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Chapter 3: Problem 11

Give an example of how a manager can increase variable costs while decreasing fixed costs.

Short Answer

Expert verified
A manager can increase variable costs by increasing production volume, such as producing more units and hiring additional labor. To decrease fixed costs, the manager can reduce expenses not tied to production levels, like downsizing the production facility to pay lower rent, or renegotiating supplier contracts for lower fixed prices. For example, a clothing manufacturing company manager hires temporary workers to meet higher demand (increasing variable costs) and moves operations to a smaller facility with lower rent (decreasing fixed costs).

Step by step solution

01

Increase Variable Costs

A manager can increase variable costs by increasing the volume of production. This could be done by producing more units of a product, requiring the company to use more raw materials, and hiring additional labor to meet the increased demand.
02

Decrease Fixed Costs

To decrease fixed costs, the manager needs to identify areas where the business spends money on expenses that do not change with production levels and find ways to reduce these costs. One way to do this is by renting a smaller facility for the production process. By downsizing the facility, the manager can reduce the rent expense, which is a fixed cost. Alternatively, the manager can also renegotiate contracts with suppliers to lower fixed price agreements like insurance or equipment leases. Example:
03

Scenario

Imagine a manager of a clothing manufacturing company who wants to increase production to meet higher demand for their products. To achieve this, the manager decides to hire additional temporary workers to help with the increased production. The additional labor cost is a variable cost because it is directly associated with the increase in production. At the same time, the manager realizes that the company's current facility is larger than necessary for the scale of production. They decide to move the operations to a smaller facility with a lower monthly rent, thereby decreasing the fixed cost for rent. By increasing variable costs (additional labor) and decreasing fixed costs (rent), the manager has achieved the desired goal.

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Key Concepts

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

Variable Costs
Understanding variable costs is crucial for effective cost management in accounting. These are expenses that change in direct proportion to changes in production volume. For example, if a company decides to increase its output, the cost of raw materials and direct labor will likely rise in tandem with the higher production levels.

Real-World Implication

Let's say a business produces handcrafted candles. As demand increases around the holiday season, it needs to purchase more wax and wicks and may have to hire extra workers to fulfill orders. These costs, which vary based on the quantity produced, are considered variable costs. A deep understanding of these costs enables managers to anticipate changes in expenses as production fluctuates, which is essential for budgeting and forecasting.
Fixed Costs
In contrast to variable costs, fixed costs do not fluctuate with production levels. They are static expenses that a company incurs, regardless of how much it produces. This includes rent for facilities, insurance, and salaries for permanent staff.

Strategic Management

Fixed costs can be a challenge to manage because they persist even when production scales down. To maintain profitability, a business may look for ways to lower these costs without impacting productivity. For instance, renegotiating long-term leases or reducing overhead by optimizing the use of space can effectively lower fixed costs. A careful balance must be struck to ensure that cost-cutting measures do not inadvertently affect the company's capacity to increase production when necessary.
Production Volume
Production volume, the total number of units produced within a specific time frame, is a pivotal factor in the equation of cost management. It influences both variable and fixed costs and thereby affects the profitability of a company.

Optimization Strategies

Businesses may strive to optimize production volume to achieve economies of scale. This means producing enough units to spread the fixed costs over a larger number of items, thereby reducing the cost per unit. However, this must be balanced against the risk of overproduction, which can lead to increased variable costs and excess inventory that may not be sold. Managers use cost-volume-profit analysis to determine the optimal production volume that maximizes profitability while keeping costs under control.

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Most popular questions from this chapter

The Doral Company manufactures and sells pens. Currently, 5,000,000 units are sold per year at \(\$ 0.50\) per unit. Fixed costs are \(\$ 900,000\) per year. Variable costs are \(\$ 0.30\) per unit. Consider each case separately: 1\. a. What is the current annual operating income? b. What is the current breakeven point in revenues? Compute the new operating income for each of the following changes: 2\. A \$0.04 per unit increase in variable costs 3\. \(A \cdot 10 \%\) increase in fixed costs and a \(10 \%\) increase in units sold 4\. \(A\) 20 \(\%\) decrease in fixed costs, a \(20 \%\) decrease in selling price, a \(10 \%\) decrease in variable cost per unit, and a \(40 \%\) increase in units sold Compute the new breakeven point in units for each of the following changes: 5\. \(A 10 \%\) increase in fixed costs 6\. \(A 10 \%\) increase in selling price and a \(\$ 20,000\) increase in fixed costs

