1、Author: Collins Qian,Reviewer: Bob Armacost,bc,Cost Accounting,March 1998,Copyright 1998 Bain & Company, Inc.,2,Cost Accounting,Importance of cost allocation Client example Definitions direct vs. indirect, fixed vs. variable breakeven volume Exercises cost allocation breakeven volume Key takeaways,A
2、genda,3,Cost Accounting,Importance of cost allocation Client example Definitions direct vs. indirect, fixed vs. variable breakeven volume Exercises cost allocation breakeven volume Key takeaways,Agenda,4,Cost Accounting,Which products are profitable? What is the breakeven volume by product? Which pr
3、oducts require cost reduction efforts? How should we price our products? Which customer segments are most profitable?,It is critical to have accurate and complete cost data to make sound strategic and tactical management decisions.,Why Allocate Costs?,5,Cost Accounting,Historically, only 20% of manu
4、facturing costs were “shared” across product lines. Today, typically 50% of costs are “shared” across products. Shared costs might include rent, freight, and administrative costs. For simplicity, accounting tracks costs by function (e.g., materials, salaries, benefits) rather than by the activity de
5、voted to product lines (e.g., maintenance of product A, freight for product B) For costs that are not easily assigned to individual product lines, companies normally select the most convenient way to assign them, not necessarily the best way for example, companies tend to allocate rent costs based o
6、n something that is easy to measure, such as direct labor dollars for each product line. A better allocation method, however, might be the actual space resource demands of each product line,Most companies lack accurate cost data by product.,Why Costs Are Often Not Allocated Correctly,6,Cost Accounti
7、ng,Importance of cost allocation Client example Definitions direct vs. indirect, fixed vs. variable breakeven volume Exercises cost allocation breakeven volume Key takeaways,Agenda,7,Cost Accounting,Middle America Manufacturing, a Bain client, believed that all three of its product lines were profit
8、able.,Return on sales:,10.0%,2.4%,1.6%,Sales:,$250MM,$100MM,$75MM,Middle America Manufacturing - Estimated Profitability,8,Cost Accounting,After a thorough evaluation, the Bain team found that $8.0MM in costs had been allocated incorrectly among the three products.,Middle America Manufacturing - Cos
9、t Allocation,9,Cost Accounting,The Bain team also determined that an additional $18.8MM in costs should be allocated to the three products.,Middle America Manufacturing - Additional Costs,10,Cost Accounting,Bains analysis indicated that both bicycles and walking mowers were unprofitable. Middle Amer
10、ica then began to investigate whether to exit or fix these two businesses.,Return on sales:,7.2%,(3.0%),(6.9%),Sales:,$250MM,$100MM,$75MM,Middle America Manufacturing - Actual Profitability,11,Cost Accounting,Importance of cost allocation Client example Definitions direct vs. indirect, fixed vs. var
11、iable breakeven volume Exercises cost allocation breakeven volume Key takeaways,Agenda,12,Cost Accounting,Definitions:,Costs that do not vary directly with changes in output,Costs that vary directly with changes in output,Costs incurred directly in the production or delivery of a firms product or se
12、rvice. These costs can easily be identified with, or assigned to, a particular product,Costs generally incurred by the firm outside of the production process. These costs cannot easily be identified with, or assigned to, a particular product,All costs can be broken down along two dimensions.,Fixed,V
13、ariable,Direct,Indirect,vs.,vs.,Examples:,Equipment depreciation Rent Advertising,Raw materials Production labor Delivery costs,Direct labor Dedicated equipment Raw materials,SG&A Office supplies Plant manager,Rule of thumb:,If a particular cost changes when production increases or decreases, the co
14、st is variable.,If a particular cost “goes away” when a product is dropped from the product line, the cost is direct.,Types of Costs,13,Cost Accounting,All costs are variable over a very long time horizon (i.e., for very large increases in volume) Costs to run and maintain a computer system that tra
15、cks product orders are clearly fixed for a small change in volume, such as that associated with a slightly busy month. However, they are variable for a large change in volume, such as that associated with a new plant. Most costs are semi-variable (i.e., they tend to be added in lumps as volume incre
16、ases) Supervisory labor tends to be considered fixed because it is unlikely that additional supervisors would have to be added to handle a small increase, say 10%, in volume. But the workforce can only increase so much before an additional supervisor is needed. In theory, production labor is variabl
17、e. However, in many client situations, restraints placed by unions and difficulty in hiring and firing people in response to short-term volume fluctuations make it, in practice, semi-variable.,Defining the appropriate time horizon for the analysis is important.,A meaningful analysis will isolate the
