are variable • Over an extremely long time period, no costs are fixed • Environmental assumptions must be made: • Wage rates, fringe benefits, material prices, technology changes

  11. “Sticky” Costs • Generally considered variable but fall less with decreases of activity than they rise with increases • Managers tend to increase resources more quickly than they decrease • Examples: • Sales commissions with minimum guarantees • Managers slower to fire employees than to hire

  12. Step-function costs • Incurred when costs are added in discrete chunks, e.g. a supervisor for every 10 • Adding the “chunk” of costs increases capacity • Height of a stair step (riser) indicates cost of adding incremental capacity • Step width (tread) shows how much additional volume of activity can be serviced by an additional increment of capacity

  13. Step function (continued) • If treads” are narrow and “risers” are low (i.e. steps are small), then steps can be approximated by a variable cost line • If it is believed within relevant time period, cost will remain within relevant range for a single stair step (tread), then cost is appropriately treated as a fixed cost for time period • Step functions are often hidden in C-V diagrams as either variable or fixed costs

  14. Questions to consider in selecting a volume measure • Input (resources used) or output (goods or services produced)? • Money or non-monetary quantities?

  15. Input or output? • Input measures: resources used (labor hours worked, labor cost, machine hours, kilowatt hours of electricity, pounds of material) • Output measures: units or dollars • Manufacturing costs might use input measures such as labor or machine hours • Retail stores might use dollar sales

  16. Money or non-monetary quantities? • A non-monetary measure is not affected by price changes and therefore may have some advantages • If price changes affect all costs equally, use of labor costs as an activity measure implicitly allows for price changes • Best volume measure should be related to the activity that causes cost • The more items of cost that are combined in the cost function the more difficult it is to relate causality to a single measure

  17. Profit-graph • Add revenue line to C-V diagram • Assumes constant selling price • UP = unit price= selling price • TR = total revenue

  18. Breakeven volume • TR = UP*X • TC = TFC + (UVC*X) • Breakeven: TR = TC • Substituting: UP*X = TFC + (UVC*X)  X = TFC/(UP - UVC)

  19. Contribution • Unit contribution = unit contribution margin = marginal income = unit selling price - variable cost per unit = UP - UVC • I = total income = (UP - UVC) * X - TFC • What is contribution: • First: contribution to cover fixed costs • Then: contribution toward profit

  20. Break-even volume • In units = Fixed costs/unit contribution • In revenue dollars = Fixed costs / contribution percent • Contribution percent = contribution margin percentage = contribution as a percent of revenues = (UP - UVC)/ UP

  21. Target Profit • Add to breakeven analysis to show units or dollar of sales to achieve a target (T) level of profit: UP*X = TFC + (UVC*X) + T X = (TFC+T)/(UP - UVC)

  22. Profit-graph shows how to improve profit performance: • Increase selling price • Decrease variable cost • Decrease fixed cost • Increase volume

  23. Measures of volume • Have assumed a single-product • If multiple productswith different cost structures, unlikely that units would be a reliable measure of activity: • Possible common denominators include: labor hours, labor dollars, machine hours, homogeneous quantities such as tons or barrels and sales value

  24. 16 End of Chapter 16

More Related