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8/4/2019 Cost Structure HO

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UAA - ACCT 202 Principlesof Managerial Accounting Dr. Fred

Barbee

Cost Structure


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Dr. Fred Barbee ACCT202 Principles of Managerial Accounting 2

Introduction

Cost structure is defined as therelationship between a firms fixed and

variable costs.


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Cost Structure

Cost Structure

Labor-Intensive = High VariableCosts

Machine-Intensive = High FixedCosts


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Abacus Computers

Performs computer services for otherfirms:

Owns 2 computers

Employs two people

Bulk of costs are . . .

Rent Expense; and

Depreciation (S/L)


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Abacus Computers

Income Statement

For Year Ended December 31, 2003

Sales $500,000 100%

Fixed Costs 300,000

Net Income $100,000

Variable Costs 100,000 20%

Contribution Margin $400,000 80%


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Tailor Made Company

Manufactures custom made mens suits

Owns one sewing machine

Employs six people

Bulk of costs are . . .

Materials; and

Labor


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Tailor Made Company

Income Statement


Sales $500,000 100%

Fixed Costs 100,000

Net Income $100,000




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Sales $500

VC 300

CM $200

FC 100

NI $100

Sales $500

VC 100

CM $400

FC 300

NI $100

Abacus

Abacus and Tailor Made Company

Income Statement Comparison


Tailor Made


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Abacus Computers

Income Statement


Sales $500,000 100%

Fixed Costs 300,000

Net Income $100,000



Abacus Computers will increase

its profits by $0.80 for eachadditional dollar of sales.


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Tailor Made Company

Income Statement


Sales $500,000 100%

Fixed Costs 100,000

Net Income $100,000



Tailor-Made Company will

increase its profits by $0.40 foreach additional dollar of sales.


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Periods of Decreased

Activity . . .

Assuming no change in selling

prices, unit VC and FC . . . Abacus Computers will reduce its profits by

$0.80 for each additional dollar of sales.

Tailor Made Company will reduce its profitsby $0.40 for each additional dollar of sales.


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Periods of Increased

Activity . . .

Assuming no change in selling

prices, unit VC and FC . . . Abacus Computers will increase its profits

by $0.80 for each additional dollar of sales.

Tailor Made Company will increase itsprofits by $0.40 for each additional dollar ofsales.


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Leverage . . .

To the scientist . . .

Leverage explains how one is able tomove a large object with a smallforce.


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Operating Leverage

Is a measure of the extent to which

fixed costs are being used in anorganization.


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Financial Leverage

Financial leverage is the financing of a

portion of the firms assets withsecurities bearing a fixed (limited) rateof return.


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Consider this . . .

Labor-Intensive Firms

Machine-IntensiveFirms

FC:TC%

% FC:TC

Therefore, machine-intensive firms usemore operating leverage than labor-

intensive firms.


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Consider two firms . . .

Firm ALabor-Intensive

Firm BMachine-Intensive

Both increase sales by 20%.

Which one will have the largerincrease in profits?

Why?


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Degree of Operating

Leverage

The DOL is the measure of how a

percentage change in sales volume at agiven level of sales activity will affectprofits.

A measure of how sensitive netoperating income is to percentagechanges in sales.


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Degree of Operating

LeverageThe Formula . . .

Contribution Margin------------------------------------ = DOL

Net Income


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Sales $500

VC 300

CM $200

FC 100

NI $100

Sales $500

VC 100

CM $400

FC 300

NI $100

Abacus

Abacus and Tailor Made CompanyIncome Statement Comparison

For Year Ended December 31, 2003 Tailor Made


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Degree of Operating

Leverage

For Abacus Computers . . .

$400,000DOL = ------------------------- = 4

$100,000


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Degree of Operating

Leverage

For Tailor Made Company

$200,000DOL = ------------------------- = 2

$100,000


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The Change in Net

Income

Abacus Computers

$100,000 x 20% x 4 = $80,000

Tailor Made Company

$100,000 x 20% x 2 = $40,000


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Observations on DOL

The DOL varies at different levels of

sales activity . . . Highest near the breakeven point

Undefined at breakeven point

Lessens with increased sales volume


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The Margin of Safety

Excess of budgeted (or actual) salesover the break-even volume of sales.

The amount by which sales can dropbefore losses begin to be incurred.

Margin of safety = Total sales - Break-even sales


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Exhaustion Unlimited has a break-evenpoint of $200,000. If actual sales are

$250,000, the margin of safety is $50,000or 100 exercise bikes.Break-even

sales

400 units

Actual sales

500 units

Sales 200,000$ 250,000$

Less: variable expenses 120,000 150,000

Contribution margin 80,000 100,000

Less: fixed expenses 80,000 80,000

Net operating income -$ 20,000$


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The margin of safety can be expressed as20%of sales.

($50,000 $250,000)Break-even

sales

400 units

Actual sales

500 units

Sales 200,000$ 250,000$Less: variable expenses 120,000 150,000

Contribution margin 80,000 100,000

Less: fixed expenses 80,000 80,000

Net operating income -$ 20,000$


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Sales Mix

Sales mix is the relative proportions inwhich a companys products are sold.

Different products have different sellingprices, cost structures, and contributionmargins.


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Multi-product break-even

analysisWind Bicycle Co. provides the followinginformation:

Bikes Carts TotalSales 250,000$ 100% 300,000$ 100% 550,000$ 100.0%

Var. exp. 150,000 60% 135,000 45% 285,000 51.8%

Contrib. margin 100,000$ 40% 165,000$ 55% 265,000 48.2%

Fixed exp. 170,000

Net operating income 95,000$

Sales mix 250,000$ 45% 300,000$ 55% 550,000$ 100.0%

$265,000$550,000

= 48.2% (rounded)


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Multi-product break-even

analysis

Bikes Carts Total

Sales 158,714$ 100% 193,983$ 100% 352,697$ 100.0%

Var. exp. 95,228 60% 87,293 45% 182,521 51.8%

Contrib. margin 63,485$ 40% 106,691$ 55% 170,176 48.2%

Fixed exp. 170,000

Net operating income 176$

Sales mix 158 714$ 45% 193 983$ 55% 352 697$ 100 0%

Rounding error

Fixed expensesCM Ratio

Break-even sales =

$170,0000.482

= $352,697

=

cost structure ho

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