Lecture 6 - A technique to manage step variable cost

Question 1

(!!!!!!!!!) Describe the contribution margin model

Answer 1

The contribution margin:

General:
- Ref. Zakken Worre
- Variability, reversibility & divisibility
- Categorize when activity specified
- CM = Sales price - unit cost
- Ability to serve capacity pay interest & form profit
- Which costs as direct consequence of sales activities
- Sales price must at least cover unit cost
- Also called standard profit analysis

____________

Unit cost:
- Vary proportionately with sales: 100% Variability degree
- Vary to activity level: Degree of variability
- Danish: Stykomkostninger
- (Often cut out if MC < 0)
- Fully reversible
- Eg. mat. or bonus salary

Dependencies:
- Span of activity level
- Time horizon
- Ability to roll back costs

Examples:
- Direct materials
- Direct labour
- VOH

___________

Capacity costs:

General:
- All other operational costs than unit costs
- Do not vary proportionately w. production volume
- Categorized since reversibility: Gone if sale stop
- Choose highest CM if capacity constraint
- Not function of activity
- Visualized in capacity network
- Structured according to division
- Not always in balance sheet
- Key capacity as network center

First dimension:

Discretionary capacity cost:
- Periodical cash impact
- Eg. Salary, insurance & machine maintenance

Committed capacity costs:
- Depreciations

Second dimension:

Specific capacity costs:
- Specific product or product group
- Only one cost object
- Not always reversible

United direct capacity costs:
- Several cost objects
- Shared capacity
- Measured with high reliability
- Can be allocated valid
- Harm other area if lowered
- Eg. Electricity

United indirect capacity costs:
- Several cost objects
- Resource consumption unreliable
- Cannot be allocated valid

__________

Marketing cost:
- Not part of contribution margin model
- Not direct consequence of sales activity
- No link between effort & effect
- No link between time & space
- Unpredictable: Yet today more data
- Forward-looking

Question 2

(!!!!!!) Describe variability, reversibility & divisibility

Answer 2

General:
- Refers to relevant costs

Variability:
- Used for output
- Measured by degree
- Larger number = Less variable
- 1-to-1 proportional relation = VC
- Cost > 1 = Capacity cost
- Sales activity units vs. # resource units

____________

Reversibility:
- Used for input
- Possibility to get rid of resource
- Important if removing product
- Not necessarily symmetric
- Change if we do things different
- Time to get rid of resource until cost impact

Time horizons:

Unit cost / VC:
- Instant impact on cost if stopping activity

Labour cost:
- May take several weeks

____________

Divisibility:
- Used for input
- Dansk: Delelighed
- Make system usable for ABC
- Separate VC & capacity cost
- The contribution principle

Question 3

Describe the cost accounting system and what cost records must include

Answer 3

General:
- Qual. aspects reduced to quant. numerically term
- Storing system of cost data
- Base data on direct attribution: Validity & reliability
- Cost stored must clarify its variability & reversibility
- Must be updated ad-hoc

Aims:
- Inspire, adjust & facilitate change
- Predict & forecast for DM
- External & internal purposes: Law, contract & management

Cost record:
- Cost amount
- Number of cost units
- Number of capacity draft units
- Number of performance units

Important functions:
- Estimate normal / satisfying price
- Fix limit on price-cutting
- Determine if products profitable
- Control inventory
- Value inventory
- Test process efficiency
- Test department efficiency
- Detect losses, waste & pilfering
- Separate idleness from prod. cost
- Tie with financial accounts

Question 4

Describe the different categories of capacity costs

Answer 4

The basic capacities:
- Staff capacity
- Material capacity: Machine/equip.
- Accommodation cap.: Building

The associated capacities:
- Suppl. cap.: Eg. Substitute staff if busy
- Subst. cap.: Change in capacity driver. Outsourcing
- Rights: Patent. trademark, logo

Question 5

Describe the SWOT for VA & CCA

Answer 5

Strengths:
- Solid database
- Has human touch
- Understand business context
- Foundation for all managerial challenges

Weaknesses:
- Complicated concepts
- Difficult to put into practise
- Not for international audience
- Limited link to IT
- No precise, step-wise implementation guide

Opportunities:
- Possible to implement to IT
- If part of ERP, likely it will be used

Threats:
- Dynamic environment

Question 6

(!) What is a mixed, a step cost and relevant range?

Answer 6

General:
- Highlight problem of distinguishing VC & FC

Mixed cost:
- Partly fixed, partly variable cost
- Eg. Monthly payment + pay per call on phone

Step cost:
- Fixed until certain activity levels
- Not auto. ref. Worre: Diff. ways to get cap. for each capacity limit

Relevant range:
- The range within the valid assumptions. Eg. Fixed cost will increase at certain prod. level

Question 7

What are the demands for the cost accounting system according to Vagn Madsen?

Answer 7

• 1. Record all cost direct & to their connected attributes
• 2. “No arbitrary allocation”
• 3. Record cost to identified type
• 4. Cost record vary proportionately to 1 factor
• 5. All cost relate to variability factors in two dimensions: Object & department. Recorded as far down hierarchy as possible
• 6. Simultan identify cost type, object & department
• 7. No standard costs

Question 8

(?) Describe the basic cost accounting model for tracking capacity costs

Answer 8

General:
- Softer kind of measuring
- Ref. to the sheep example

______________

X-axis

Type of cost:
- Eg. Purchase price
- Eg. Scrap value

Information entrance:
- Reference person
- Ref. Cost center

Process:
- Eg. Yearly produced units

Object:
- Eg. Cost per prod. units

_____________

Y-axis:
- Costs
- Capacity draft units
- Performance units:

______________

Registration levels of capacity costs:

Cost in monetary units:
- Whole cost data without arbitrary allocation

Resource spending in units:
- Number units represented by the cost

Capacity draft units:
- Number of units covering the cost, equivalent to the capacity concept from ABC

Performance units:
- Measurable expression of output from the process

Question 9

(!) Describe capacity network

Answer 9

• Framework
• Key capacity as center
• Show interrelations

Question 10

(!) Describe the Local Brew example