DQ 1

DQ 1.
What are some examples of fixed and variable costs from your workplace? Which costs may have both variable and fixed components? How can this be resolved for analysis purposes? I work for civil service in the Army. We're an international school that trains foreign students. We are funded by DoD.

Variable costs are those costs " which increase directly in proportion to the level of sales in dollars or units sold. Depending on your type of business, some examples would be cost of goods sold, sales commissions, shipping charges, delivery charges, costs of direct materials or supplies, wages of part-time or temporary employees, and sales or production bonuses.
"Fixed costs," which remain the same regardless of your level of sales. Depending on your type of business, some typical examples would be rent, interest on debt, insurance, plant and equipment expenses, business licenses, and salary of permanent full-time workers.

In the case of international school the variable costs can be:
1. Cost of Study material
2. Transportation charges
3. Faculty expenses
4. Bonus
5. Other direct expenses

The fixed costs can be:
1. Rent
2. Insurance, Depreciation
3. Salary of Staff
4. License fees

There can be some costs which are mixed costs. These have both the elements, such as utility costs, maintenance costs. These can be separated with the use of:

HIGH-LOW METHOD:
This is a method for separating costs into fixed and variable components, based upon the difference between costs at the highest and lowest observed levels of activity
With the high-low technique, the highest and lowest levels of activity are identified for a period of time. Say the highest repair paid is $2000, and the lowest is $1500. The difference in cost between the highest and lowest level of activity represents the variable cost ($2000 - $1500 = $500) associated with the change in activity (1500 tshirts on the high end and 1,000 tshirts on the low end yields a 500 tshirts difference from high to low). The cost difference is divided by the activity difference to determine the variable cost for each additional unit of activity ($500/500 = $1 ). The fixed cost can be calculated by subtracting variable cost (per-unit variable cost multiplied by the activity level) from total cost. Thus fixed cost is 2000-(1500*1)=$500

Another method is METHOD OF LEAST SQUARES. This is more accurate method than the former.
Here both the costs are ascertained by a line so that it fits through a set of points on a graph, where the cumulative sum of the squared distances between the points and the line is minimized (hence, the name "least squares").

Useful in decision making
By knowing the cost nature one can use it to take various decisions such as:
Break-even analysis is one of the tools of the managerial accounting, a device for determining the point at which sales will just cover total costs.
or the break even point for a product is the point where total revenue received equals total costs (TR=TC). A break even point is typically calculated in order to determine if it would be worthwhile to sell a proposed product, or to try to figure out whether an existing product can be made profitable. If a firm's costs were all variable, the problem of break-even volume would never arise. By having some variable and some fixed costs, the firm must suffer losses up to a given volume.

This figure can be used to make advantageous decisions concerning rates, prices, effect on operating costs and profits. Break-even analysis is especially useful when considering volume and plant expansion. If the firm is to avoid losses, its sales must cover all costs?those that vary directly with production and those that do not change as production levels change.

Knowing the consequences of alternative prices
This analysis is also useful in comparing the consequences of alternative prices. By inserting different prices into the formula, you will obtain a number of break even points, one for each possible price charged.

Thus it seeks to provide answers to the following questions:
1. What sales volume is necessary to produce an X amount of operating profit.
2. What will be the operating profit or loss at X sales volume be.
3. What will be the effect on operating profit be if the company's fixed costs have increased or sales mix have been changed.
4. What sales volume is needed to achieve the budgeted profit or to cover the additional fixed charges from the proposed new project.

DQ 2.
When is it appropriate for companies to use activity-based costing? How might activity-based costing be used in your company? What are some differences between ABC and traditional costing?
ABC is appropriate for today's companies because of following assumptions about today's companies:
§ Creates a variety of products and services
§ Has high overhead costs as compared to direct labor
§ An overabundance of data
§ Substantial non-product costs that can dramatically affect true product, distribution channel and customer profitability.