18、 fixed cost and variable components of a particular cost,Fixed vs. Variable,14,Cost Accounting,The following is an illustration of cost behavior for fixed, semi-variable, and variable costs:,Cost (Dollars),Volume (Units),Variable costs,Semi-variable costs,Fixed costs,Fixed vs. Variable - Illustratio
19、n,15,Cost Accounting,It is useful to know the following terms when doing cost analysis:,Simplified income statement:,- Variable Cost,Gross Margin,- Fixed Cost,Operating Margin,Revenue = Price per Unit x Volume,Gross margin is also called “Gross Profit,” or “Contribution Margin”,Operating Margin is a
20、lso called “Operating Profit”,Revenue,Income Statement Terms,16,Cost Accounting,Breakeven volume is the volume at which the company covers its fixed costs. At breakeven volume, the operating profit is zero.,Volume,Contribution margin (i.e., revenue less variable costs),Fixed costs,Breakeven volume,$
21、,Operating Loss,Fixed costs,Unit contribution,Price per unit - Variable cost per unit,Breakeven volume =,Fixed costs,=,Operating Profit,Contribution Margin,Breakeven Volume,17,Cost Accounting,Operating Profit = Revenue - Costs= Revenue - Variable Costs - Fixed costs= (Price per unit x Volume) - (Var
22、iable cost per unit x Volume) - Fixed costs= Volume x (Price per unit - Variable cost per unit) - Fixed costs= Volume x Unit contribution - Fixed costsThe breakeven volume is the volume for which operating profit = 00 = Breakeven volume x Unit contribution - Fixed costs,Fixed costs,Unit contribution
23、,Price per unit - Variable cost per unit,Breakeven volume =,Fixed costs,=,Backup for Breakeven Formula,18,Cost Accounting,Importance of cost allocation Client example Definitions direct vs. indirect, fixed vs. variable breakeven volume Exercises cost allocation breakeven volume Key takeaways,Agenda,
24、19,Cost Accounting,All products are made using the same equipment and machinery Plant supervisors oversee production of all three products Equipment capacity exists to increase production by 50% Sales people sell all three products Sales people are paid a base salary, plus a commission which is a pe
25、rcentage of the selling price Most advertising is product specific The company uses a trucking company to deliver products to customers (costs are based on the length of trip and weight),Maple Leaf Company wants to allocate costs to the three products it makes and sells.,Cost Allocation Exercise - B
26、ackground,20,Cost Accounting,How would you characterize the following costs over a time horizon in which the company plans to increase sales volume by 10%?,Fixed,Variable,Direct,Indirect,CEOs salary Raw materials Supervisory labor Production floor labor Rent,Equipment depreciation Office supplies Fr
27、eight to customer Electricity to run machines Interest expense to finance inventory,Advertising Goodwill amortization Sales commissions Sales peoples salaries Sales travel and expenses,Costs:,Cost Allocation Exercise - Question,21,Cost Accounting,Cost Allocation Exercise - Answer,Most costs are fixe
28、d indirect or variable direct.,Fixed,Variable,Direct,Indirect,Advertising,Raw materials Production floor labor Freight to customer Interest expense to finance inventory Sales commissions,Equipment depreciation CEOs salary Supervisory labor Rent Office supplies Goodwill amortization Sales peoples sal
29、aries Sales travel and expenses,Electricity to run machines,22,Cost Accounting,Cost Components,Fixed vs. Variable,Direct vs. Indirect,Advertising,Fixed, because advertising is usually not tied directly to volume,Direct, because, in this case, most of it is product specific,Equipment depreciation,Fix
30、ed, because excess capacity exists for a 10% increase in volume,Indirect, because all products are made on the same machines,CEOs salary,Fixed, assuming his/her salary does not change with 10% sales increase,Indirect, because CEO oversees the whole company,Supervisory labor,Fixed, because it is unli
31、kely that additional supervisors will be needed to handle a 10% increase in volume,Indirect, because supervisors oversee production of all three products,Indirect, because all three products are produced at the same site,Rent,Fixed, assuming current facility has excess capacity,Cost Allocation Exerc
32、ise - Detailed Answer (1 of 3),23,Cost Accounting,Cost Components,Fixed vs. Variable,Direct vs. Indirect,Office supplies,Fixed, because it is unlikely that additional office supplies will be needed to handle 10% increase in volume,Indirect, because the office supplies are used to support all three p
33、roducts,Goodwill amortization,Fixed, because goodwill is not directly related to volume,Indirect, assuming the goodwill is incurred to support the whole company,Salespeoples salaries,Fixed, assuming that current sales force can handle 10% additional volume,Indirect, because each salesman sells all t
34、hree products,Sales travel and expenses,Fixed, assuming that 10% volume increase will not require significant increase in sales activities,Indirect, because sales-force handles all three products,Raw material,Variable, because a 10% increase in volume would require 10% more raw materials,Direct, bec
