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Chapter 9: Problem 8

What are the factors that affect the breakeven point under (a) variable costing and (b) absorption costing?

Short Answer

Expert verified
In variable costing, breakeven is affected by variable costs, fixed costs, and selling price. In absorption costing, inventory levels and fixed overheads also play roles.

Step by step solution

01

Understanding Breakeven Point

The breakeven point is the level of sales at which total revenues equal total costs, resulting in neither profit nor loss. Understanding the breakeven point is crucial for making informed pricing, cost control, and sales strategies.
02

Factors Affecting Breakeven Point in Variable Costing

In variable costing, the breakeven point is affected by changes in the variable costs per unit, the selling price per unit, and fixed costs. The formula for the breakeven point (in units) is: \[ \text{Breakeven Point (Units)} = \frac{\text{Total Fixed Costs}}{\text{Selling Price per Unit} - \text{Variable Cost per Unit}} \] An increase in variable costs per unit or a decrease in selling price per unit will increase the breakeven point, while an increase in fixed costs will also raise it.
03

Factors Affecting Breakeven Point in Absorption Costing

In absorption costing, the breakeven point is influenced by the same factors as variable costing, but fixed manufacturing overhead costs are included in the product cost. Therefore, inventory changes can affect the breakeven point: 1. Prices for materials, labor, and overheads. 2. Changes in inventory levels. 3. Changes in the selling price per unit. Variable and fixed cost changes influence breakeven in both costing systems, but absorption costing's treatment of fixed manufacturing costs can cause different inventory impacts.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Variable Costing
Variable costing, also known as direct costing or marginal costing, is a method where only variable costs are included in the product cost. Fixed costs are treated as period costs and are expensed in the period they are incurred. This method is particularly helpful for internal reporting and decision-making. It provides clarity on how changes in production levels impact overall profitability by focusing solely on variable expenses linked to production.
If you are analyzing the breakeven point with variable costing, remember that:
  • Only costs that change with production volume are included.
  • Fixed costs do not affect the cost of producing one more unit.
  • Decision making can focus on how these costs vary with production levels.
This typically makes it easier to adjust strategies for changes in demand or market conditions.
Absorption Costing
Absorption costing, sometimes called full costing, is different from variable costing in that it includes all manufacturing costs in the cost of a product, regardless of whether they are fixed or variable. This means that fixed manufacturing overhead is allocated to each unit produced, and thus becomes part of the inventory cost until the inventory is sold.
Key points to remember about absorption costing:
  • Includes both variable and fixed manufacturing costs in product costs.
  • Helps in external financial reporting as it complies with GAAP and IFRS.
  • Can result in higher reported profits compared to variable costing due to fixed cost allocation to unsold inventory.
When considering breakeven analysis, absorption costing can be more complex due to the inclusion of fixed costs in inventory, affecting how breakeven points shift with inventory changes.
Cost Accounting
Cost accounting involves tracking, recording, and analyzing costs associated with a company's activities. It is a critical part of a business's financial management as its insights help in budgeting, controlling costs, and making strategic decisions. Within cost accounting, both variable costing and absorption costing play roles in determining how costs contribute to product pricing and overall profitability.
Cost accounting provides businesses with information to:
  • Manage and reduce costs effectively.
  • Decide on pricing or discount strategies.
  • Conduct cost-benefit analysis which is pivotal in decision-making.
By understanding these cost structures, businesses can better assess their economic standing and make well-informed decisions.
Fixed and Variable Costs
Fixed and variable costs are fundamental concepts in cost accounting. These categories are essential for managerial decisions and are the cornerstone of breakeven point analysis.
  • Fixed Costs: These costs do not change with the level of output or production. Examples include rent, salaries, and insurance.
  • Variable Costs: These costs vary directly with the level of production. Examples include raw materials and direct labor costs.
Understanding the difference between these costs allows businesses to set prices appropriately, adjust production levels, and streamline operations to enhance profitability. This balance is crucial for both short-term decision-making and long-term strategic planning. By knowing these components, businesses can forecast more accurately and plan better for varying business scenarios.

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Most popular questions from this chapter

Differences in operating income between variable costing and absorption costing are due solely to accounting for fixed costs. Do you agree? Explain.

'Companies that make no variable-cost/fixed-cost distinctions must use absorption costing, and those that do make variable-cost/fixed-cost distinctions must use variable costing." Do you agree? Explain.

Match each of the following items with one or more of the denominator-level capacity concepts by putting the appropriate letter(s) by each item: a. Theoretical capacity b. Practical capacity c. Normal capacity utilization d. Master-budget capacity utilization 1\. Measures the denominator level in terms of what a plant can supply 2\. Is based on producing at full efficiency all the time 3\. Represents the expected level of capacity utilization for the next budget period 4\. Measures the denominator level in terms of demand for the output of the plant 5\. Takes into account seasonal, cyclical, and trend factors 6\. Should be used for performance evaluation in the current year 7\. Represents an ideal benchmark 8\. Highlights the cost of capacity acquired but not used 9\. Should be used for long-term pricing purposes 10\. Hides the cost of capacity acquired but not used 11\. If used as the denominator-level concept, would avoid the restatement of unit costs when expected demand levels change

Do companies in either the service sector or the merchandising sector make choices about absorption costing versus variable costing?

Cayzer Associates operates a chain of 10 hospitals in the Los Angeles area. Its central food-catering facility, Mealman, prepares and delivers meals to the hospitals. It has the capacity to deliver up to 1,300,000 meals a year. In \(2012,\) based on estimates from each hospital controller, Mealman budgeted for 975,000 meals a year. Budgeted fixed costs in 2012 were \(\$ 1,521,000\) Each hospital was charged \(\$ 6.46\) per meal \(-\$ 4.90\) variable costs plus \(\$ 1.56\) allocated budgeted fixed cost. Recently, the hospitals have been complaining about the quality of Mealman's meals and their rising costs. In mid- 2012 , Cayzer's president announces that all Cayzer hospitals and support facilities will be run as profit centers. Hospitals will be free to purchase quality-certified services from outside the system. Ron Smith, Mealman's controller, is preparing the 2013 budget. He hears that three hospitals have decided to use outside suppliers for their meals; this will reduce the 2013 estimated demand to 780,000 meals. No change in variable cost per meal or total fixed costs is expected in 2013. 1\. How did Smith calculate the budgeted fixed cost per meal of \(\$ 1.56\) in \(2012 ?\) 2\. Using the same approach to calculating budgeted fixed cost per meal and pricing as in 2012 , how much would hospitals be charged for each Mealman meal in \(2013 ?\) What would their reaction be? 3\. Suggest an alternative cost-based price per meal that Smith might propose and that might be more acceptable to the hospitals. What can Mealman and Smith do to make this price profitable in the long run?
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