Flashcards in Chapter 28 Cost Deck (16):
What are the uses of cost data?
1 Business costs are a key factor in the ‘profit equation’. Profits or losses cannot be calculated without accurate cost data.
2 Cost data are also of great importance to other departments, such as marketing. Marketing managers will use cost data to help inform their pricing decisions.
3 Keeping cost records also allows comparisons to be made with past periods of time. In this way, the efficiency of a department of the profitability of a product may be measured and assessed over time.
4 Help set budget
5 Comparing cost data can help a manager make decisions about resource use.
6 Calculating the costs of different options can assist managers in their decision making and help improve business performance.
What are the different categories of cost?
1 Direct costs
2 Indirect costs
3 Fixed costs
4 Variable costs
5 Marginal costs
Explain direct costs.
Direct costs are costs that can be clearly identified with each unit of production and can be allocated to a cost center
The two most common direct costs in a manufacturing business are labour and materials. The most important direct cost in a service business, such as retailing, is the cost of the goods being sold
Explain indirect costs
Indirect costs are costs that cannot be clearly identified with each unit of production or allocated accurately to a cost center
Indirect costs are often referred to as overheads. Examples are,
Explain Fixed cost
These costs do not vary with output in the short run, such as rent of premises
Explain Variable cost
These costs vary with output, such as the direct cost of materials used in making a washing machine.
Explain Marginal costs
These costs are the extra cost of producing one more unit of output.
What is the break-even point?
The break-even point of production is the level of output at which total costs equal total revenue – neither a profit nor a loss is made
What are the two ways to identify the break-even point?
1 The graphical method
2 The equation method
What is the margin of safety?
The margin of safety is the amount by which the sales level exceeds the break-even level of output
What is the formula to calculate Break-even?
break-even level of output = fixed costs
Selling price - variable cost
What are further uses of the break-even technique?
1 A marketing decision e.g. the impact of a price increase
2 An operations-management decision e.g. the purchase of new equipment with lower variable costs
3 Choosing between two locations for a new factory
What are the benefits of Break-even analysis?
1 Charts are relatively easy to construct and interpret
2 Analysis provides useful guidelines to management on break-even points, safety margins and profit/loss levels at different rates of output
3 Comparisons can be made between different options by constructing new charts to show changed circumstances.
4 The equation produces a precise break-even result.
5 Break-even analysis can be used to assist managers when taking important decisions, such as location decisions, whether to buy new equipment and which project to invest in.
What are the limitations to break-even analysis?
1 The assumption that costs and revenues are always represented by straight lines is unrealistic. Not all variable costs change directly or ‘smoothly’ with output. The revenue line could be influenced by price reductions made necessary to sell all units produce at high output levels.
2 Not all costs can be conveniently classified into fixed and variable costs. The introduction of semi-variable costs will make this technique much more complicated.
3 There is no allowance for inventory levels on the break-even chart. It is assumed that all units produced are sold. This is unlikely to always be the case in practice.
4 It is also unlikely that fixed costs will remain unchanged at different output levels up to maximum capacity
How to calculate safety margin?
Safety margin = Sales volume - Break-even point (in units)