35、ause raw materials are directly traceable to individual products,Cost Allocation Exercise - Detailed Answer (2 of 3),24,Cost Accounting,Cost Components,Fixed vs. Variable,Direct vs. Indirect,Direct, because even though the products are made on the same machine, the hours spent working on each of the
36、 products are directly traceable,Production floor labor,Variable, because more production labor will be needed to handle the increase in volume,Freight to customers,Variable, because the freight cost clearly increases with the volume increase,Direct, because weight and distance can be directly trace
37、d to individual products,Interest expense to finance inventory,Variable, because more inventory means more inventory financing and hence more interest expense,Direct, because inventory is product specific,Sales commissions,Variable, because sales commissions are paid based on a percentage of sales,D
38、irect, because commissions are based on individual product sales,Electricity to run machines,Variable, because it clearly varies with volume,Indirect, because all products are made on the same machines,Cost Allocation Exercise - Detailed Answer (3 of 3),25,Cost Accounting,Labor In many client situat
39、ions, restraints placed by unions and difficulty in hiring and firing people in response to short term volume fluctuations make a portion of labor costs behave as fixed costsElectricity to run machines In theory this is direct, but in practice it is considered indirect because it is difficult to tra
40、ce electricity cost to products Also, the 80/20 rule applies here. Electricity is usually a small cost item, and, for simplicity, could be allocated using machine hours spent on productionAdvertising Usually, advertising is not tied to volume. For example, advertising to support a corporate brand is
41、 not tied to the volume of the products under that brand. If advertising is not tied to volume, it is fixed and indirect.,There are few caveats:,Cost Allocation Exercise - Caveats,26,Cost Accounting,A dean of a business school is considering starting an executive program. She estimates the revenues
42、and costs as follows:,Question: How many students does the program need to break even?,Costs:,Revenue:,Advertising Classroom rental (Each classroom can accommodate 15 students) Program administration Program directors salary Faculty salaries (The program will be staffed with 1 faculty member for eve
43、ry 5 students) Guest lecturer Room and board per student Text and supplies per student,Tuition per student,$3,000,$13,500,$500,$30,000 per classroom,$15,000,$20,000,$20,000 per faculty member,$12,000,$3,200,Breakeven Exercise - Background,27,Cost Accounting,Step 1: Categorize costs,Advertising Class
44、room rental Program administration Program directors salary Faculty salaries Guest lectures Room and board per studentText and supplies per student,Fixed,Variable,Step 2: Calculate fixed costs,Fixed costs:,$3,000 Advertising$15,000 Program administration$20,000 Program directors salary$12,000 Guest
45、lectures$50,000,Semi-Variable,First, you must categorize costs and calculate fixed costs.,Breakeven Exercise - Answer (1 of 3),28,Cost Accounting,Step 4: Calculate unit contributionUnit contribution = Price per unit - Variable cost per unit= $13,500 tuition- 3,200 room and board- 500 text and suppli
46、es$9,800,Step 3: Calculate semi-variable costs Classroom Faculty10 students $30,000 $40,00015 students $30,000 $60,00020 students $60,000 $80,000,Then you must calculate semi-variable costs and the unit contribution.,Breakeven Exercise - Answer (2 of 3),29,Cost Accounting,*The most effective way to
47、calculate the breakeven volume is to write a simple formula in Excel,Step 5: Calculate breakeven volumeBreakeven volume = For 10 students: = 12.2 students with 10 students the program does not,If you keep increasing the number of students by one and redoing the calculation*, you will find that the b
48、usiness school needs to have 15 students to break even on the executive program,Fixed costs,Unit contribution,$140,000,$9,800,Now you are ready calculate the breakeven volume.,For 15 students:,$120,000,$9,800,= 14.3 students,break even,Breakeven Exercise - Answer (3 of 3),30,Cost Accounting,Importan
49、ce of cost allocation Client example Definitions direct vs. indirect, fixed vs. variable breakeven volume Exercises cost allocation breakeven volume Key takeaways,Agenda,31,Cost Accounting,A company must know the total cost associated with the production and delivery of its good and services in orde
50、r to make the right strategic and tactical decisionsMost companies lack accurate cost data by product All costs can be broken down along two dimensions: fixed versus variable and direct versus indirectDefining the appropriate time horizon for costs is important because fixed costs are “fixed” only for a certain time frame Breakeven volume is the minimum amount of product that a company must sell in order to cover its fixed costs. At breakeven volume, the companys operating profit is zero,
