Untitled Quiz

Cost Behavior, Operating Leverage, and Profitability Analysis

• Chapter 11 of the Survey of Accounting textbook covers cost behavior, operating leverage, and profitability analysis.
• Key concepts include cost behavior (fixed vs. variable vs. mixed), contribution margin vs. gross margin, and break-even analysis.

Cost Classifications for Predicting Cost Behavior

• Cost behavior describes how a cost reacts to changes in activity level.
• Common classifications are fixed costs, variable costs, and mixed costs.

Cost Behavior (Fixed vs. Variable)

• Fixed costs remain constant regardless of volume changes.
• Variable costs change in direct proportion to volume (increase when volume increases, decrease when volume decreases).
• Mixed costs have both fixed and variable components.

Fixed Cost Behavior

• Understanding fixed cost behavior helps managers effectively plan costs.
• Total fixed costs remain constant, while per-unit fixed costs decrease with increased volume.
• Fixed costs are consistent with total cost behavior.
• Example: A concert promoter (SPI) paying a band $48,000 regardless of ticket sales. The cost per ticket changes depending on the number of tickets sold.

Risk and Reward Assessment

• Risk involves the possibility of sacrifices exceeding benefits.
• Fixed costs represent economic sacrifice and significant risk for ventures.
• Example: If SPI pays a band $48,000 but no tickets are sold, a loss results.
• Risk can be mitigated by shifting cost structures to variable costs. (paying per ticket instead of a fixed sum)

Fixed Cost Behavior Patterns

• Total fixed costs remain constant as activity levels change.
• Per-unit fixed costs decrease as activity increases and increase as activity decreases.
• Example table shows variations in annual rent and annual production (units) under different scenarios.

Variable Cost Behavior

• Variable costs change proportionately with activity levels.
• Variable cost per unit remains constant irrespective of volume.
• Example: Paying the band $16 per ticket sold. The total variable cost increases as the number of tickets sold increases.

Variable Cost Behavior Patterns

• When activity increases, total variable costs increase proportionately.
• When activity decreases, total variable costs decrease proportionately.
• Per-unit variable costs remain constant.
• Example table shows the total variable cost under different scenarios.

Shifting the Cost Structure from Fixed to Variable

• Shifting from fixed to variable costs helps avoid fixed cost risks.
• Example: A company is better off paying variable costs instead of a fixed cost if there's uncertainty regarding sales volume.

Fixed and Variable Cost Behavior

• Variable costs increase or decrease in line with activity levels
• Fixed costs remain constant regardless of activity level changes.
• Per unit values can vary depending on the level of activity.
• Tables illustrated fixed/variable cost behavior at different levels of activity.

Fixed vs. Variable Exercise

• Example demonstrating differences in total costs and per-unit costs for varying activity levels.
• McGreggor Industries exemplifies fixed and variable costs related to selling dog collars.

Mixed Costs (Semivariable Costs)

• Mixed costs have both fixed and variable components.
• Example: A service fee of $1,000 plus $20 per hour.
• The constant $1,000 is a fixed component, while the $20/hour is variable.

Mixed Costs Equation

• The total mixed cost can be represented as Y = a + bX where:
  • Y: total mixed cost
  • a: total fixed cost
  • b: variable cost per unit
  • X: level of activity

Calculating Mixed Costs

• Method to calculate total cost when a mixed cost is given, illustrating how fixed and variable costs combine to form mixed costs.
• Illustrative tables provide mixed cost calculation for different scenarios.

Examples of Mixed Costs

• Illustrative examples of mixed costs in various business contexts, including sales staff, truck rental, legal fees, and others.
• Categorized by fixed and variable components.

Fixed, Variable, or Mixed Exercise

• Application exercise to classify costs as fixed, variable, or mixed based on factors like customer count or sales figures.
• Illustrative examples for Molly's Restaurant in the context of activity level. (analyzing different costs at various levels)

The Relevant Range

• The activity range within which fixed and variable cost definitions are accurate.
• The relevant range changes when the company's activity level goes beyond its normal range of production or sales.
• Example: A concert hall with a capacity of 4000 people that the promotion company considers.

Contribution Margin Approach

• Income statements often classify costs by behavior patterns.
• Variable costs are subtracted from revenue to find contribution margin, which covers fixed costs and generates profits.
• Sales revenue minus variable cost is the contribution margin.

Bright Day Distributors: CM & BE Example

• Bright Day Distributors distributes a new herb mixture (Delatine).
• Selling price: $36/bottle; Cost: $24/bottle; advertising Campaign: $60,000.

Contribution Margin per Unit Method

• The difference between sales price per unit and variable cost per unit.
• Every sale contributes $12 to covering fixed costs then, profits.
• The amount left to pay fixed costs after paying the variable cost of production.

Determining the Break-Even Point

• The point where total revenue equals total costs, resulting in zero profit. There is no net income or loss.
• Methods: Equation method and unit sales method are employed.
• The break-even point is where profits and losses are calculated to be zero.

Equation Method

• Calculates the break-even point by setting profit to zero in the income statement equation.
• Demonstrates the calculation to obtain the break-even point in units for Delatine using the sales volume and related costs.

Break-Even Point in Units

• Calculates the break-even point in units needed to cover fixed costs based on the contribution margin per unit.
• This is a straightforward calculation, presenting the method and solution in units needed to achieve the break-even threshold.

Determining Break-Even Volume in Dollars

• Calculates the overall break-even point in dollars by multiplying the break-even point in units by the sales price per unit.

Determining the Sales Volume Necessary to Reach a Desired Profit

• Calculates the sales volume required to achieve a specific profit target.
• The variable cost per unit, fixed costs, and desired profit are factors in reaching this point.

End of Presentation