Cost Management

2  Component of Managerial Accounting system ...focuses on improving the organisation ’ s cost effectiveness through understanding and managing the real causes of costs...

Types of costs  Direct Costs/Indirect Costs  Controllable/Uncontrollable Costs  Joint Costs  Relevant/Irrelevant Costs  Sunk Costs (Past costs)  Opportunity Costs  Fixed Costs  Variable Costs  Semifixed/Semivariable Costs (Mixed costs)

Cost Distribution  Single Allocation Base Approach Square Footage Sales Revenue Ratio Number of Employees Machine-hour basis Direct Labor-hour basis  Multiple Allocation Base Approach (activity-based costing)

Cost Distribution (Square Footage)  Example: Rooms: 40,000 square feet F&B: 15,000 square feet

Cost Distribution (Number of Employees)  Rooms: 14 people (41.18%)  F&B: 20 people (58.82%)

Why do I need to know this information? Good question. Here are some examples of when you would want to know this. Cost Behavior: Analysis and Use

Knowledge of Cost Behavior Setting Sales Prices Outsourcing Should we close? Buying/Replacing Equipment Which business should we buy?

Cost Behavior Patterns changes in levels of business activity.  The reaction of costs to changes in levels of business activity. Variable costs Fixed costs Mixed costs

Minutes Talked Total Telephone Bill Total variable costs change when activity changes. Your total telephone bill is based on how many minutes you talk. Variable Costs

Minutes Talked Per Minute Telephone Charge Variable costs per unit do not change as activity increases. The cost per minute talked is constant. For example, 10 cents per minute. Variable Costs

Number of customers Monthly Rent Total fixed costs remain unchanged when activity changes. The TOTAL monthly rent of your restaurant does not change based on the number of customers visiting the restaurant. Fixed Costs

Number of Customers Monthly Rent per Customer Fixed costs per unit decline as activity increases. Your average rent cost PER CUSTOMER decreases as you have more people visiting your restaurant. Fixed Costs

Example Laura Jorgensen is planning a party. She identifies two major costs: 1. Entertainment (a live band) 2. Food and drinks $3,650 was spent last year on this party: ♫ $525 for entertainment ☺ $3,125 for food and drinks

Example The spending limit for this event, this year, is $5,500. Prices for entertainment and food and drinks are expected to remain the same. 175 guests are expected to attend this year’s party, compared to 125 last year.

Cost Behavior Patterns 125 Guests175 Guests Total fixed cost: $525 $ Guests Cost per guest: $525 ÷ 125 = $ Guests Cost per guest: $525 ÷ 175 = $3.00

Cost Behavior Patterns What is the total variable cost for 175 guests? Cost per guest: $3,125 ÷ 125 = $25.00 What is the variable cost per guest?

Determining Total Cost What is the total cost for 175 guests? Total variable cost: $25 × 175 = $4,375 Total fixed cost = $525 Total cost: $525 + $4,375 = $4,900

Contribution Margin  Variable cost/Sales Revenue =Variable Cost Percentage (Ratio) Useful in setting pricing policy; price must be higher than variable costs and each sale will then make a contribution towards covering fixed costs and make profit. For example, if variable costs per unit of a product are $55 and the product sells for $100, the variable cost ratio is 55%. The difference between the selling price and variable cost/unit is known as unit contribution margin (CM); this amount is the contribution toward meeting fixed costs.

Should You Accept The Proposal?  You were asked to cater for a lunch for 60 people at $10 per person. Your variable costs average 60% of total sales revenue and total fixed costs are $146,000 per year. Determine the contribution margin and operating income. Should you accept the lunch proposal? Contribution Margin Income Statement Sales Revenue$600 Less: Variable Costs (60%x600)(360) Contribution Margin$240 Less: Fixed Costs (146,000/365)(400) Operating loss($160)

Should You Accept The Proposal?  By selling below the total cost of $760 ( ), we offset $240 of the $400 fixed costs that would be incurred with or without the function.  In the short-run as long as sales revenue exceeds variable costs and contributes towards fixed costs, it is beneficial to accept the business.

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 utility charge Fixed service fee Variable charge per kilowatt hour used Semi Variable Costs (Mixed Costs)

Variable Utility Charge Activity (Kilowatt Hours) Total Utility Cost Total mixed costs Fixed Monthly Utility Charge Semi Variable Costs (Mixed Costs)

Cost Behavior Summary

End of Cost Management