How Costs Behave

Chapter 10

The Dorli Farmers Society

Find the Breakeven Point.

How costs are related to the volume?

Cost of Crop Rs. 40 per unit (Variable) Transport hire: There appears to be a minimum figure of Rs. 5000 plus Rs.5 per unit quantity over 500 units. Bags: Rs.1 per unit quantity Rent: Fixed at Rs. 1,000. Labour wages: There appears to be a minimum figure of Rs. 2,500, which increases by Rs. 1 per unit for any increase over 700 units.

How costs are related to the volume?

Salaries: Fixed at Rs. 5,000. Crop Treatment: Rs. 2,000 minimum plus Rs. 1 per unit for any increase over 800 units. Stationery, postage and meeting expenses: Fixed total of Rs. 500.

How costs are related to the volume?

If X = the unit sold, Revenue = 60X Cost of Crop = 40X Transport costs = 5,000 + 5 (X-500) Bags = 1X Rent = 1,000

How costs are related to the volume?

Labour wages = 2,500 + (X-700) Salaries = 5,000 Crop Treatment = 2,000 + (X-800) Stationery, postage and meeting expenses: = 500

Breakeven Point
The point at which the Revenue will equal the costs is the break-even units and may be calculated as follows: Revenue = Total costs Revenue = Cost of Crop + Transport costs + bags + rent + wages + salaries + crop treatment + stationery, postage, meeting expenses. 60X = 40X + 5,000 + 5 (X-500) + X + 1,000 + 2,500 + (X-700) + 5,000 + 2,000 + (X-800) + 500 60X = 40X + 5,000 + 5X - 2,500 + X + 1,000 + 2,500 + X - 700 + 5,000 + 2,000 + X - 800 + 500

Breakeven Point
X = 1,000 units

This is the normal procedure to estimate BEP, but note that mathematical accuracy should not be allowed to delude members, or the manager, into believing that any form of economic activity can be forecast with complete accuracy.

Cost Terminology
Variable Costs costs that change in total in relation to some chosen activity or output Fixed Costs costs that do not change in total in relation to some chosen activity or output Mixed Costs costs that have both fixed and variable components; also called semivariable costs

Mixed Costs
Mixed costs contain a fixed portion that is incurred even when facility is unused, and a variable portion that increases with usage. Example: monthly electric bill
Fixed service fee (meter rent)
Variable charge per kilowatt hour used

Mixed Costs
Slope is variable cost per unit of activity. Variable
Utility Charge Fixed Monthly Utility Charge Activity (Kilowatt Hours)

Total Utility Cost

The Linear Cost Function

y = a + bX
The Dependent Variable: The cost that is being predicted The Slope of the Line: Variable cost per unit The Independent Variable: The cost driver

The Intercept: Fixed costs

Bridging Accounting and Statistical Terminology

Accounting
Variable Cost Fixed Cost Mixed Cost

Statistics
Slope Intercept Linear Cost Function

Cost Estimation Methods

1. 2. 3. 4. Industrial Engineering Method Conference Method Account Analysis Method Quantitative Analysis Methods
1. High-Low Method 2. Regression Analysis

Account Analysis Method

Estimates cost functions by classifying various cost accounts as variable, fixed, or mixed with respect to the identified level of activity
Is reasonably accurate, cost-effective, and easy to use, but is subjective

Quantitative Analysis
Uses a formal mathematical method to fit cost functions to past data observations Advantage: results are objective

High-Low Method
Simplest method of quantitative analysis Uses only the highest and lowest observed values

Steps in the High-Low Method

1. Calculate variable cost per unit of activity
Variable Cost per Unit of Activity

Cost associated with highest activity level Highest activity level

Cost associated with lowest activity level Lowest activity level

Steps in the High-Low Method

2. Calculate Total Fixed Costs
Total Cost from either the highest or lowest activity level (Variable Cost per unit of activity X Activity associated with above total cost) = Fixed Costs

3.

Summarize by writing a linear equation

Y = Fixed costs + ( Variable cost per unit of Activity * Activity ) Y = FC + (VCu * X)

Regression Analysis
Regression analysis is a statistical method that measures the average amount of change in the dependent variable associated with a unit change in one or more independent variables
Is more accurate than the High-Low method because the regression equation estimates costs using information from all observations; the High-Low method uses only two observations

A fast food joint selling pizza has recorded following costs. Analyse the costs and calculate BEP. Pizza Fixed Raw Electricit Total Month Revenue Fuel Misc Profit Sold # Costs material y Costs Jan-11 75 3750 2000 1125 1375 725 300 5525 -1775 Feb-11 140 7000 2000 2100 1700 920 325 7045 -45 Mar-11 300 15000 2000 4500 2500 1400 270 10670 4330 Apr-11 400 20000 2000 6000 3000 1700 330 13030 6970 May-11 370 18500 2000 5550 2850 1610 340 12350 6150 Jun-11 500 25000 2000 7500 3500 2000 350 15350 9650 Jul-11 420 21000 2000 6300 3100 1760 360 13520 7480

