HB 302 Exam 3 Study Guide Chapter 6 Fixed Costs Remain constant in short run even when sales vary does not increase or decrease Includes Salaries rent expense insurance expense property taxes depreciation expense interest expense Classified as either capacity ability to provide goods services or discretionary costs that managers may choose to avoid in short run to meet budget Can be related to sales volume to determining the average fixed cost per unit sold Variable Costs Expense that changes with production output Includes cost of food sold cost of beverages sold some labor costs and supplies Determined by multiplying variable cost per unit by number of unit sales VC rise as production increases and fall when production decreases Step Costs Constant within a range of activity Increase or decrease based once a threshold is crossed Stairstep Pattern Mixed Cost Mix of both fixed and variable Total Mixed Costs Fixed Costs variable cost per unit X unit sales Total Costs Sum of Fixed variable step and mixed costs Total Costs Fixed Costs variable costs per unit X unit sales Three methods for Estimating Mixed Costs High Low Two Point Scatter Diagram Regression Analysis High Low Two Point Method 1 Select the two extreme months of sales activity 2 Calculate the differences in total mixed cost and activity for the periods 3 Divide the mixed cost difference by the activity difference to determine variable cost per activity unit 4 Multiply variable cost per activity unit by the total activity for the period of lowest sales to determine total variable cost 5 Subtract result from 4 from total mixed cost for the period of lowest activity to determine the fixed cost for the period 6 Check answer in Step 5 by repeating 4 and 5 for the period with the greatest activity 7 Multiply the fixed cost per period by the number of periods in the time span to calculate the fixed costs for the entire time period 8 Subtract the total fixed costs from the total mixed costs to determine the total variable costs Scatter Diagram Detailed approach to determining fixed and variable elements of a mixed cost 1 Prepare a graph with the independent varable on the horizontal axis and the dependent variable cost on the vertical axis 2 Plot data on the graph by periods 3 Draw a straight line through the points keeping an equal number of points above and below the line 4 Extend the line to the vertical axis The intersection indicates the fixed costs for the period 5 Multiply the fixed costs for the period by the number of periods to determine the fixed costs for the time span 6 Determine total variable costs by subtracting total fixed costs from total mixed costs 7 Determine variable costs per sales unit by dividing total variable costs by total units sold Regression Analysis mathematical approach to fitting straight line to data points perfectly 1 Straight Line Formula y a bx 2 Use this formula to determine values As a rule of thumb y dependent variable x independent variable n of periods in the time span 3 Evaluate Results Fixed vs Variable Costs Goods and services can be purchased as either a fixed or variable cost Managements decision is select fixed or variable cost arrangement based on cost benefit considerations Indifference point Level of activity at which the period cost is the same under either arrangement Example Food service operation has option of signing either an annual fixed least of 48 000 or a variable lease set at 5 of revenue The indifference point is then determined as follows Variable cost x Revenue Fixed Lease Cost 05 Revenue 48 000 Revenue 48 000 05 Revenue 960 000 This means that when annual revenue is 960 000 the lease expense will be 48 000 regardless of whether the lease arrangement is fixed or variable So if annual revenue exceeds 960 000 management should decide to go with a fixed lease Less than 960 000 and the logical choice would be to sign a variable lease Direct Costs Traced to a cost object with little effort These could be classified as a product a department project ext Typically benefit a single cost object therefore classification as direct indirect is done by taking the cost object into perspective Examples in a hotel Payroll and related expenses commissions contract cleaning guest transportation laundry and dry cleaning linen operating supplies reservations ext Indirect Costs Cannot be accurately attributed to a specific cost object Typically benefit multiple cost objects and impractical to trace them to individual products Examples undistributed operating expenses mgmt fees fixed charges income taxes Overhead costs All costs other than the direct costs incurred by profit centers Normally not distributed to profit centers Cost allocation is the process where managers distribute overhead costs among the profit centers Controllable Costs These are costs over which a person is able to exert an influence Examples include cost of food sold payroll expense food and service supplies expense versus rent expense which is not controllable However ALL costs are ultimately considered controllable given sufficient time and input GM and dept managers are held accountable for controllable costs Differential Costs Costs that differ between two alternatives Managers use these to narrow the set of cost considerations to those that make a difference between two alternatives These include labor utilities supplies and insurance Relevant Costs In order for cost to be relevant it must be differential future and quantifiable Cost must not have already occurred but must be incurred only after the decision is made Sunk Costs Past cost relating to a past decision Mgmt will review financial records to determine net book value cost less accumulated depreciation of a fixed asset that is to be replaced Managers consider the net book value of a fixed asset the sunk cost Opportunity Costs The cost of the best foregone opportunity in decision making Use calculations to determine best alternative Average and Incremental Costs Average Cost to provide products and services is determined by dividing the total production and service costs by the quality of production Incremental Costs is the cost to produce and serve the next product service ext Standard Costs A forecast of what actual costs should be under projected conditions Serve as comparisons for control purposes and as evaluations of productivity Chapter 7 Cost Volume Profit Analysis CVP Analysis Management Tool that expresses the relationships among various