Basics of financial management Chapter 12

Absorption costing (AC) Total costs Total volume Cost per unit = Cost per unit can only be calculated at the end of the period and changes in relation to volume change Actual volume Cost per unit changes in relation to volume change Budgeted volume Cost per unit does not change in relation to volume change Normal volume

Total fixed and variable cost at normal volume Full cost per unit Full (standard) cost per unit: Total cost per unit at normal volume Normal volume: Average capacity utilization for the next years based on estimated sales Total fixed and variable cost at normal volume Normal volume Full cost per unit = or, in case of proportional costs

Volume variance A > N  favourable variance A < N  unfavourable variance A = N  no volume variance

Direct costing (DC) Direct costing allocates only variable costs to products Variabele costs  Product costs Fixed costs  Period costs On the short-term the operating profit only depends on the (controllable) variable costs. Fixed costs are deducted directly from sales to calculate profit. Essence

Operating profit in direct costing Sales p x q Variable costs of sales -/- v x q Total contribution margin (p – v) x q Total fixed costs -/- F Operating profit (p – v) x q - F

Comparison AC and DC Production volume > sales volume  profit AC > profit DC Production volume = sales volume  profit AC = profit DC Production volume < sales volume  profit AC < profit DC Cause: treatment of fixed costs Difference: inventory change x fixed costs per unit

Costs and decision making Different costs for different purposes! Examples: Limiting factor approach Differential calculation

Limiting factor approach Maximizing profit is impossible due to a limiting factor External (market): Maximum sales volume < production capacity Internal: Production capacity < possible sales volume The solution is optimizing capacity allocation to products in order to realize the highest possible contribution margin.

Solution limiting factor approach External limiting factor First allocate capacity to the product with the highest contribution margin per product unit. Internal limiting factor First allocate capacity to the product with the highest contribution margin per limiting factor unit (e.g. machine time)

Differential calculation Calculation of change in costs and revenue in relation to a change in volume. Differential costs: Extra costs caused by an increase in volume above the basic volume. Example: Special order: Assessment on the basis of differential costs and differential revenue

Economic lifespan Period during which the average costs per product unit are lowest. Caused by: Purchase Use Costs include: Depreciation Interest Operating costs

Economic lifespan determination Value/ costs Operating costs Depreciation + interest Performance value Economic lifespan Technical lifespan