Atkinson, Solutions Manual t/a Management Accounting, 6E
Chapter 3
Using Costs in
Decision Making
QUESTIONS
Cost information is used in pricing, product planning, budgeting,
performance evaluation, and contracting. Examples of specific uses of
cost information include deciding whether to introduce a new product
or discontinue an existing product (given the price structure),
assessing the efficiency of a particular operation, and assessing the
cost of serving customer segments.
Variable costs are costs that increase proportionally with changes in
the activity level of some variable. Fixed costs are costs that in the
short run do not vary with a specified activity. Fixed costs depend on
how much of the resource (capacity) is acquired, rather than on how
much is used.
Contribution margin per unit, which is the difference between revenue
per unit and variable cost per unit, is the contribution that each unit
makes to covering fixed costs and generating a profit. The
contribution margin is therefore an important component of the
equation to determine the breakeven point and to understand the effect
on profit of proposed changes, such as changes in sales volume in
response to changes in advertising or sales prices.
Contribution margin per unit is the difference between revenue per
unit and variable cost per unit. The contribution margin per unit
indicates how much the total contribution margin will increase with an
additional unit of sales. The contribution margin ratio expresses
similar ideas, but as a percentage of sales dollars. Specifically, the
contribution margin ratio is the total contribution margin divided by
total sales dollars (or contribution margin per unit divided by sales
price per unit), and indicates how much the total contribution margin
increases with an additional dollar of sales revenue.
In evaluating whether a business venture will be profitable, the
,breakeven point is the volume at which the profit equals zero, that is,
revenues equal total costs.
– 52 –
,Atkinson, Solutions Manual t/a Management Accounting, 6E
A mixed cost is a cost that has a fixed component and a variable
component. For example, utilities bills may include a fixed
component per month plus a variable component that depends on the
amount of energy used. A step variable cost increases in steps as
quantity increases. For example, one supervisor may be hired for
every 20 factory workers. Mixed costs and step variable costs both
have elements of fixed and variable costs. However, mixed costs have
distinct fixed and variable components, with fixed costs that are
constant over a fairly wide range of activity (for a given time period)
and variable costs that vary in proportion to activity. Step variable
costs are fixed for a fairly narrow range of activity and increase only
when the next step is reached.
Step variable costs are fixed for a fairly narrow range of activity and
increase when the next step is reached. For example, one supervisor
may be hired for every 20 factory workers. Fixed costs are costs that
in the short run do not vary with a specified activity for a wide range
of activity. For example, factory rent per month would likely remain
unchanged as production increased or decreased, even if by large
amounts.
Incremental cost is the cost of the next unit of production and is
similar to the economist‘s notion of marginal cost. In a manufacturing
setting, incremental cost is often defined as a constant variable cost of
a unit of production. However, in some situations, the variable cost of
a unit of production may be more complicated. For example, the
variable cost of labor per unit may decrease over time if workers
become more efficient (a learning effect. Alternatively, the variable
cost of labor per unit will change during overtime hours if workers
receive an overtime premium (commonly 50%). Finally, some costs
exhibit step-variable behavior, as when one supervisor can supervise a
quantity of employees but an additional supervisor is needed beyond a
certain number of employees.
In evaluating the different alternatives from which managers can
choose, it is better to focus only on the relevant costs that differ across
different alternatives because it does not divert the manager‘s
attention with irrelevant facts. If some costs remain the same
regardless of what alternative is chosen, then those costs are not useful
for the manager‘s decisions, as they are not affected by the decision.
Therefore, it is better to omit them from the cost analysis used to
support the decision. Moreover, resources are not expended to find or
prepare irrelevant information.
Sunk costs are costs that are based on a previous commitment and
, cannot be recovered. For example, depreciation on a building reflects
the historical cost of
– 53 –
Chapter 3
Using Costs in
Decision Making
QUESTIONS
Cost information is used in pricing, product planning, budgeting,
performance evaluation, and contracting. Examples of specific uses of
cost information include deciding whether to introduce a new product
or discontinue an existing product (given the price structure),
assessing the efficiency of a particular operation, and assessing the
cost of serving customer segments.
Variable costs are costs that increase proportionally with changes in
the activity level of some variable. Fixed costs are costs that in the
short run do not vary with a specified activity. Fixed costs depend on
how much of the resource (capacity) is acquired, rather than on how
much is used.
Contribution margin per unit, which is the difference between revenue
per unit and variable cost per unit, is the contribution that each unit
makes to covering fixed costs and generating a profit. The
contribution margin is therefore an important component of the
equation to determine the breakeven point and to understand the effect
on profit of proposed changes, such as changes in sales volume in
response to changes in advertising or sales prices.
Contribution margin per unit is the difference between revenue per
unit and variable cost per unit. The contribution margin per unit
indicates how much the total contribution margin will increase with an
additional unit of sales. The contribution margin ratio expresses
similar ideas, but as a percentage of sales dollars. Specifically, the
contribution margin ratio is the total contribution margin divided by
total sales dollars (or contribution margin per unit divided by sales
price per unit), and indicates how much the total contribution margin
increases with an additional dollar of sales revenue.
In evaluating whether a business venture will be profitable, the
,breakeven point is the volume at which the profit equals zero, that is,
revenues equal total costs.
– 52 –
,Atkinson, Solutions Manual t/a Management Accounting, 6E
A mixed cost is a cost that has a fixed component and a variable
component. For example, utilities bills may include a fixed
component per month plus a variable component that depends on the
amount of energy used. A step variable cost increases in steps as
quantity increases. For example, one supervisor may be hired for
every 20 factory workers. Mixed costs and step variable costs both
have elements of fixed and variable costs. However, mixed costs have
distinct fixed and variable components, with fixed costs that are
constant over a fairly wide range of activity (for a given time period)
and variable costs that vary in proportion to activity. Step variable
costs are fixed for a fairly narrow range of activity and increase only
when the next step is reached.
Step variable costs are fixed for a fairly narrow range of activity and
increase when the next step is reached. For example, one supervisor
may be hired for every 20 factory workers. Fixed costs are costs that
in the short run do not vary with a specified activity for a wide range
of activity. For example, factory rent per month would likely remain
unchanged as production increased or decreased, even if by large
amounts.
Incremental cost is the cost of the next unit of production and is
similar to the economist‘s notion of marginal cost. In a manufacturing
setting, incremental cost is often defined as a constant variable cost of
a unit of production. However, in some situations, the variable cost of
a unit of production may be more complicated. For example, the
variable cost of labor per unit may decrease over time if workers
become more efficient (a learning effect. Alternatively, the variable
cost of labor per unit will change during overtime hours if workers
receive an overtime premium (commonly 50%). Finally, some costs
exhibit step-variable behavior, as when one supervisor can supervise a
quantity of employees but an additional supervisor is needed beyond a
certain number of employees.
In evaluating the different alternatives from which managers can
choose, it is better to focus only on the relevant costs that differ across
different alternatives because it does not divert the manager‘s
attention with irrelevant facts. If some costs remain the same
regardless of what alternative is chosen, then those costs are not useful
for the manager‘s decisions, as they are not affected by the decision.
Therefore, it is better to omit them from the cost analysis used to
support the decision. Moreover, resources are not expended to find or
prepare irrelevant information.
Sunk costs are costs that are based on a previous commitment and
, cannot be recovered. For example, depreciation on a building reflects
the historical cost of
– 53 –
