ACCTG 211 1st Edition Lecture 27Review Areas for Focus Cost Behavior:Variable costs (VC) when stated on a per unit basis, variable costs remain constant across all production levels within the relevant rangefixed costs (FC) Fixed costs do not vary with the production level.Mixed costs If, within a relevant range, a cost is neither fixed nor variable, it is called semi-variable or mixed.Relevant range issues The relevant range is the range of activity (e.g., production or sales) over which these relationships are validGraphing the concepts: Total Costs = FC + VC  FC = TC - VCUsing the High/Low Method to separate Mixed Costs into the respective Variable and Fixed Costs “High-Low” Method: First, find the highest level of activity (in terms of units) Second, find the lowest level of activity (in terms of units)- Important: you must use both the “x” and “y” from each of the highest and lowest levels of activity Third, plug into the following formula to find the variable cost per unit (or the slope of the trend line): Variable Cost Per Unit = (Total Cost of Highest Level of Activity – Total Cost of Lowest Level of Activity) / ( Units of Highest Level of Activity – Units of Lowest Level of Activity) Equations- TC = FC + VC - TC = (VC per Unit X # of Units) + Total FC formula for a line: y = ax + b- y = total cost, x = volume- a = slope of the line, b = y-intercept- Slope of the line = variable costs per unit- Y-intercept = total fixed costsUnit Contribution Margin- Sales – Variable Costs = Contribution Margin Think of contribution margin (CM) as the amount “contributed” to covering fixed costs Once fixed costs are covered by CM, entirety of additional CM goes straight to profit Contribution Margin Ratio- CM ratio = CM / Sales (in total, per unit, by percentage)Contribution Margin Income Statement format Contribution Margin Income Statement - Sales – VC = CM – Fixed Costs = Net Income Break-even analysis & Cost-Volume-Profit  Goal: project profits (“P” for “profit”) for different production levels (“V” for “volume”) assumingdifferent cost structures (“C” for “cost”) In units &/or dollars  Units Sold = Units Produced Income Statement Approach  Traditional Income Statement - Sales – COGS = Gross Profit – Expenses = Net Income  The formulas  ( Total Fixed Costs + Any Desired Profit )/ ( Contribution Margin Per Unit )= # Units Required to Cover Fixed Costs and Desired Profit Weighted Average Contribution Margin (more than 1 product) (Aggregate sales - Aggregate variable expenses) / Number of units soldRelevant/irrelevant information Information is “relevant” for business decisions if it: Provides information about expected future revenues or costs Differs between alternatives Information is “irrelevant” for business decisions if it: Provides information about past revenues or costs (information about a past cost is dubbed a “sunk” cost) Does not differ between alternativesIncremental analysis Incremental Income = Decrease in TC – Decrease in Revenue - If negative: DO NOT DROP- If positive: DROP - Typically FC is not decrease but a special deal may be madeShort-term decisions to deal with: Special Order Pricing Target Costing  Cost-Plus- Start with the cost to produce- Add a reasonable profit margin- Set the sales price – remember, you have market power as a price-setter, so the market price is likely reasonable Keep/Drop (i.e., Discontinue?) segments under the following scenarios: Avoidable Fixed Costs Unavoidable Fixed Costs If we drop a segment, there is impact on another segment Product Mix (constrained resources) Outsourcing (we'll limit the discussion to Make or Buy) Sell-As-Is or Process Further Joint Production CostsCapital Budgeting Capital Budgeting is related to the purchase of property, plant, and equipment  Minimum desired rates of return: why we use them and how to calculate the weighted average cost of capital Capital investment decision methods:  Payback period Payback period = Amount Invested / Expected Annual CF For Uneven cash flow- Figure out atleast how many years and then figure out the portion of the final year that is needed by doing (Amount remaining/ CF from year)  Accounting rate of return ARR: the average annual rate of return over an asset’s life ARR = Average Annual Operating Income / Initial Investment- Average Annual Operating Income = Annual project income (accrual income) minus any depreciation expense Net present value Time value of money Equal and unequal cash flows Comparing the Cash flows vs. Income flows of potential