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Chapter_3_Notes

# Chapter_3_Notes - Chapter 3 Notes Please note that these...

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Chapter 3 Notes Please note that these notes are the notes I would use to teach the class in person. They do not replace your responsibility of reading the chapters, but are meant to assist you in succeeding in the course. Also, proper grammar may not be used in all instances as they are teaching notes. This chapter continues with the classification of costs into their fixed and variable components and introduces the contribution format income statement. Types of Cost Behavior Cost behavior focuses on the portion of a firm’s costs that is variable, fixed or mixed (semivariable – having a fixed and a mixed portion). This is important as firms with different cost structures respond to changes in volume differently. Variable costs – These costs are constant per unit but change in direct proportion with the activity level. If production increases by 30% then the related variable costs will also increase by 30%. Examples of variable costs would be hamburgers sold at McDonalds every hamburger sold increases variable costs by the same cost per hamburger. Some companies have a high proportion of variable costs (most restaurants and retail operations) and some have a low proportion of variable costs (most public utilities). For costs to be variable it must have an activity base – the activity that causes the cost to incur. It is also known as a cost driver. Examples of cost drivers include direct materials (as the number of shoes produced by Nike, the total direct material costs increase), direct labor, units sold (as the number of units sold increase, the total cost of goods sold increase) and units produced. The number of patients seen in a doctor’s office or the number of students served in a college cafeteria would also be cost drivers. Although they generate revenue, they also create costs. True variable versus step variable – a true variable cost increases with every unit while a step variable will stay constant for a period and then increase. For example an instructor can only teach 25 students on-line. Once the number of students exceeds 25 another instructor must be hired. The costs increase like steps. If the instructor receives \$2,000 to teach the course, the cost to the college if there is 1 student is \$2,000. If there are 10 students, the cost is \$2,000. If there are 25 students, the cost is \$2,000. Once the number of students increases to 26, the cost increases to \$4,000 up to 50 students. See exhibit 3-3

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Chapter_3_Notes - Chapter 3 Notes Please note that these...

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