Chapter 2 Notes - Cost Behavior Operating Leverage...

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Cost Behavior, Operating Leverage, & Profitability Analysis
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Cost Behavior Manner in which a cost changes as a related activity changes. Classifications of Cost Behavior Variable Costs Fixed Costs Mixed Costs
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Summer Vacation Let’s say you and 2 friends are going to Cancun for 4 nights. You are going to fly down there and stay in a hotel. The hotel charges $100 per night regardless of how many people stay in the room. TOTAL Expected Lodging Cost = $400
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Two days before you leave one more friend decides to come along. How does this affect your hotel bill? No change – total lodging is still $400 This is a fixed cost – The total cost does not change.
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Two days before you leave one friend comes down with chicken pox and can’t go. What happens to your hotel bill now? No Change This is a fixed cost – The total cost does not change
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How does all this affect you? Total Hotel Bill = $400 How much do you have to pay? Fixed Cost Behavior # of People (a) 2 people 3 people 4 people Total Lodging (b) $400 $400 $400 Lodging per person (b / a) $200 $133 $100
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What about the airfare? You were able to get plane tickets for $200 roundtrip per person. Variable Cost Behavior # of tickets (a) 2 3 4 Total Airfare (a * b) $400 $600 $800 Cost per ticket (b) $200 $200 $200
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Under a variable cost structure the cost per unit stays the same and the total cost changes Using the Variable Cost Structure avoids Fixed Cost Risk
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Whether a cost is fixed or variable depends on the underlying circumstances. Let’s look back at our lodging for spring break. What if we decide to stay 5 nights instead of 4? What if we come home a day early? # of Nights (a) 3 4 5 Total Lodging (a * b) $300 $400 $500 Cost per night (b) $100 $100 $100
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Here the lodging is a variable cost. The cost per night stays the same and the total cost changes. # of Nights (a) 3 4 5 Total Lodging (a * b) $300 $400 $500 Cost per night (b) $100 $100 $100
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Relevant Range What happens if three more friends decide to come along and you have a total of 6 people?
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