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1、BAIN & COMPANYCost AccountingAuthor: Collins QianReviewer: Bob ArmacostImportanee of cost allocationClient exampleDefi nitions-direct vs. in direct, fixed vs. variable-breakeven volumeExercises-cost allocation-breakeven volumeAgendaBAIN & COMPANYKey takeawaysImportanee of cost allocationClie

2、nt exampleDefi nitions-direct vs. in direct, fixed vs. variable-breakeven volumeExercises-cost allocation-breakeven volumeAgendaBAIN & COMPANYKey takeawaysWhy Allocate Costs?It is critical to have accurate and complete cost data to make sound strategic and tactical management decisionsWhich prod

3、ucts are profitable?What is the breakeven volume by product?Which products require cost reduction efforts? How should we price our products?Which customer segments are most profitable?BAIN & COMPANYWhy Costs Are Often Not Allocated CorrectlyMost companies lack accurate cost data by productHistor

4、ically, only 20% of manufacturing costs were "shared” across product lines. Today, typically 50% of costs are "shared” across products. Shared costs might in elude rent, freight, and administrative costs.For simplicity, accounti ng tracks costs by functi on (e.g., materials, salaries, ben

5、efits) rather tha n by the activity devoted to product lines (e.g., mainten a nee of product A, freight for product B)For costs that are not easily assigned to individual product lines, companies normally select the most convenient way to assign them, not necessarily the best way-for example, compan

6、ies tend to allocate rent costs based on something that is easy to measure, such as direct labor dollars for each product line. A better allocation method, however, might be the actual space resource demands of each product lineBAXZ CZOMPAM YImportanee of cost allocation Client example Defi nitions-

7、direct vs. in direct, fixed vs. variable-breakeven volumeExercises-cost allocation-breakeven volumeAgendaBAIN & COMPANYKey takeawaysMiddle America Manufacturing - Estimated ProfitabilityMiddle America Manufacturing, a Bain client, believed that all three of its product lines were profitable.$30-

8、$25-$20-$15-$10-$5-$0- Riding mowersSales:$250MMReturn on sales:10.0%(se=OQ jo suo=乏)芒0d 6UReJ(Ddo xoald$25.0MMBicycles$100MM2.4%Walking mowers$75MM1.6%Middle America Manufacturing Cost AllocationAfter a thorough evaluation, the Bain team found that $8.0MM in costs had been allocated incorrectly amo

9、ng the three products.(S5OCJ JO su.2 s二 so。Middle America Manufacturing Additional CostsThe Bain team also determined that an additional $18.8MM in costs should be allocated to the three products(SJe=OQosuo=s二SooS20-,S15-S10-S5-S0-S18.8MMGeneral administative expensesInventory carrying costsAddition

10、al unallocated costsS18.8MMWalking mowersRiding mowersAdditional costs reallocatedMiddle America Manufacturing Actual Profitability Bain's analysis indicated that both bicycles and walking mowers were unprofitable Middle America then began to investigate whether to exit or fix these two business

11、es.conSales:Return on sales:$250MM7.2%$100MM(3.0%)$75MM(6.9%)(SJQOQ jo suo 三-乏)Q一-q2匸 0d uf|t5npodAgendaImportanee of cost allocation Client exampleDefi nitions-direct vs. in direct, fixed vs. variable-breakeven volumeExercises-cost allocation-breakeven volumeKey takeawaysAll costs can be broken dow

12、n along two dimFixed vs. VariableDefinitions: Costs that do Costs that varynot vary directlydirectly withwith changes inchanges inoutputoutputExamples: Equipment Raw materialsdepreciation Production labor Rent Delivery costs AdvertisingRule of thumb:If a particular cost changes when production incre

13、ases or decreases, the cost is variable.Types of Costsensions.Directvs.In directCosts incurred directly in the production or delivery of a firm's product or service. These costs can easily be identified with, or assigned to, a particular productDirect laborDedicated equipment Costs generally inc

14、urred by the firm outside of the production process. These costs cannot easily be identified with, or assigned to, a particular productSG&A Office supplies Plant managerRaw materials oIf a particular cost “goes away"when a product is dropped fromthe product line, the cost is direct.Fixed vs

15、. VariableDefining the appropriate time horizon for the analysis is important.All costs are variable over a very long time horizon (i.e., for very large increases in volume)-Costs to run and maintain a computer system that tracks product orders are clearly fixed for a small change in volume, such as