A fast food joint selling pizza has recorded following costs. Analyse the costs and calculate BEP. Pizza Fixed Raw Electricit Total Month Revenue Fuel Misc Profit Sold # Costs material y Costs Jan-11 75 3750 2000 1125 1375 725 300 5525 -1775 Feb-11 140 7000 2000 2100 1700 920 325 7045 -45 Mar-11 300 15000 2000 4500 2500 1400 270 10670 4330 Apr-11 400 20000 2000 6000 3000 1700 330 13030 6970 May-11 370 18500 2000 5550 2850 1610 340 12350 6150 Jun-11 500 25000 2000 7500 3500 2000 350 15350 9650 Jul-11 420 21000 2000 6300 3100 1760 360 13520 7480 Variable Mixed Mixed Variable Non Nature Fixed @ 1000+ 500+ @50/unit Variable 15/unit 5/unit 3/unit

A fast food joint selling pizza has recorded following costs. Analyse the costs and calculate BEP. Pizza Fixed Raw Electricit Total Month Revenue Fuel Misc Profit Sold # Costs material y Costs Jan-11 75 3750 2000 1125 1375 725 300 5525 -1775 Feb-11 140 7000 2000 2100 1700 920 325 7045 -45 Mar-11 300 15000 2000 4500 2500 1400 270 10670 4330 Apr-11 400 20000 2000 6000 3000 1700 330 13030 6970 May-11 370 18500 2000 5550 2850 1610 340 12350 6150 Jun-11 500 25000 2000 7500 3500 2000 350 15350 9650 Jul-11 420 21000 2000 6300 3100 1760 360 13520 7480 Variable Mixed Mixed Variable Non Nature Fixed @ 1000+ 500+ @50/unit Variable 15/unit 5/unit 3/unit

Fixed VC/unit
BEP (units)

2000 15

1000 5

500 3

325

3825 23

A fast food joint selling pizza has recorded following costs. Analyse the costs and calculate BEP. Pizza Fixed Raw Electricit Total Month Revenue Fuel Misc Profit Sold # Costs material y Costs Jan-11 75 3750 2000 1125 1375 725 300 5525 -1775 Feb-11 140 7000 2000 2100 1700 920 325 7045 -45 Mar-11 300 15000 2000 4500 2500 1400 270 10670 4330 Apr-11 400 20000 2000 6000 3000 1700 330 13030 6970 May-11 370 18500 2000 5550 2850 1610 340 12350 6150 Jun-11 500 25000 2000 7500 3500 2000 350 15350 9650 Jul-11 420 21000 2000 6300 3100 1760 360 13520 7480 Variable Mixed Mixed Variable Non Nature Fixed @ 1000+ 500+ @50/unit Variable 15/unit 5/unit 3/unit
Fixed VC/unit BEP (units) 2000 15 1000 5 500 3 325 3825 23 142

Cost Allocation: Support Deptt.

Chapter 15

25

A Dairy plant has two support departments (Plant Maintenance & Information Systems) and two operating departments (Milk Powder Plant & Butter Plant). Costs incurred in each department for a particular period is as follows. Allocate Support Department cost to Operating Departments as follows: Plant maintenance costs are allocated based on labor-hours Information systems cost are allocated based on budgeted computer time
OPERATING DEPARTMENTS Powder Plant 4,00,000 2,400 30% 1,600 80% Butter Plant 2,00,000 4,000 50% 200 10%

SUPPORT DEPARTMENTS

Plant Maint.
Budgeted Costs Plant Maintenance Budgeted labor-hours Percentage 200 10% 6,00,000

Information systems 1,16,000 1,600 20% -

Total
13,16,000 8,000 100% 2,000 100%

Information Systems
Budgeted computer time Percentage

A Dairy plant has two support departments (Plant Maintenance & Information Systems) and two operating departments (Milk Powder Plant & Butter Plant). Costs incurred in each department for a particular period is as follows. Allocate Support Department cost to Operating Departments as follows: Plant maintenance costs are allocated based on labor-hours Information systems cost are allocated based on budgeted computer time
OPERATING DEPARTMENTS Powder Plant 4,00,000 2,400 30% 1,600 80% Butter Plant 2,00,000 4,000 50% 200 10%

SUPPORT DEPARTMENTS

Plant Maint.
Budgeted Costs Plant Maintenance Budgeted labor-hours Percentage 200 10% 6,00,000

Information systems 1,16,000 1,600 20% -

Total
13,16,000 8,000 100% 2,000 100%

Information Systems
Budgeted computer time Percentage

A Dairy plant has two support departments (Plant Maintenance & Information Systems) and two operating departments (Milk Powder Plant & Butter Plant). Costs incurred in each department for a particular period is as follows. Allocate Support Department cost to Operating Departments as follows: Plant maintenance costs are allocated based on labor-hours Information systems cost are allocated based on budgeted computer time
OPERATING DEPARTMENTS Powder Plant 4,00,000 2,400 30% 1,600 80% Butter Plant 2,00,000 4,000 50% 200 10%

SUPPORT DEPARTMENTS

Plant Maint.
Budgeted Costs Plant Maintenance Budgeted labor-hours Percentage 200 10% 6,00,000

Information systems 1,16,000 1,600 20% -

Total
13,16,000 8,000 100% 2,000 100%

Information Systems
Budgeted computer time Percentage

Cost Allocation of Support Departments

Support Departments do not earn revenue from outside parties and therefore cost incurred by them has to be borne by operating departments. What will be total costs of Milk Powder Plant & Butter Plant after Support Department Costs are allocated to them? Methods
Direct Method Step-down Method Reciprocal Method

Next Session
Case : Rosemont Hill Health Center