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Basic Cost Concepts

Basic Cost Concepts. Chapter 6. Cost Related Questions. What Are the Hotel’s Fixed Costs? Which Costs Are Relevant to Purchasing a New Microcomputer? What Are the Variable Costs of Serving a Steak Dinner? What Is the Opportunity Cost of Adding 25 Rooms to the Motel?. Cost Related Questions.

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Basic Cost Concepts

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  1. Basic Cost Concepts Chapter 6

  2. Cost Related Questions • What Are the Hotel’s Fixed Costs? • Which Costs Are Relevant to Purchasing a New Microcomputer? • What Are the Variable Costs of Serving a Steak Dinner? • What Is the Opportunity Cost of Adding 25 Rooms to the Motel?

  3. Cost Related Questions • What Is the Standard Cost of Catering a Banquet for 500 People? • What Are the Hotel’s Controllable Costs? • How Are Fixed Cost Portions of Mixed Costs Determined?

  4. Cost Related Questions • How Are Costs Allocated to the Operating Departments? • Which Costs Are Sunk Costs in Considering a Future Purchase? • Which Costs Are Relevant to Pricing a Lobster Dinner?

  5. Cost Terminology • Fixed Costs - Costs That Are Normally Not Affected by Changes in Sales Volume Over a Relevant Range • Rent, Insurance, Taxes • Relevant Range - Range of Activity Under Which Cost Data Are Valid • 100 to 300 rooms sold • 301 to 500 rooms sold

  6. Cost Terminology • Variable Costs - Costs That Are Constant on a Per Unit Basis • Salad bar; Gasoline • Mixed Costs - Also Called Semi Fixed or Semi Variable Costs and Have a Fixed and a Variable Component • Telephone Bill; Utility Bill

  7. Cost Terminology • Controllable Costs - Costs That Can Be Changed in the Short Run and Are Under the Control of an Operating Manager • Hourly Wages; Supplies • Noncontrollable Costs - Costs That Normally Cannot Be Changed in the Short Run • Taxes; Insurance

  8. Cost Terminology • Prime Costs - Material Plus Labor • Unit Cost - Cost Per Salable Unit

  9. Cost Terminology • Avoidable Costs - Fixed Costs That Are Eliminated During a Shutdown • Insurance & Labor • Capacity Fixed Costs - Costs Incurred When Providing Goods or Services • Depreciation; Taxes

  10. Cost Terminology • Discretionary Fixed Costs - Costs That Management Can Avoid • Educational & Training Costs • Step Costs - Costs That Change Due to Changes in a Range of Activity • Housekeeping wages 100-300 rooms • Housekeeping wages 301-400 rooms

  11. Cost Terminology • Overhead Costs - All Costs Other Than Direct Costs Incurred by Profit Centers (Indirect Costs) • Differential Costs - Costs That Differ Between Two Alternatives • Sunk Cost - A Past Cost Relating to a Past Decision

  12. Cost Terminology • Average Cost - Cost to Produce an Item (Include All Costs) • Incremental Costs - How Much It Costs to Produce Another Unit (Variable Costs Only)

  13. Cost Terminology • Standard Costs - What Costs Should Be Under Ideal Situations • Indifference Point - The Level of Activity Where Costs Are the Same Under Variable and Fixed Arrangements

  14. Determination of Mixed Cost Elements • TMC = FC + (VC/Unit * Unit Sales) • High - Low (Two Point Method) • Scattergram • Regression Analysis (Method of Least Squares)

  15. High - Low (Two Point Method) • Select a Sample High and Low Month for Sales (or Costs) • Calculate Difference in Two Measures (Sales or Costs and Activity)

  16. High - Low (Two Point Method) • Divide Activity Difference Into Sales or Cost Difference • Result Is Variable Cost Per Unit • Solve for Fixed Costs

  17. Scattergram • Graph Sales (Cost) Data With Activity • Draw Best Straight Line Through Data • Where Intersects Y Axis Is Fixed Costs • Solve for Variable Cost Per Unit

  18. Regression AnalysisMethod of Least Squares • Computation of BestStraight Line • Y = a + bx • b = Slope of Line or Variable Cost Per Unit • A = Y Intercept or Fixed Cost

  19. Indifference Point • Formula VC% * Revenue = FC • Assume Fixed Lease of $48,000 or 5% or Revenue 0.05 * (revenue) = $48,000 Revenue = $48,000 / 0.05 Revenue = 960,000 • If sales will be < $960,000 use VC lease • If sales will be > $960,000 use FC lease

  20. Cost Allocation • Distribution of Overhead Costs to the Profit Centers • Single Allocation Base Approach - Uses a Single Factor Such As Square Footage, Number of People, Revenue • Multiple Allocation Approach - Use the Most Closely Related Factor

  21. Analysis After Allocation • What Is Income (Loss)? • Which Allocated Overhead Costs Are Fixed? • What Other Departments Are Affected? • Any Operating Alternatives?

  22. Use of Cost Data • Which Piece of Equipment Should Be Purchased? • How Much Should We Charge? • Can We Sell Below Cost?

  23. Use of Cost Data • What Time Periods Should We Be Open? • Should We Close For the Season? • Which Segment Should Get the Most Support?

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