16、 that associated with a slightly busy month. However, they are variable for a large change in volume, such as that associated with a new plant.Most costs are semi-variable (i.e., they tend to be added in lumps as volume in creases)-Supervisory labor tends to be considered fixed because it is unlikel

17、y that additional supervisors would have to be added to handle a small increase, say 10%, in volume. But the workforce can only increase so much before an additional supervisor is needed.-In theory, production labor is variable. However, in many die nt situatio ns, restrai nts placed by unions and d

18、ifficulty in hiring and firing people in response to short-term volume fluctuations make it, in practice, semi-variable.A meaningful analysis will isolate the fixed cost andvariable comp on ents of a particular costFixed vs. Variable IllustrationThe following is an illustration of cost behavior for

19、fixed, semivariable, and variable costs:Fixed costs(se=OQ)lsooVolume (Units)Income Statement TermsIt is useful to know the following terms when doing cost analysis:Simplified in come statement:Revenue-Variable CostGross Margin-Fixed CostOperating MarginRevenue = Price per Unit x VolumeGross margin i

20、s also called “Gross Profit,n or "Contribution Margin"Operating Margin is also called "Operating ProfitnBreakeven VolumeBreakeven volume is the volume at which the company covers its fixed costs. At breakeven volume, the operating profit is zero.Contribution margin(i.e., revenue less

21、variable costs)Fixed costsFixed costsu 6e 乏 uo lnq£uooBreakeven volume =Fixed costsUnit contributionPrice per unit - Variable cost per unitBackup for Breakeven FormulaOperating Profit = Revenue - Costs= Revenue - Variable Costs - Fixed costs =(Price per unit x Volume) - (Variable cost per unit

22、x Volume) Fixed costs= Volume x (Price per unit - Variable cost per unit) Fixed costs= Volume x Unit contribution - Fixed costsThe breakeven volume is the volume for which operating profit = 00= Breakeven volume x Unit contribution Fixed costsBreakeven volume =Fixed costsFixed costsUnit contribution

23、 Price per unit Variable cost per unitAgendaImportanee of cost allocationClient exampleDefi nitions-direct vs. in direct, fixed vs. variable-breakeven volumeExercises-cost allocation -breakeven volumeKey takeawaysCost Allocation Exercise BackgroundMaple Leaf Company wants to allocate costs to the th

24、ree products it makes and sellsAll products are made using the same equipment and machinery Plant supervisors oversee production of all three productsEquipment capacity exists to in crease production by 50%Sales people sell all three productsSales people are paid a base salary, plus a commissi on wh

25、ich is a percentage of the selling priceMost advertising is product specificThe company uses a trucking company to deliver products to customers(costs are based on the length of trip and weight)Cost Allocation Exercise - QuestionHow would you characterize the following costs over a time horizon in w

26、hich the company plans to increase sales volume by 10%?FixedVariableCosts:CEO's salary Raw materials Supervisory labor Product!on floor laborRent Equipment depreciation Office supplies Freight to customer Electricity to run machines Interest expense to finance inventoryAdvertisi ngGoodwill amort

27、izationSales commissionsSales peoples* salariesSales travel and experisesDirectIn directCost Accounting Cost Allocation Exercise AnswerMost costs are fixed indirect or variable directFixedVariableDirectAdvertising Raw materials Production floor labor Freight to customer Interest expense to finance i

28、nventorySales commissionsIndirectEquipment depreciation CEO's salary Supervisory labor RentOffice supplies Goodwill amortization Sales people's salaries Sales travel and expenses Electricity to run machi nesCost Allocation Exercise Detailed Answer (1 of 3)Cost ComponentsFixed vs. VariableDir

29、ect vs. IndirectAdvertisi ngFixed, because advertising is usually not tied directly to volumeDirect, because, in this case, most of it is product specificEquipme nt depreciatio nFixed, because excess capacity exists for a 10% increase in volumeIn direct, because all products are made on the same mac

30、hinesCEO's salaryFixed, assuming his/her salary does not change with 10% sales increaseIn direct, because CEO oversees the whole companySupervisory laborFixed, because it is unlikely that additional supervisors will be needed to handle a 10% increase in volumeIn direct, because supervisors overs

31、ee production of all three productsRentFixed, assuming current facility has excess capacityIn direct, because all three products are produced at the same siteCost Allocation Exercise Detailed Answer (2 of 3)Cost ComponentsFixed vs. VariableDirect vs. IndirectOffice suppliesFixed, because it is unlik

