Chapter 9: Using Cost Information to Make Special Decisions
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This document discusses using cost information to make special decisions. It defines key terms like fixed and variable costs. It explains how to construct and interpret a break even chart. Special decisions may consider nonfinancial factors and tools like break even analysis can help by studying relationships between price, volume, and profits. The break even point is where total revenues equal total costs. Contribution margin and product margin are also defined and used in decision making.
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Chapter 9: Using Cost Information to Make Special Decisions
- 1. Using Cost Information to Make Special Decisions Chapter 9
- 2. Learning Objectives • Define fixed and variable costs • Compute price, fixed cost, variable cost per unit, or quality given to others • Construct and interpret a break even chart • Apply the concepts of contribution margin and product margin
- 3. Special Decisions • They are made on an as needed basis as opposed to a standard schedule • Nonfinancial criteria may outweigh financial criteria • Tools help make these decisions • Break even analysis • Role of fixed and variable costs • Break even chart • Contribution Margin • Product Margin
- 4. Break Even Analysis • Also called Cost-Volume-Profit (CVP) analysis • Studies relationships • Approach can determine price, charges, and reimbursement • Formula to determine total revenues • Total revenue=Price x Quantity
- 5. Role of Fixed Costs • The average fixed cost per visit is inversely related to volume as long as total fixed cost remains constant • Caution when using this for decisions major errors • Assuming that cost per unit does not change when volume changes • Using fixed cost per unit derived at one level to forecast total fixed costs at another level
- 6. Role of Variable Costs • 2 major characteristics • Total variable costs change directly with a change in activity • Variable cost per unit stays the same with a change in activity • Formula Total variable costs=variable cost per unit x number of units per activity
- 8. Break Even Equation • Price x Volume=Fixed Cost + Variable Cost • Break even formula can be used to : • Find Price • Find quantity • Find Fixed cost • Find Variable cost per unit
- 11. Break Even Chart • Graphically displays the relationships in the break even equation • Break even point is the point where total revenues equal total costs • Shortcut to calculating breakeven is Contribution Margin • Total Contribution Margin=Total Revenue-Total Variable Cost
- 12. Product Margin • Subtracting avoidable fixed cost from the total contribution margin yields product margin • Multiple Services-organizational fixed costs and service specific fixed costs • Avoidable fixed costs-a fixed cost that can be avoided if a service is not provided • Nonavoidable fixed costs- A fixed cost that will remain even if a specific service is discontinued
- 13. Product Margin Used in Special Decision Making • Make or Buy Decisions- After comparing product margins, the alternative with the higher product margin should be chosen • Adding or Dropping a Service-If proposed service is expected to have a positive product margin it should be added, if lower drop • Expanding or Reducing Service-Compare both product margins. Higher anticipated product margin should be chosen
- 14. Summary • In order to make a decision regarding a service, a break even analysis can be used. • Fixed and variable costs must be understood and used as a tool. • Total contribution and product margins must be understood • All contribute to the decision making process