Managerial Accounting - Module 2 (Ch. 18) Sec. 1

Introduction

• Presenter: Larry Walter
• Chapter: 18
• Focus: Cost behavior patterns and implications for managing a business

Types of Costs

Variable Costs

• Definition: Costs that vary in direct proportion to changes in the level of activity
• Examples: Direct material, direct labor, sales force commissions
• Characteristics:
  • Each additional unit of production adds a uniform increment in cost
  • E.g., NGO produces portable music players, each requiring a digital chip costing $11
• Graphical Representation:
  • Total variable cost increases with production
  • Variable cost per unit remains constant
• Activity Base: The item or event that triggers a variable cost (e.g., units produced)

Fixed Costs

• Definition: Costs that do not fluctuate with changes in activity levels
• Examples: Management salaries, rent, property tax
• Characteristics:
  • Remains constant regardless of production volume
  • E.g., NGO leases manufacturing facility for $1.2M
• Graphical Representation:
  • Total fixed cost remains constant
  • Fixed cost per unit decreases with increased production

Business Cost Structure

• Importance: Knowing the proportion of fixed vs. variable costs is key for business management
• Examples:
  • Airlines: High fixed costs; profitability highly variable with economy
  • Tech Support Outsourcing: Controls fixed costs by paying per unit rather than maintaining a fixed staff

Relevant Range

• Definition: The level of activity for which cost and volume assumptions hold true
• Importance: Ensures cost behavior analysis remains accurate
• Example: Ordering parts in bulk due to cost advantages (Economies of scale)

Step Costs

• Definition: A type of fixed cost that increases in increments based on production levels
• Example: Assembly line production requiring additional lines as production increases
• Graphical Representation: Costs increase stepwise as production thresholds are met

Fixed Costs Nature

Committed Costs

• Characteristics: Long-term, unavoidable costs related to the firm's operations
• Examples: Depreciation, rent, insurance

Discretionary Costs

• Characteristics: Arising from top management’s yearly spending plans, adjustable
• Examples: Advertising budget, employee training programs

Optimization Strategies

• Economic Order Quantity (EOQ): Balancing carrying and order cost to achieve lower prices
• Overtime Premiums: Adjusting direct labor to avoid extra costs by better workload management

Conclusion

• Effective planning and analysis of cost behavior are crucial for maintaining a profitable business.