1. ACTG 6310 Chapter 2 – The Nature of Costs

2. What is a cost? “A resource sacrificed or forgone to achieve a specific objective Not necessarily an expense; could go to asset first then be expensed. Example: inventory Actual outlays - resources have been sacrificed Examples: average cost, common cost, full cost, historical cost, joint cost, marginal cost, period cost, product cost, standard cost, fixed cost, opportunity cost, sunk cost, variable cost

3. Opportunity Costs Benefit forgone by choosing one course of action over another. This is not recorded in the accounting records. Sometimes the alternatives are easy to determine, other times not. There is always something else you can do with your money, time, space, etc.

4. Opportunity Costs Forward looking – not historical costs Not sunk, past costs –Inventory –Depreciation –Includes interest

5. Cost Variation Cost behavior –Variable –Fixed –Mixed (semivariable) –Step costs Relevant Range Choice of Cost Driver Marginal costs – cost of producing one more unit Average cost – Total costs/units produced Marginal cost DOES NOT equal average cost.

6. Cost-Volume-Profit Analysis Procedure that examines changes in costs -- variable and fixed-- and volume levels and the resulting effects on net income. Used for planning -- to determine effects of anticipated changes in revenues, variable costs, fixed costs and volume Used for controlling -- what happens to net income when changes occur

7. Contribution Margin Sales - Variable Costs Per unit –Sales Price per unit - var. costs per unit –Tells us how much in $ is contributed to firm Ratio –CM per unit/Sales price per unit –Tells us what % of each dollar is contributed to the firm

8. Example of Contribution Margin Billy Bob’s Bicycles (Sales of 200 bikes) Sales Revenues $100,000 Var. Costs 40,000 Contr. Margin 60,000 Less Fixed costs 30,000 Net Income $30,000

9. Contribution Margin CM in total = $60,000 CM per unit = –$100,000/200 bikes = $500 sales price per bike –$ 40,000/200 bikes = $200 var.costs per bike –$ 60,000/200 bikes = $300 CM per bike CM Ratio = –$300/$500 = 60% OR –$60,000/$100,000 = 60%

10. Break-even Analysis Algebraic equation method: Sales = Var. Costs + Fixed Costs $500x = $200x + $30,000 $300x = $30,000 x = 100 bikes Check Sales $50,000 (100 x $500) Var. Costs 20,000 (100 x $200) CM $30,000 - Fixed 30,000 Net Income -0-

11. Equation Method Break-even in sales dollars Sales = 100% x Variable costs = VC/SP = 200/500 = 40%x Fixed costs are the same for all sales levels Therefore, equation : 1X =.40X + $30,000.60X = $30,000 x = $50,000 Break-even in sales dollars

12. Break-even Analysis Contribution Margin Method 1) Determine the CM per unit $500 - $200 = $300 2) Calculate how many units must be sold to break even by the following formula: Fixed costs $30,000 = 100 bikes CM per unit $300

13. Break-even Analysis In Sales Dollars B.E. in units x Sales price per unit OR Fixed Costs CM ratio = $30,000/.60 = $50,000

14. Target Profit Analysis Add desired profit to fixed costs Before-Tax Equation Method $500x = $200x + $30,000 fixed + $60,000 Desired profit $300x = $90,000 x = 300 bikes Contribution Margin Approach $30,000 + $60,000 $300 = $90,000/300 = 300 bikes

15. Target Net Profit Analysis (After-tax) Desired After-Tax Profit 100% - Tax rate = Before-tax profit Example for after-tax profit of $36,000: $36,000/1-.40 =$36,000/.60 =$60,000 Before tax profit

16. C-V-P in a Multiproduct Environment Sales Mix - more than one product sold –Ratio of each product sold to total –Example: Pizza Hut sells pizza, breadsticks, etc. –How many pizzas sold per breadsticks? –Assume four pizzas to one breadstick –Sales mix = 4P + 1B –This equation is called a “basket” of goods

17. C-V-P in a Multiproduct Environment Breakeven/Target Profit analysis for multiproducts - use the CM per basket of goods Example: Assume the CM for pizzas is $4 and the CM for breadsticks is $2, equation would be: 4P ($4) + 1B ($2) = $18 CM per basket of goods Proceed as usual with break-even analysis

18. C-V-P for Multiproducts Basket of Goods Approach Example: Fixed costs = $90,000 Break-even point = $90,000/18 CM = 5,000 baskets of goods 1 basket = 4 P + 1B, therefore Break-even is 4 x 5000 = 20,000 pizzas and 1 x 5000 = 5,000 breadsticks All analysis is based on baskets of goods!!!

19. C-V-P for Multiproducts Weighted Average Approach Can weight the basket of goods to get a weighted average CM per unit (4/5 x $4) + (1/5 x $2) = $3.60 $90,000/ $3.60 = 25,000 baskets of goods 25,000 x 4/5 = 20,000 pizzas 25,000 x 1/5 = 5,000 breadsticks

20. Cost Structure- what portions of costs are fixed or variable Company 1 - Pizza Pizza Sales$200,000 -Var. costs 150,000 CM 50,000 -Fixed costs 20,000 Net income 30,000 Company 2 - Pizza oven manufacturers Sales$200,000 -Var. costs 50,000 CM 150,000 -Fix. costs 120,000 Net income 30,000

21. Cost Structure What is CM ratio for each company? Company 1 = 50,000/200,000 Company 2 = 150,000/200,000 Which company is riskier? Operating Leverage = Contribution Margin Net Income Higher operating leverage, more risky company

22. Product/Period Costs Product costs –Included in inventory until sold Manufacturing Costs –Direct material (DM) –Direct labor (DL) –Manufacturing overhead (OH) Prime costs – DM and DL –Conversion costs – DL and OH Period costs –Entire amount is expensed in period incurred –Selling, marketing and administrative costs

23. Direct/Indirect Costs Direct - costs directly related to cost object –Always direct materials and direct labor Indirect - costs not specifically associated with the cost object; varies based on cost object Cost objects: 1 Nissan truck, the Nissan truck division, the Smyrna Nissan plant

24. Problems/Cases P2-4 Silky Smooth Lotions P2-8 Taylor Chemicals P2-34 Candice Company ALL DUE NEXT WEDNESDAY, JANUARY 28