cost-analysis

Perhaps it occurred to you that one might order and

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Unformatted text preview: w such costs can vary based on quantities ordered. Perhaps it occurred to you that one might order and store large quantities of the diodes for use in future periods (after all, 1200 units at $.208 each > 3000 units at $0.08 each). In a subsequent chapter, you will learn how to calculate economic order quantities that take into account carrying and ordering costs in balancing these important considerations. Even direct labor cost can be subject to adjustment for overtime premiums, based on whether or not overtime is worked. It may or may not make sense to meet customer demand by ramping up production when overtime premiums kick in. Later in this book, you will learn how to perform incremental analysis for such decision tasks. The interplay between all of the different costs emphasizes the importance of good planning. The trick is to synchronize operations so that the benefits of each fixed cost are maximized, and variable cost patterns are established in the most economic position. All of this must be weighed against revenue opportunities; you must be able to sell what you produce. Some advanced managerial accounting courses present sophisticated linear programming models that take into account constraints and opportunities and project the ideal firm positioning. Those models are beyond the scope of an introductory class, but a number of simpler tools are available, and will be covered next. 360° thinking Please click the advert . 360° thinking . 360° thinking . Discover the truth at www.deloitte.ca/careers © Deloitte & Touche LLP and affiliated entities. Discover the truth at www.deloitte.ca/careers © Deloitte & Touche LLP and affiliated entities. Download free ebooks at bookboon.com 13 Discover the truth at www.deloitte.ca/careers © Deloitte & Touche LLP and affiliated entities. © Deloitte & Touche LLP and affiliated entities. D Cost Behavior Analysis Cost Analysis 2. Cost Behavior Analysis Good managers must not only be able to understand the conceptual underpinnings of cost behavior, but they must also be able to apply those concepts to real world data that do not always behave in the expected manner. Cost data are impacted by complex interactions. Consider for instance the costs of operating a vehicle. Conceptually, fuel usage is a variable cost that is driven by miles. But, the efficiency of fuel usage can fluctuate based on highway miles versus city miles. Beyond that, tires wear faster at higher speeds, brakes suffer more from city driving, and on and on. Vehicle insurance is seen as a fixed cost; but portions are required (liability coverage) and some portions are not (collision coverage). Furthermore, if you have a wreck or get a ticket, your cost of coverage can rise. Now, the point is that assessing the actual character of cost behavior can be more daunting than you might first suspect. Nevertheless, management must understand cost behavior, and this sometimes takes a bit of forensic accounting work. Let’s begin by considering the case of “mixed costs.” 2.1 Mixed Costs Many costs contain both variable and fixed components. These costs are called mixed or semi variable. If you have a cell phone, you probably know more than you wish about such items. Cell phone agreements usually provide for a monthly fee plus usage charges for excess minutes, text messages, and so forth. With a mixed cost, there is some fixed amount plus a variable component tied to an activity. Mixed costs are harder to evaluate, because they change in response to fluctuations in volume. But, the fixed cost element means the overall change is not directly proportional to the change in activity. To illustrate, assume that Butler’s Car Wash has a contract for its water supply that provides for a flat monthly meter charge of $1,000, plus $3 per thousand gallons of usage. This is a classic example of a mixed cost. Below is a graphic portraying Butler’s potential water bill, keyed to gallons used: Download free ebooks at bookboon.com 14 Cost Behavior Analysis Cost Analysis Look closely at the data in the spreadsheet, and notice that the “variable” portion of the water cost is $3 per thousand gallons. For example, spreadsheet cell B12 is $2,100 (700 thousand gallons at $3 per thousand); observe the formula for cell B12 in the upper bar of the spreadsheet (=(A12/1000)*3). In addition, the “fixed” cost is $1,000, regardless of the gallons used. The total in column D is the summation of columns B and C. The cost components are mapped in the diagram at the right. Hopefully, the preceding illustration is clear enough. But, what if you were not given the “formula” by which the water bill is calculated? Instead, all you had was the information from a handful of past water bills. How hard would it be to to sort it out? Could you estimate how much the water bill should be for a particular level of usage? This type of problem is frequently encountered in business, as many expenses (individually and by category) contain both fixed and variable com...
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