Classical Glasses operates a kiosk at the local mall, selling sunglasses for \(\$ 30\) each. Classical Glasses currently pays \(\$ 1,000\) a month to rent the space and pays two full-time employees to each work 160 hours a month at \(\$ 10\) per hour. The store shares a manager with a neighboring kiosk and pays \(50 \%\) of the manager's annual salary of \(\$ 60,000\) and benefits of \(\$ 12,000\). The wholesale cost of the sunglasses to the company is \(\$ 10\) a pair. 1\. How many sunglasses does Classical Glasses need to sell each month to break even? 2\. If Classical Glasses wants to earn an operating income of \(\$ 5,300\) per month, how many sunglasses does the store need to sell? 3\. If the store's hourly employees agreed to a \(15 \%\) sales-commission-only pay structure, instead of their hourly pay, how many sunglasses would Classical Glasses need to sell to earn an operating income of \(\$ 5,300 ?\) 4\. Assume Classical Glasses pays its employees hourly under the original pay structure, but is able to pay the mall \(10 \%\) of its monthly revenue instead of monthly rent. At what sales levels would Classical Glasses prefer to pay a fixed amount of monthly rent, and at what sales levels would it prefer to pay \(10 \%\) of its monthly revenue as rent?

Garrett Manufacturing sold 410,000 units of its product for \(\$ 68\) per unit in 2017 Variable cost per unit is \(\$ 60,\) and total fixed costs are \(\$ 1,640,000\) 1\. Calculate (a) contribution margin and (b) operating income. 2\. Garrett's current manufacturing process is labor intensive. Kate Schoenen, Garrett's production manager, has proposed investing in state-of-the-art manufacturing equipment, which will increase the annual fixed costs to \(\$ 5,330,000\). The variable costs are expected to decrease to \(\$ 54\) per unit. Garrett expects to maintain the same sales volume and selling price next year. How would acceptance of Schoenen's proposal affect your answers to (a) and (b) in requirement 1? 3\. Should Garrett accept Schoenen's proposal? Explain.

Corporate Printing Company currently leases its only copy machine for \(\$ 1,500\) a month. The company is considering replacing this leasing agreement with a new contract that is entirely commission based. Under the new agreement, Corporate would pay a commission for its printing at a rate of \(\$ 20\) for every 500 pages printed. The company currently charges \(\$ 0.20\) per page to its customers. The paper used in printing costs the company \(\$ 0.05\) per page and other variable costs, including hourly labor, amount to \(\$ 0.10\) per page. 1\. What is the company's breakeven point under the current leasing agreement? What is it under the new commission-based agreement? 2\. For what range of sales levels will Corporate prefer (a) the fixed lease agreement and (b) the commission agreement? 3\. Do this question only if you have covered the chapter appendix in your class. Corporate estimates that the company is equally likely to sell \(20,000,30,000,40,000,50,000,\) or 60,000 pages of print. Using information from the original problem, prepare a table that shows the expected profit at each sales level under the fixed leasing agreement and under the commission- based agreement. What is the expected value of each agreement? Which agreement should Corporate choose?

Kindmart is an international retail store. Kindmart's managers are considering implementing a new business-to-business (B2B) information system for processing merchandise orders. The current system costs Kindmart \(\$ 2,000,000\) per month and \(\$ 55\) per order. Kindmart has two options, a partially automated B2B and a fully automated B2B system. The partially automated B2B system will have a fixed cost of \(\$ 6,000,000\) per month and a variable cost of \(\$ 45\) per order. The fully automated B2B system has a fixed cost of \(\$ 14,000,000\) per month and a variable cost of \(\$ 25\) per order. Based on data from the past two years, Kindmart has determined the following distribution on monthly orders: $$\begin{array}{cc} \text { Monthly Number of Orders } & \text { Probability } \\ \hline 300,000 & 0.25 \\ 500,000 & 0.45 \\ 700,000 & 0.30 \end{array}$$ 1. Prepare a table showing the cost of each plan for each quantity of monthly orders. 2\. What is the expected cost of each plan? 3\. In addition to the information system's costs, what other factors should Kindmart consider before deciding to implement a new B2B system?
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