32、ely that additional office supplies will be needed to handle 10% increase in volumeIn direct, because the office supplies are used to support all three productsGoodwill amortizationFixed, because goodwill is not directly related to volumeIn direct, assuming the goodwill is incurred to support the wh

33、ole companySalespeople's salariesFixed, assuming that current sales force can handle 10% additi onal volumeIn direct, because each salesman sells all three productsSales travel and expensesFixed, assuming that 10% volume in crease will not require significant increase in sales activitiesIn direc

34、t, because sales-force han dies all three productsRaw materialVariable, because a 10% increase in volume would require 10% more raw materialsDirect, because raw materials are directly traceable to in dividual productsCost Allocation Exercise Detailed Answer (3 of 3)Cost ComponentsFixed vs. VariableD

35、irect vs. IndirectProduct!on floor laborVariable, because more production labor will be needed to handle the in crease in volumeDirect, because even though the products are made on the same machine, the hours spent working on each of the products are directly traceableFreight to customersVariable, b

36、ecause the freight cost clearly increases with the volume in creaseDirect, because weight and distanee can be directly traced to individual productsInterest expense to finance inventoryVariable, because more inventory means more inventory financing and hence more interest expenseDirect, because inve

37、ntory is product specificSales commissionsVariable, because sales commissions are paid based on a percentage of salesDirect, because commissions are based on individual product salesElectricity to run machinesVariable, because it clearly varies with volumeIn direct, because all products are made on

38、the same machi nesCost Allocation Exercise CaveatsThere are few caveats: Labor-In many die nt situati ons, restraints placed by unions and difficulty in hiring and firing people in response to short term volume fluctuations make a portion of labor costs behave as fixed costs Electricity to run machi

39、nes-In theory this is direct, but in practice it is considered indirect because it is difficult to trace electricity cost to products-Also, the 80/20 rule applies here. Electricity is usually a small cost item, and, for simplicity, could be allocated using machine hours spent on productionAdvertisin

40、g-Usually, advertising is not tied to volume. For example, advertising to support a corporate brand is not tied to the volume of the products under that brand. If advertising is not tied to volume, it is fixed and in direct.Breakeven Exercise BackgroundA dean of a business school is considering star

41、ting an executiveprogram She estimates the revenues and costs as follows:Revenue:Tuition per student$13,500Costs:Advertisi ng$3,000Classroom rental(Each classroom can accommodate 15 students)$30,000 per classroomProgram administration$15,000Program director's salary$20,000Faculty salaries(The pr

42、ogram will be staffed with 1 faculty member for every 5 students)$20,000 per faculty memberGuest lecturer$12,000Room and board per student$3,200Text and supplies per student$500Question: How many students does the program need to break even?Breakeven Exercise - Answer (1 of 3) First, you must catego

43、rize costs and calculate fixed costs.Step 1: Categorize costsAdvertisi ngClassroom rentalProgram administrationProgram director's salaryFaculty salariesGuest lecturesRoom and board per studentText and supplies per studentStep 2: Calculate fixed costsFixed costs:$3,000$15,000$20,000Fixed Semi-Var

44、iable VariableAdvertisingProgram administrationProgram director's salaryGuest lectures$12,000 $50,000Breakeven Exercise - Answer (2 of 3)Then you must calculate semi-variable costs and the unit contribution.Step 3: Calculate semi-variable costs10 students15 students20 studentsClassroom$30,000$30

45、,000$60,000Faculty$40,000$60,000$80,000Step 4: Calculate unit contributionUnit contribution = Price per unit - Variable cost per unit=$13,500tuition-3,200room and board500text and supplies$9,800Breakeven Exercise Answer (3 of 3) Now you are ready calculate the breakeven volume.Fixed costs-Unit contr

46、ibutionBreakeven volumeStep 5: Calculate breakeven volumeFor 10 students:$120,000$9,800=12.2 students with 10 students the program does notbreak evenoIf you keep increasing the number of students by one and redoing the calculation*, you will find that the business school needs to have 15 students to

47、 break even on the executive programFor 15 students:$140,000$9,800=14.3 studentsAgendaImportanee of cost allocationClient exampleDefi nitions-direct vs. in direct, fixed vs. variable-breakeven volumeExercises-cost allocation-breakeven volumeKey takeawaysKey TakeawaysCost Allocation Overview A company must know the total cost associated with the production and delivery of its good and services in order to make the right strategic and tactical decisions Most companies lack accurate cost data by productTypes oT Costs All costs can be broken down alon