You are on page 1of 30

Cost Structure

UAA - ACCT 202 Principles of Managerial Accounting Dr. Fred Barbee

Introduction

Cost structure is defined as the relationship between a firms fixed and variable costs.

Dr. Fred Barbee

ACCT202 Principles of Managerial Accounting

Cost Structure
Labor-Intensive = High Variable Costs

Cost Structure

Machine-Intensive = High Fixed Costs


Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 3

Abacus Computers

Performs computer services for other firms:

Owns 2 computers

Employs two people

Bulk of costs are . . .


Rent Expense; and


Depreciation (S/L)
ACCT202 Principles of Managerial Accounting 4

Dr. Fred Barbee

Abacus Computers Income Statement For Year Ended December 31, 2003
Sales Variable Costs Contribution Margin Fixed Costs Net Income
Dr. Fred Barbee

$500,000 100,000 $400,000 300,000 $100,000


ACCT202 Principles of Managerial Accounting

100% 20% 80%

Tailor Made Company

Manufactures custom made mens suits


Owns one sewing machine Employs six people

Bulk of costs are . . .


Materials; and Labor


ACCT202 Principles of Managerial Accounting 6

Dr. Fred Barbee

Tailor Made Company Income Statement For Year Ended December 31, 2003

Sales Variable Costs Contribution Margin Fixed Costs Net Income


Dr. Fred Barbee

$500,000 300,000 $200,000 100,000 $100,000


ACCT202 Principles of Managerial Accounting

100% 60% 40%

Abacus and Tailor Made Company Income Statement Comparison For Year Ended December 31, 2003

Abacus
$500 100 $400 300 $100

Tailor Made
$500 300 $200 100 $100
8

Sales VC CM FC NI
Dr. Fred Barbee

Sales VC CM FC NI

ACCT202 Principles of Managerial Accounting

Abacus Computers Income Statement For Year Ended December 31, 2003

Sales $500,000 Abacus Computers will increase

100% 20% 80%

its profits by $0.80 for each Variable Costs 100,000 additional dollar of sales.
Contribution Margin Fixed Costs Net Income
Dr. Fred Barbee

$400,000 300,000 $100,000

ACCT202 Principles of Managerial Accounting

Tailor Made Company Income Statement For Year Ended December 31, 2003

SalesTailor-Made Company will $500,000

100% 60% 40%

increase its profits by $0.40 for Variable Costs 300,000 each additional dollar of sales.
Contribution Margin Fixed Costs Net Income
Dr. Fred Barbee

$200,000 100,000 $100,000

ACCT202 Principles of Managerial Accounting

10

Periods of Decreased Activity . . .

Assuming no change in selling prices, unit VC and FC . . .

Abacus Computers will reduce its profits by $0.80 for each additional dollar of sales.
Tailor Made Company will reduce its profits by $0.40 for each additional dollar of sales.
ACCT202 Principles of Managerial Accounting 11

Dr. Fred Barbee

Periods of Increased Activity . . .

Assuming no change in selling prices, unit VC and FC . . .

Abacus Computers will increase its profits by $0.80 for each additional dollar of sales.
Tailor Made Company will increase its profits by $0.40 for each additional dollar of sales.
ACCT202 Principles of Managerial Accounting 12

Dr. Fred Barbee

Leverage . . .

To the scientist . . .

Leverage explains how one is able to move a large object with a small force.

Dr. Fred Barbee

ACCT202 Principles of Managerial Accounting

13

Operating Leverage
Is

a measure of the extent to which fixed costs are being used in an organization.

Dr. Fred Barbee

ACCT202 Principles of Managerial Accounting

14

Financial Leverage

Financial leverage is the financing of a portion of the firms assets with securities bearing a fixed (limited) rate of return.

Dr. Fred Barbee

ACCT202 Principles of Managerial Accounting

15

Consider this . . .
Labor-Intensive Firms

FC:TC

Machine-Intensive Firms

FC:TC

Therefore, machine-intensive firms use more operating leverage than laborintensive firms.
Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 16

Consider two firms . . .


Firm A Labor-Intensive Firm B Machine-Intensive

Both increase sales by 20%. Which one will have the larger increase in profits? Why?
Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 17

Degree of Operating Leverage


The DOL is the measure of how a percentage change in sales volume at a given level of sales activity will affect profits. A measure of how sensitive net operating income is to percentage changes in sales.

Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 18

Degree of Operating Leverage


The

Formula . . .

Contribution Margin ------------------------------------ = DOL Net Income

Dr. Fred Barbee

ACCT202 Principles of Managerial Accounting

19

Abacus and Tailor Made Company Income Statement Comparison For Year Ended December 31, 2003

Abacus
$500 100 $400 300 $100

Tailor Made
$500 300 $200 100 $100
20

Sales VC CM FC NI
Dr. Fred Barbee

Sales VC CM FC NI

ACCT202 Principles of Managerial Accounting

Degree of Operating Leverage


For

Abacus Computers . . .

$400,000 DOL = ------------------------- = 4 $100,000

Dr. Fred Barbee

ACCT202 Principles of Managerial Accounting

21

Degree of Operating Leverage


For

Tailor Made Company

$200,000 DOL = ------------------------- = 2 $100,000

Dr. Fred Barbee

ACCT202 Principles of Managerial Accounting

22

The Change in Net Income


Abacus Computers $100,000 x 20% x 4 = $80,000

Tailor Made Company


$100,000 x 20% x 2 = $40,000
Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 23

Observations on DOL

The DOL varies at different levels of sales activity . . .

Highest near the breakeven point


Undefined at breakeven point Lessens with increased sales volume

Dr. Fred Barbee

ACCT202 Principles of Managerial Accounting

24

The Margin of Safety

Excess of budgeted (or actual) sales over the break-even volume of sales. The amount by which sales can drop before losses begin to be incurred.

Margin of safety = Total sales - Break-even sales

Dr. Fred Barbee

ACCT202 Principles of Managerial Accounting

25

The Margin of Safety


Exhaustion Unlimited has a break-even point of $200,000. If actual sales are $250,000, the margin of safety is $50,000 or 100 exercise bikes.
Break-even sales Actual sales 400 units 500 units Sales $ 200,000 $ 250,000 Less: variable expenses 120,000 150,000 Contribution margin 80,000 100,000 Less: fixed expenses 80,000 80,000 Net operating income Principles of Managerial Accounting 20,000 $ $ Dr. Fred Barbee ACCT202

26

The Margin of Safety


The margin of safety can be expressed as 20% of sales. ($50,000 $250,000)
Break-even sales 400 units Sales $ 200,000 Less: variable expenses 120,000 Contribution margin 80,000 Less: fixed expenses 80,000 Net operating income $ Dr. Fred Barbee

Actual sales 500 units $ 250,000 150,000 100,000 80,000 $ 20,000


27

ACCT202 Principles of Managerial Accounting

Sales Mix

Sales mix is the relative proportions in which a companys products are sold. Different products have different selling prices, cost structures, and contribution margins.

Dr. Fred Barbee

ACCT202 Principles of Managerial Accounting

28

Multi-product break-even analysis


Wind Bicycle Co. provides the following information:
Sales $ Var. exp. Contrib. margin $ Fixed exp. Net operating income Sales mix $ Bikes 250,000 100% 150,000 60% 100,000 40% Carts $ 300,000 135,000 $ 165,000 100% 45% 55% Total $ 550,000 285,000 265,000 170,000 $ 95,000 $ 550,000 100.0% 51.8% 48.2%

250,000

45%

300,000

55%

100.0%

Dr. Fred Barbee

$265,000 = 48.2% (rounded) $550,000 ACCT202 Principles of Managerial Accounting 29

Multi-product break-even analysis Fixed expenses


Break-even sales =

CM Ratio

$170,000 = 0.482

= $352,697
Bikes Carts Sales $ 158,714 100% $ 193,983 Var. exp. 95,228 60% 87,293 Contrib. margin $ 63,485 40% $ 106,691 Fixed exp. Rounding error Net operating income
Dr. Fred Barbee

100% 45% 55%

Total $ 352,697 182,521 170,176 170,000 $ 176 $ 352,697

100.0% 51.8% 48.2%

ACCT202 Principles of Managerial Accounting

30

Sales mix

$ 158,714

45%

$ 193,983

55%

100.0%

You might also like