535handout_1 - IS/PM 535 Handout #1 This handout includes...

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1 IS/PM 535 Handout #1 This handout includes selected sections from chapters of two 24x7 books available on DePaul digital library for instruction purpose only. Chapter 5: Cost Behavior And The Relationship To The Budgeting Process by Eugene H. Kramer From Handbook of Budgeting, 4e, by Robert Rachlin (ed.), John Wiley & Sons, 1999 5.1 Introduction. Management is always faced with uncertainty about the future. Unless managers can forecast cost and revenue trends reasonably well, their decisions may yield unfavorable results. Forecasts concerning cost–volume–profit relationships are necessary to make accurate decisions about such matters as how many units should be manufactured, should price be changed, should advertising be increased, or should plant and equipment be expanded. 5.2 Cost Behavior. Cost–volume–profit relationships depend on accurate descriptions of cost behavior. Cost behavior is affected by a number of factors, including volume, price, efficiency, sales mix, and production changes. Therefore, any analysis must be made with regard to its limitations. The benefit of cost–volume–profit relationships is in understanding the interrelationships affecting profits. To be analyzed, all costs must be broken down into their fixed and variable portions. This is essential in determining what a cost will be at a certain point (usually defined as production or sales volume). Otherwise, management will not be able to regulate the costs properly, which is vital for efficient budgeting or for making any plans or decisions. Various alternatives as to how costs will be allocated may be utilized, and accurate cost estimates should be prepared for each alternative in determining the best decisions. (a) Fixed Costs. Costs that remain constant over the entire range of output are referred to as fixed costs. These costs are incurred simply because of the passage of time and do not change as a direct result of changes in volume. Exhibit 5.1 depicts the relationship of fixed costs on a graph. Exhibit 5.1. Relationship of fixed costs Depreciation, property insurance, property taxes, and administrative salaries are all examples of fixed costs. (b) Variable Costs. Costs that vary directly with changes in volume are referred to as variable costs. Exhibit 5.2 depicts the relationship of variable costs on a graph. Exhibit 5.2. Relationship of variable costs
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2 Variable cost equals unit cost multiplied by the volume. A good example is the direct materials used in making a product. Every automobile has one steering wheel. If steering wheels cost $10 each, then the steering wheel cost of one automobile is $10, of two automobiles $20, of 100 automobiles $1,000, and so on. Other examples include direct labor in variation with production volume and sales commissions and cost of goods sold in variation with sales volume. (c) Semivariable Costs.
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This note was uploaded on 10/11/2011 for the course ECT ect535 taught by Professor Susichan during the Fall '11 term at DePaul.

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535handout_1 - IS/PM 535 Handout #1 This handout includes...

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