Cost behave in two basic way in cost accounting. With the increase in output, either the cost of products increases or the cost remains indifferent regardless of level of output. Variable cost may be defined as the cost that varies with the level of output produced. For example, labor and raw material requirement in producing the output. Corporate expense is regarded as variable cost and they fluctuate with output level. Depending upon the volume of production of organization, variable costs varies. With the increase in level of output, the variable costs increases and they fall with the fall in level of output.
There is a significant difference between variable cost and fixed cost as the later remains unchanged irrespective of level of output produced. Fixed cost within an organization is rent, office suppliers and insurance. Total costs comprised of fixed as well as variable costs.
A project can be completed and the necessary factors incudes variable costs that may involve direct labor costs or direct material costs. The packaging of the product o company involves the variable costs, as the coast would vary depending upon the number of packages. Cost of packaging of the product would increase if the company increases the volume of products it is producing. On the other hand, there would be a fall in cost of packaging if the fewer products were sold.
Fixed costs are such costs that must be incurred by the company whether the products are produced or not. Over the range of production or specified period, the fixed cost remains fixed. With the increase or decrease for products produces and sold, the fixed costs remains unaffected. It is incurred even if the company is having zero production. Regardless of the business activities of the company, they have to incur and pay fixed costs. Along with the variable costs, fixed costs is also regarded as one of the component of total costs.
Irrespective of level of production, it is not possible for the business to avoid fixed costs, as it is an operating expense. Break even analysis usually make use of fixed costs that is used to determine the production level, pricing and sales (Otley & Emmanuel, 2013). It is regarded as the level of costs under which the company does not make profit nor it incurs loss. The total cost structure of company is decomposed into total fixed costs and total variable costs. An organization is able to ensure its level of profitability with the help of its total cost structure.
The total amount of revenue required by the company so that the total variable and fixed costs expenses are covered is determined by break-even point during specified time. Revenues can be stated in different measurement such as it can be measured by delivering the services in hours or it can be stated in units. The level of output at which the total cost of doing the business or costs involved in producing the output is exactly equal to the total amount of revenue earned by the business is the break-even point (Kaplan & Atkinson, 2015). An organization can calculate the sales revenue by multiplying the price of the products by the number of level of output produced. Such calculation can be done at any level of output produced. A company uses assumption for calculating the break-even point that change in revenue is associated with the change in level of sales. However, such assumption may not hold true in some of the cases because, it is certainly possible that company will have varying degree of profitability due to the diversion of products. For grabbing the attention of customers and with the variation in demand, the company may diversify the customers. There are many reasons that is attributable to increase in the selling expense and it may increase due to selling the products in diversified market and not due to selling expense arising from the additional unit production. It is the reason that the selling price in two different markets will be different.
The market price of security is exactly equal to the costs at the price level that is determined by using the break-even analysis. In the event of trading options, buyers of option is reached at the option providing using the break even analysis and it is the price that must be reached by buyer for buying the options for avoiding loss if the options are exercised by them. Premium paid and the exercise price determines the breakeven point for a byer buying call option. On the other hand, the break-even point for buyer of put position is determined by subtracting the premium paid from the strike price.
For purchasing the right to sell or buy the particular stocks at a specified time, options are exercised by investors. It is required by investor to become aware of the market price and whether they are generating loss or gain. Therefore, break-even is considered important to investors as it helps them with the investment decisions.
Subtracting all the associated variable costs form the price of products gives the contribution margin and for each unit of products sold, the result is incremental profit. The total earning available for generating the profit and paying the fixed expenses is given by the total contribution margin. In situation of special pricing, the decision to allow a lower pricing is determined by contribution margin. It would not be wise for the organization to sell the product at price where the contribution margin is negative or excessively low. The concept of contribution margin is applicable in many areas and it includes profit center, subsidiaries, product line, customer sales and distribution channel.
The contribution margin can be obtained by deducting the total variable costs from the revenue generated by the net revenue. The variable cost of any products involves cost of direct raw material and sales commission for selling the products. The contribution margin ratio is expressed as percentage and it is the difference between sales and variable expense.
In association with team logos, Kincaid Company sells flags. The company has a variable cost expense of $ 4.20 per flag and the total fixed costs stands at $ 639600. Hence, the price of each flag to be sold is $ 12.00. It is point, which is, pre-determined at which the investor would exit the market if it were in profitable position. KinCaid Company sells flags at the breakeven point of 82000 flags and this is considered as the target of the company products to be sold every year. The target profit is compared with the actual income generated a n depicted in the income statement and it is obtained from the process of budgeting. The formal for calculating the target profit is obtained by deducting the variable as well as fixed costs from the net revenue.
It is required by Kincaid to make sales worth $ 1034000. It is obtained by adding up the target profit with the fixed costs and then dividing into the contribution ratio. The result of unprofitable operation of company is recorded and depicted in the contribution margin of the income statement for the year ending 31st December 2016. The data depicts sales revenue of $ 900000, fixed cost of $ 639600, variable cost of $ 315000, operating loss of $ 54600 and contribution margin of $ 585000. Effect of taxes, interest expenses and interest income is not considered in the operating loss. However, in some cases expenses concerning depreciation might be included. A company would require external financing if it is consistently generating operating losses. Whether the core operations of the company is profitable or not is indicated by the operating loss. It is therefore required to either decrease the costs or increase the revenue. For some startup companies, operating loss is expected as they attempt to grow their business on faster pace.
Kaplan, R. S., & Atkinson, A. A. (2015). Advanced management accounting. PHI Learning.
Otley, D., & Emmanuel, K. M. C. (2013). Readings in accounting for management control. Springer.
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