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Lecture Fundamental accounting principles (21e) - Chapter 21: Cost allocation and performance measurement

After completing this chapter you should be able to: Distinguish between direct and indirect expenses and identify bases for allocating indirect expenses to departments; explain controllable costs and responsibility accounting; analyze investment centers using return on assets, residual income, and balanced scorecard; analyze investment centers using profit margin and investment turnover. | Chapter 21 Cost-Volume-Profit Analysis Chapter 21: Cost-Volume-Profit Analysis Cost-volume-profit analysis is used to answer questions such as: What sales volume is needed to earn a target income? What is the change in income if selling prices decline and sales volume increases? How much does income increase if we install a new machine to reduce labor costs? What is the income effect if we change the sales mix of our products or services? Identifying Cost Behavior Cost-volume-profit analysis will allow us to answer many questions and make important decisions involving the relationships between the volume of activity and costs and revenues. Before we can answer these questions using cost-volume-profit analysis, we must first study cost behavior. Fixed Costs Total fixed costs remain constant as activity increases. Number of Local Calls Monthly Basic Telephone Bill Cost per call declines as activity increases. Number of Local Calls Monthly Basic Telephone Bill per Local Call C 1 We begin our study of cost behavior with fixed costs. Your basic land-line telephone has a monthly connect charge that remains constant regardless of the number of local calls that you might make. The monthly charge that is independent of call activity is a fixed cost. Fixed costs per unit decline as activity increases. Dividing your monthly connect fee by more local calls reduces the cost per call by spreading the fixed amount over a higher number of calls. For example, if your monthly connect charge is $20 and you make 40 local calls in a month, your cost per local call is $0.50. If you make 100 local calls in a month, your cost per local call is $0.20. Variable Costs Total variable costs increase as activity increases. Minutes Talked Total Costs Cost per Minute Minutes Talked Cost per Minute is constant as activity increases. C 1 Total variable costs increase as activity increases. For most people, the total land-line long distance telephone bill is based on the number of minutes talked. As | Chapter 21 Cost-Volume-Profit Analysis Chapter 21: Cost-Volume-Profit Analysis Cost-volume-profit analysis is used to answer questions such as: What sales volume is needed to earn a target income? What is the change in income if selling prices decline and sales volume increases? How much does income increase if we install a new machine to reduce labor costs? What is the income effect if we change the sales mix of our products or services? Identifying Cost Behavior Cost-volume-profit analysis will allow us to answer many questions and make important decisions involving the relationships between the volume of activity and costs and revenues. Before we can answer these questions using cost-volume-profit analysis, we must first study cost behavior. Fixed Costs Total fixed costs remain constant as activity increases. Number of Local Calls Monthly Basic Telephone Bill Cost per call declines as activity increases. Number of Local Calls Monthly Basic Telephone Bill per Local Call C 1 We begin