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ECON 203: Exam 4
cost behavior |
how costs behave relative to level of business activity |
fixed costs |
cost does not change regardless of how many units sold |
fixed cost per unit |
not fixed. can change with the number of units sold |
reviewing fixed cost data |
can reduce risk of undertaking an unprofitable venture |
physical leverage |
heavy objects can be moved with little effort |
operating leverage |
used by business managers to magnify smal changes in revenue into dramatic changes in profitability |
productivity |
the lever between revenue + profitability (small % change in revenue = dramatic % change in profitability) |
calculating percentage change in profitability |
(alternative measure - base measure) / base measure = % change |
base measure |
starting point (ex. 3,000 units [base] to 3,300 units [alternative measure]) |
risk |
possibility that the sacrifice may not exceed the benefits |
ultimate risk |
fixed cost - represents a commitment to an economic sacrifice (i.e. SPI pays a band X amount then nobody buys tickets) |
reduce risk |
change fixed costs to variable costs |
variable costs per unit |
remain constant regardless of how many sold (no matter how many tickets sold, the ticket cost is still $16) |
shifting from fixed to variable costs |
reduces potential profits. does not offer operating leverage. |
variable costs structure |
produces a proportional relationship between sales and profitability (10% increase/decrease in sales results in corresponding profitability). |
contribution margin |
revenue - variable costs. represents amount available to cover fixed expenses and thereafter provide company profits. |
net income |
contribution margin - fixed cos |
contribution style income statement |
cannot be used for public reporting, widely used internally |
HICO bottling pays a salary of $5,000 month. a salesperson is paid commission, $2 for each product sold The salesperson's cost is: |
variable |
contribution margin income statements |
allow managers to easily measure operating leverage |
magnitude of operating leverage |
contribution margin / net income |
magnitude of operating leverage # |
measures change in profitability ("4x greater change in profitability than a given change in revenue") - neither good nor bad |
fixed cost behavior |
cost per unit inversely changes with change in level of activity |
variable cost behavior |
changes proportionally with volume activity - cost per unit remains fixed at all levels of activity |
mixed costs |
fixed + variable (eg. room rental fixed, refreshments variable) |
relevant range |
when total cost remains the same whether 1 or 100 tickets are sold. the cost is fixed relative to ticket sales |
breaking even |
sales - variable costs - fixed costs = profit (net income) |
contribution margin per unit |
sales price - variable cost per unit = contribution margin per unit |
break even pt in units |
fixed costs / contribution margin per unit |
accuracy |
desirable, not not as important as relevance |
margin of safety |
gap between budgeted sales and sales required to break even. the amount by which actual sales can fall short before the company begins to incur losses |
margin of safety equation |
budgeted cost - break even cost / budgeted cost |
relevant information |
differs among the alternatives, future oriented |
historical costs |
not relevant because they do not differ between alternatives associated with current decisions |
sunk costs |
historical costs. incurred in the past, not relevant for current decisions |
opportunity costs |
sacrifice incurred in order to obtain an alternative opportunity. not cumulative. |
relevance |
independent from cost behavior, context sensitive, does not need to be exact |
quantitative |
deals in facts, measurable |
qualitative |
preference, immesurable |
differential revenue |
when relevant revenue differs among alternatives |
avoidable costs |
costs managers can eliminate by making specific choices |
unit-level costs |
costs incurred each time a company generates one unit of production |
batch-level costs |
increasing/decreasingunits have no effect |
product-level costs |
costs incurred to support specific products - quality inspections, engineering design, obtaining/defending patents |
facility level costs |
support the entire company ("facility-sustaining costs") building rent, landscaping, utilities. cannot be avoided unless the entire company is dissolved |
special order |
company is offered to sell its goods at a price significantly below its normal selling price |
outsourcing |
buying from companies as opposed to producing internally |
vertical integration |
reduced by outsourcing |
low-ball pricing |
lures a manufacturer in, then the supplier raises prices |
certified suppliers |
offer incentives to motivate suppliers to ship high-quality on a timely basis. suppliers + manufacturers work together to minimize costs |
segments |
organizing operations into subcomponents, used to make comparisons among different products/departments/divisions |
segment reports |
show segment revenues and costs. used to determine whether relevant revenues exceed relevant costs. |
equipment replacement decisions |
should be based on profitability analysis rather than physical deterioration |