costs Flashcards
some of the major uses of cost data
■ Business costs are a key factor in the ‘profit equation’. Profits or losses cannot be calculated without accurate cost data. If businesses do not keep a record of their costs, then they will be unable to take effective and profitable decisions, such as where to locate.
■ 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.
■ Keeping cost records also allows comparisons to be made with past periods of time. In this way, the efficiency of a department or the profitability of a product may be measured and assessed over time.
the most important catergories of cost classifications are:
■ direct costs ■ indirect costs ■ fixed costs ■ variable costs ■ marginal costs
examples of direct costs (these costs can be clearly identified with each unit of production and can be allocated to a cost centre)
■ One of the direct costs of a hamburger in a fast-food restaurant is the cost of the meat.
■ One of the direct costs for a garage in servicing a car is the labour cost of the mechanic.
■ One of the direct costs of the Business Studies department is the salary of the Business Studies teacher.
Indirect costs Indirect costs are often referred to as overhead
■ One indirect cost to a farm is the purchase of a tractor.
■ One indirect cost to a supermarket is its promotional expenditure. ■ One indirect cost to a garage is the rent
costs may be classified as follows:
■ Fixed costs: These remain fixed no matter what the level of output, such as rent of premises
. ■ Variable costs: These vary as output changes, such as the direct cost of materials used in making a washing machine or the electricity used to cook a fast-food meal
■ Marginal costs: These are the additional costs of producing one more unit of output, and will be the extra variable costs needed to make this extra unit
Break-even point of production
the level of output at which total costs equal total revenue, neither a profit nor a loss is made.
Break-even analysis can be undertaken in two ways:
1 the graphical method
2 the equation method
the break even chart itself is usually drawn showing three pieces of information
1 Fixed costs, which, in the short term, will not vary with the level of output and which must be paid whether the firm produces anything or not.
2 Total costs, which are the addition of fixed and variable costs; we will assume, initially at least, that variable costs vary in direct proportion to output.
3 Sales revenue, obtained by multiplying selling price by output level.
Margin of safety
the amount by which the sales level exceeds the break-even level of output
The break-even equation
break-even level of output= fixed cost divided by contribution per unit
The usefulness of break-even analysis
1 A marketing decision
2 An operations-management decision
3 Choosing between two locations for a new factory
the limitations of the break even analysis
■ Not all costs can be conveniently classified into fixed and variable costs. The introduction of semi-variable costs will make the technique much more complicated.
■ There is no allowance made 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.
■ It is also unlikely that fixed costs will remain unchanged at different output levels up to maximum capacity.
