HFT 3431 Chapter 6 Basic Cost Concepts

Cost Related Questions n What Are the Hotel’s Fixed Costs? n Which Costs Are Relevant to Purchasing a New Microcomputer? n What Are the Variable Costs of Serving a Steak Dinner? n What Is the Opportunity Cost of Adding 25 Rooms to the Motel?

Cost Related Questions n What Is the Standard Cost of Catering a Banquet for 500 People? n What Are the Hotel’s Controllable Costs? n How Are Fixed Cost Portions of Mixed Costs Determined?

Cost Related Questions n How Are Costs Allocated to the Operating Departments? n Which Costs Are Sunk Costs in Considering a Future Purchase? n Which Costs Are Relevant to Pricing a Lobster Dinner?

Cost Terminology n Fixed Costs - Costs That Are Normally Not Affected by Changes in Sales Volume Over a Relevant Range –Rent, Insurance, Taxes n Relevant Range - Range of Activity Under Which Cost Data Are Valid –100 to 300 rooms sold –301 to 500 rooms sold

Cost Terminology n Variable Costs - Costs That Are Constant on a Per Unit Basis –Salad bar; Gasoline n Mixed Costs - Also Called Semi Fixed or Semi Variable Costs and Have a Fixed and a Variable Component –Telephone Bill; Utility Bill

Cost Terminology n Controllable Costs - Costs That Can Be Changed in the Short Run and Are Under the Control of an Operating Manager –Hourly Wages; Supplies n Noncontrollable Costs - Costs That Normally Cannot Be Changed in the Short Run –Taxes; Insurance

Cost Terminology n Prime Costs - Material Plus Labor n Unit Cost - Cost Per Salable Unit

Cost Terminology n Avoidable Costs - Fixed Costs That Are Eliminated During a Shutdown –Insurance & Labor n Capacity Fixed Costs - Costs Incurred When Providing Goods or Services –Depreciation; Taxes

Cost Terminology n Discretionary Fixed Costs - Costs That Management Can Avoid –Educational & Training Costs n Step Costs - Costs That Change Due to Changes in a Range of Activity –Housekeeping wages rooms –Housekeeping wages rooms

Cost Terminology n Overhead Costs - All Costs Other Than Direct Costs Incurred by Profit Centers (Indirect Costs) n Differential Costs - Costs That Differ Between Two Alternatives n Sunk Cost - A Past Cost Relating to a Past Decision

Cost Terminology n Average Cost - Cost to Produce an Item (Include All Costs) n Incremental Costs - How Much It Costs to Produce Another Unit (Variable Costs Only)

Cost Terminology n Standard Costs - What Costs Should Be Under Ideal Situations n Indifference Point - The Level of Activity Where Costs Are the Same Under Variable and Fixed Arrangements

Determination of Mixed Cost Elements n TMC = FC + (VC/Unit * Unit Sales) n High - Low (Two Point Method) n Scattergram n Regression Analysis (Method of Least Squares)

High - Low (Two Point Method) n Select a Sample High and Low Month for Sales (or Costs) n Calculate Difference in Two Measures (Sales or Costs and Activity)

High - Low (Two Point Method) n Divide Activity Difference Into Sales or Cost Difference n Result Is Variable Cost Per Unit n Solve for Fixed Costs

Scattergram n Graph Sales (Cost) Data With Activity n Draw Best Straight Line Through Data n Where Intersects Y Axis Is Fixed Costs n Solve for Variable Cost Per Unit

Regression Analysis Method of Least Squares n Computation of Best Straight Line n Y = a + bx n b = Slope of Line or Variable Cost Per Unit n A = Y Intercept or Fixed Cost

Indifference Point   Formula VC% * Revenue = FC   Assume Fixed Lease of $48,000 or 5% or Revenue 0.05 * (revenue) = $48,000 Revenue = $48,000 / 0.05 Revenue = 960,000   If sales will be < $960,000 use VC lease   If sales will be > $960,000 use FC lease

Cost Allocation n Distribution of Overhead Costs to the Profit Centers n Single Allocation Base Approach - Uses a Single Factor Such As Square Footage, Number of People, Revenue n Multiple Allocation Approach - Use the Most Closely Related Factor

Analysis After Allocation n What Is Income (Loss)? n Which Allocated Overhead Costs Are Fixed? n What Other Departments Are Affected? n Any Operating Alternatives?

Use of Cost Data n Which Piece of Equipment Should Be Purchased? n How Much Should We Charge? n Can We Sell Below Cost?

Use of Cost Data n What Time Periods Should We Be Open? n Should We Close For the Season? n Which Segment Should Get the Most Support?

Homework n Textbook: Problems 4,6,11,14 –To be turned in