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Business

BU247

Esther Maier

Winter

Description

Differences Between ABC and Traditional Product Costs
1. Tradtional costing allocates all manufacturing overhead to products. ABC costing only
assigns manufacturing overhead costs consumed by products to those products
2. Traditional costing allocates all manufacturing overhead costs using a volume-related
allocation base while ABC costing also uses non-volume related allocation bases
3. Traditional costing disregards selling and admin expenses since they are assumed to be
period expenses. ABC costing directly traces shipping costs to products and includes non-
manufacturing overhead costs caused by products in the activity cost pools that are assigned to
products
Chapter 6: Cost Behaviour Analysis and Use
Variable and Fixed Cost Behaviour
Cost In Total Per Unit
Variable Total VC is proportional to VC per unit is constant
the activity level (ex. telephone cost/min)
Fixed Total FC remains constant FC per unit goes down as
activity level goes up
Variable Cost – dollar amount varies in direct proportion to changes in the activity level
Fixed Cost – dollar amount remains constant as the activity level changes
Step-Variable Cost – a resource that is obtainable in large chunks and whose costs
increase/decrease only in response to fairly wide changes in activity
An example of step-variable costs is maintenance
workers. Small changes in the level of production
are not likely to have any effect on the number of
maintenance workers employed. Only fairly wide
changes in the activity level will cause a change in
the number of maintenance workers employed.
Two Types of Fixed Costs:
1) Committed Fixed Costs – long-term, cannot be significantly reduced in short term (depreciation)
2) Discretionary Fixed Costs – may be altered in the short-term (advertising)
The relevant range of activity for a fixed cost is the range of activity over which the graph of
the cost is flat
Ex. Office space is available at a rental rate of $30,000/year in increments of 1,000 square feet.
As the business grows, more space is rented, increasing the total cost
Mixed Costs – a mixed cost has both fixed and variable
components If your fixed monthly utility charge
is $40 and your variable cost is
Y = a +
bX $0.03 per kilowatt hour, and your
monthly activity level is 2,000
kilowatt hours, what is the
amount of your utility bill?
Y = a + bX
Y = $40 + ($0.03 x 2,000) = $100
Ways to Analyze Mixed Costs
1) Scattergraph Method
- plot the data points, draw a line through the data points with about an equal number of points
above and below the line Now make a quick estimate of variable cost per unit and determine the cost equation:
2) High-Low Method The variable cost per hour of
maintenance is equal to the change
in cost divided by the change in
hours.
$2,400 = $8.00/hour
300
Therefore the Cost Equation for
Total Fixed Cost = Total Cost – Total Variable Cost
Maintenance is:
Total Fixed Cost = $9,800 - ($8/hour x 800 hours)
Total Fixed Cost = $9,800 - $6,400 Y = $3,400 + $8X
Total Fixed Cost = $3,400
3) Least Squares Regression Model (don’t have to know how to calculate for midterm)
A method used to analyze mixed costs if a scattergraph reveals an approximately linear
relationship between the X and Y variables.
This method uses all of the data points to estimate the fixed/variable cost components of a
mixed cost. The goal of this method is to fit a straight line to the data that minimizes the sum of
the squared errors.
The cost analysis objective is the same: Y = a + bX, and least-squares regression also provides
2
a statistic, called the R , which is a measure of how well the regression line fits to the data
points.
R varies from 0% to 100% and the higher percentage the better.
Contribution Format The contribution method emphasizes cost behaviour. Contribution margin covers fixed costs
and provides for income.
Chapter 7: Cost-Volume-Profit Relationships
Contribution Margin (CM) – the amount remaining from sales revenue after variable expenses
have been deducted
- CM is used first to cover fixed expenses and any remaining CM contributes to net operating
income
Total Per
Unit Every month, they must
Sales 87,750 $250
Less: Variable Expenses 52,650 generate at least $35,100 in
total CM to break even.
150
Contribution Margin 35,100 $100
Less: Fixed Expenses 35,000 Operating Income $ 100
Increased Number of Speakers to be Sold 25
Contribution Margin per Speaker x$100
Increase in operating income $2,500
If contribution margin per unit is $100, then for every additional speaker that the company can
sell during the month, $100 more will be available to help cover the fixed expenses.
CVP Graph – the relationships among revenues, costs, and level of activity in an organization
presented in graphic form
The break-
even point is
where profit is
0. CVP Relationships: Increase in Units
In this example, the variable expenses are increasing with sales, and the contribution margin is
increasing and covering fixed expenses progressively more.
Contribution Margin Ratio – the contribution margin as a percentage of total sales
CM ratio = Contribution Margin (or in terms of units) CM Ratio = Unit CM _
Sales Unit Selling Price
If the CM ratio is 40%, each $1.00 increase in sales results in a total contribution margin
increase of 40
Incremental Analysis – an analytical approach that focuses only on those items of revenue,
cost, and volume that will change as a result of a decision
Ex 1) There is an increase in advertising budget by $10,000 which increases sales by $30,000:
Solution 1: Alternate
Solution:
With this solution, you are multiplying the CM ratio by the incremental difference in sales.
Ex 2) Change in Variable Costs and Sales Volume
If the company is currently selling 400 speakers/month and management is considering using
higher quality components, which would increase variable costs and reduce the contribution
margin by $10/speaker. The higher quality would increase sales to 480 speakers/month.
Should the higher quality components by used? (The $10 increase in variable costs will
decrease

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