Use of ABC
Activity-Based Costing (ABC) is an accounting technique that allows an organization to determine the actual cost associated with each product and service produced by the organization without regard to the organizational structure. Activity- based costing can be used to identify discrete activities as well as identifying the primary output measure for each activity. With using activity-based costing there are value added-activities and non- value added-activities. Value added-activities are activities which customers are willing to pay for or show that after the process there will be a profit. Non- value activities are activities which customers are not willing to pay for or activities which do not show future profit. The activities must be analyzed in order to decide what will be a productive measure. When using activity-based costing an organization can measure costs against individual activities. With seeing what the results are, the company can figure out if there can be an adjustment made to create a value added-activity. If the activity turns out to be a non-value added-activity the organization may decide to delete the activity all together.

Activity-Based Costing is a more accurate cost management methodology. ABC will allow us to focus on indirect costs, including our overhead. We can trace our expense category to a particular cost object rather than to allocate it. Using this process will also help us make indirect expenses direct. Activity-Based Costing is a costing model that identifies the cost pools, or activity centers, in an organization and assigns costs to products and services (cost drivers) based on the number of events or transactions involved in the process of providing a product or service. Making clear connections between costs and outputs creates a truer financial picture.

Benefits of Activity Based Costing:
A). Models the business from a functional perspective.
B). Focuses on understanding and changing business practices, not automation of business practices.
C). Inputs and Outputs do not represent data.
D). Provides a complete description of a set of activities.
E). Avoids distortions in product costing that result from arbitrary allocations of indirect costs.
F). Helps benchmark for improvements.

How does this ABC differ from traditional costing systems?
Activity-based costing is cost accounting methodology that assigns costs to activities-based on their use of resources, and assigns costs to cost objects (products, functions, projects) based on their use of activities. It attempts to precisely allocate overhead-based on the real factors that create costs. This system differs from traditional costing systems in that ABC recognized that resources are consumed by processes or products in different proportions for each activity. Traditional costing systems focus primarily on direct materials and direct labor and arbitrary allocate other resources-based on direct labor hours, labor dollars or direct machine hours. In this process, sales, marketing and administrative costs are not included.
In activity-based costing, the primary goal is to make indirect costs meaningful so that they can be assigned to processes to determine how costs are incurred. All costs can be found in resources such as material, labor, services, equipment, or space. The cost associated with these activities represents the amount of resource consumed for each unit of activity. Resources and activities are then applied to cost objects. A cost object can be a process or product and either an interim cost object or an end user (customer) cost object.

DQ 3.
What is the definition of operating leverage? How does operating leverage differ in manufacturing, service, merchandising, and e-commerce companies? How can operating leverage be used to increase a company's profitability?

Operating leverage is a part of overall risk of the firm. Risk is an aspect of any organization's operation. When it is recognized, understood, and managed, risk can set the stage for sustainable growth. Companies need identify risk within their operations and plan a systematic approach to managing it.
According to www.anao.gov.au:
"Effective risk management contributes to better decision-making because it develops a deeper insight into risks and their potential impact. It is a structured and disciplined approach: it aligns strategy, processes, people, technology, and knowledge with the purpose of evaluating and managing the uncertainties the enterprise faces as it creates value."

Business risk is the riskiness of the firm without debt, which is due to the uncertainty associated with the firm's cash flows. This type of risk depends on a number of factors including demand variability, sales price variability, input cost variability, pricing power, R&D efficiency, foreign risk exposure, and the degree of operating leverage
Thus Operating leverage is use of fixed costs by the firm in the operations. The "operating leverage" is fixed operating expenses as a percentage of revenue: revenue / operating expense.
It is calculated by = Contribution/EBIT.
Operating leverage greatly differ according to the nature of the organizations. It will depend on the level of the fixed cost in a particular organization.

Case of manufacturing organizations:
In labour intensive facilities the variable costs are high and fixed costs are less. Thus here break even point can be achieved earlier as compared to capital intensive facility with low operating leverage. On the other hand there is high operating leverage in the capital intensive manufacturing facilities as fixed costs are high.

Case of service organizations and ecommerce organizations:
There is low operating leverage in the capital intensive manufacturing facilities as fixed costs are low.

Case of merchandising organizations:
Its fixed costs are medium, thus having medium operating leverage.

Use of Operating leverage to increase profitability
The profitability can be increase by increase in sales is leading to increase in contribution thus greater cushion to meet the fixed expenses. As we move away from BEP the contribution is higher. Thus it gives margin of safety to the organization and will increase the profits.