S_Session 02 - Cost Concepts.pdf

Some costs or pools of costs may behave in a non

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Some costs (or pools of costs) may behave in a non-linear fashion Nonlinear Costs and Relevant Range 13 But their behavior may be (approximately) linear within some (relevant) range of activity.
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Defining Fixed and Variable Costs What decision are you trying to make (pricing, make-or-buy, operational improvements, etc.)? What is the time frame for the analysis (short vs. long)? What are ALL of the relevant cost drivers? (Not just the volume of products or services) Are costs linear with respect to their cost drivers? What is the relevant range for the decision? 14
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Practice: Fixed Cost or Variable Cost? Fixed or variable? If variable, what’s the cost driver? Raw materials Depreciation CEO compensation Assembly line labor Plant electricity Salesforce commissions Product manager salary 15
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Examples Direct Costs Fixed Costs Indirect Costs Variable Costs Costs 16
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Where are Fixed and Variable Costs in Published Financial Statements (Financial Accounting)? Balance sheet Work-in-process Finished goods Income statement Revenue - Cost of Goods Sold Gross Margin - SG&A Net Income 17
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Contribution Margin: A Key Concept in Decision-Making Contribution Margin (CM) = Revenues - All Variable Costs (Variable costs include variable manufacturing as well as variable SG&A costs but exclude all fixed costs.) Gross Margin (GM) (found in GAAP financial statements) = Revenues - All Costs of Goods Sold (Cost of Goods Sold includes both variable and fixed manufacturing costs but excludes all SG&A costs.) CM per unit is the contribution from each unit sold to: First, cover fixed costs. Then, earn a profit. 18
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Contribution Margin: A Key Concept in Decision-Making 19 COGS SG&A Gross Margin =Rev COGS Contribution Margin = Rev Variable Manufacturing Cost Variable SG&A Income Statement Revenue (-) Variable Manufacturing Cost (-) Fixed Manufacturing OH Gross Margin (-) Variable SG&A (-) Fixed SG&A Operating Profit
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An Example: Fixed and Variable Costs in Sales Force Compensation A wholesale company engages independent sales agents to market its products. These agents currently receive a
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