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8/4/2019 Cost Structure HO
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UAA - ACCT 202 Principlesof Managerial Accounting Dr. Fred
Barbee
Cost Structure
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 2
Introduction
Cost structure is defined as therelationship between a firms fixed and
variable costs.
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 3
Cost Structure
Cost Structure
Labor-Intensive = High VariableCosts
Machine-Intensive = High FixedCosts
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 4
Abacus Computers
Performs computer services for otherfirms:
Owns 2 computers
Employs two people
Bulk of costs are . . .
Rent Expense; and
Depreciation (S/L)
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 5
Abacus Computers
Income Statement
For Year Ended December 31, 2003
Sales $500,000 100%
Fixed Costs 300,000
Net Income $100,000
Variable Costs 100,000 20%
Contribution Margin $400,000 80%
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 6
Tailor Made Company
Manufactures custom made mens suits
Owns one sewing machine
Employs six people
Bulk of costs are . . .
Materials; and
Labor
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 7
Tailor Made Company
Income Statement
For Year Ended December 31, 2003
Sales $500,000 100%
Fixed Costs 100,000
Net Income $100,000
Variable Costs 300,000 60%
Contribution Margin $200,000 40%
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 8
Sales $500
VC 300
CM $200
FC 100
NI $100
Sales $500
VC 100
CM $400
FC 300
NI $100
Abacus
Abacus and Tailor Made Company
Income Statement Comparison
For Year Ended December 31, 2003
Tailor Made
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 9
Abacus Computers
Income Statement
For Year Ended December 31, 2003
Sales $500,000 100%
Fixed Costs 300,000
Net Income $100,000
Variable Costs 100,000 20%
Contribution Margin $400,000 80%
Abacus Computers will increase
its profits by $0.80 for eachadditional dollar of sales.
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 10
Tailor Made Company
Income Statement
For Year Ended December 31, 2003
Sales $500,000 100%
Fixed Costs 100,000
Net Income $100,000
Variable Costs 300,000 60%
Contribution Margin $200,000 40%
Tailor-Made Company will
increase its profits by $0.40 foreach additional dollar of sales.
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 11
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 profitsby $0.40 for each additional dollar of sales.
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 12
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 itsprofits by $0.40 for each additional dollar ofsales.
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 13
Leverage . . .
To the scientist . . .
Leverage explains how one is able tomove a large object with a smallforce.
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 14
Operating Leverage
Is a measure of the extent to which
fixed costs are being used in anorganization.
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 15
Financial Leverage
Financial leverage is the financing of a
portion of the firms assets withsecurities bearing a fixed (limited) rateof return.
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 16
Consider this . . .
Labor-Intensive Firms
Machine-IntensiveFirms
FC:TC%
% FC:TC
Therefore, machine-intensive firms usemore operating leverage than labor-
intensive firms.
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 17
Consider two firms . . .
Firm ALabor-Intensive
Firm BMachine-Intensive
Both increase sales by 20%.
Which one will have the largerincrease in profits?
Why?
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 18
Degree of Operating
Leverage
The DOL is the measure of how a
percentage change in sales volume at agiven level of sales activity will affectprofits.
A measure of how sensitive netoperating income is to percentagechanges in sales.
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 19
Degree of Operating
LeverageThe Formula . . .
Contribution Margin------------------------------------ = DOL
Net Income
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 20
Sales $500
VC 300
CM $200
FC 100
NI $100
Sales $500
VC 100
CM $400
FC 300
NI $100
Abacus
Abacus and Tailor Made CompanyIncome Statement Comparison
For Year Ended December 31, 2003 Tailor Made
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 21
Degree of Operating
Leverage
For Abacus Computers . . .
$400,000DOL = ------------------------- = 4
$100,000
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 22
Degree of Operating
Leverage
For Tailor Made Company
$200,000DOL = ------------------------- = 2
$100,000
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 23
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
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 24
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
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 25
The Margin of Safety
Excess of budgeted (or actual) salesover the break-even volume of sales.
The amount by which sales can dropbefore losses begin to be incurred.
Margin of safety = Total sales - Break-even sales
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 26
The Margin of Safety
Exhaustion Unlimited has a break-evenpoint of $200,000. If actual sales are
$250,000, the margin of safety is $50,000or 100 exercise bikes.Break-even
sales
400 units
Actual sales
500 units
Sales 200,000$ 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 -$ 20,000$
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 27
The Margin of Safety
The margin of safety can be expressed as20%of sales.
($50,000 $250,000)Break-even
sales
400 units
Actual sales
500 units
Sales 200,000$ 250,000$Less: variable expenses 120,000 150,000
Contribution margin 80,000 100,000
Less: fixed expenses 80,000 80,000
Net operating income -$ 20,000$
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 28
Sales Mix
Sales mix is the relative proportions inwhich a companys products are sold.
Different products have different sellingprices, cost structures, and contributionmargins.
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 29
Multi-product break-even
analysisWind Bicycle Co. provides the followinginformation:
Bikes Carts TotalSales 250,000$ 100% 300,000$ 100% 550,000$ 100.0%
Var. exp. 150,000 60% 135,000 45% 285,000 51.8%
Contrib. margin 100,000$ 40% 165,000$ 55% 265,000 48.2%
Fixed exp. 170,000
Net operating income 95,000$
Sales mix 250,000$ 45% 300,000$ 55% 550,000$ 100.0%
$265,000$550,000
= 48.2% (rounded)
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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 30
Multi-product break-even
analysis
Bikes Carts Total
Sales 158,714$ 100% 193,983$ 100% 352,697$ 100.0%
Var. exp. 95,228 60% 87,293 45% 182,521 51.8%
Contrib. margin 63,485$ 40% 106,691$ 55% 170,176 48.2%
Fixed exp. 170,000
Net operating income 176$
Sales mix 158 714$ 45% 193 983$ 55% 352 697$ 100 0%
Rounding error
Fixed expensesCM Ratio
Break-even sales =
$170,0000.482
= $352,697
=