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ACCOUNTING
COST CONCEPTS,
BREAK-EVEN ANALYSIS,
And PRESENT ECONOMY
I. COST CONCEPTS
DEMAND is the quantity of a certain commodity that is bought at a
certain price at a given place and time.
SUPPLY is the quantity of a certain commodity that is offered for
sale at a certain price at a given place and time.
FIXED COST are costs that do not vary in proportion to the
quantity of output.
VARIABLE COST are costs that vary in proportion to quantity of
output.
BREAK EVEN POINT is the level of production at which revenue
is exactly equal to total costs
LAW OF SUPPLY
The supply of the commodity varies directly as
the price of the commodity, though not
proportionately
p
r
i
c
e
Supply
LAW OF DEMAND
The demand for a commodity varies inversely as
the price of the commodity, though not
proportionately
p
r
i
c
e
Demand
p
r
i
c
e
Quantity
p = a - bD
Demand (D)
TOTAL REVENUE
VOLUME RELATIONSHIP
T
O
T
A
L
R
e
v
e
n
u
e
COST - VOLUME
RELATIONSHIP
Total Cost
C
o
s
t
Variable Cost
Fixed Cost
Volume (D)
C
o
s
t
R
e
v
or
e
n
u
e
Represents the
Maximum Profit
Total Cost
Volume (D)
COST CONCEPTS
FORMULAS:
A: Price is not constant
price:
p = a bD
Total Revenue:
TR = pD
Profit:
P = TR TC
Demand that maximizes total revenue:
= a / 2b
Demand that maximizes total profit: D* = (a vc) / 2b
Total Cost:
TC = TVC + TFC
Total Variable Cost:
TVC = vcD
Break even points: - (a-vc) SQRT {( a-vc )2 4(-b)(-TFC)}
2 (-b)
where:
a, the y intercept
b, slope of the line
D, demand
TFC, total fixed cost
Cost / Revenue
Marginal
( Incremental) Cost
Profit is maximum where
Total Revenue exceeds
Total Cost by greatest amount
Maximum
Profit
Cost / Revenue
Quantity ( Output )
Marginal
Demand
Revenue
TC
Profit
Total Revenue
TFC
D1
D*
D2
Quantity ( Output )
Demand
PROFIT MAXIMIZATION D*
Occurs
BREAKEVEN POINT
D1 and D2
Occurs
where TR = TC
( aD - D2 ) / b = TFC + (uvC ) D
- D2 / b + [ (a / b) - uvC ] D - TFC
Using the quadratic formula:
D = - [ ( a / b ) - uvC ] + { [ (a / b ) - uvC ] 2 - ( 4 / b ) ( - TFC ) }1/2
-----------------------------------------------------------------------2/b
COST CONCEPTS
B: Price is constant
Break even point:
R
C
O or e
v
S
e
T
n
u
e
D = TFC / ( p vc)
IT
F
O
PR
ss
o
L
Volume (D)
Examples:
A company has determined that the price and the monthly
demand of one if its products are related by the equation
D = 400 - p
Where p is the price per unit in dollars and D is the monthly
demand. The associated fixed costs are $1,125/month and
the variable costs are $100/unit. Use this information to
answer the following:
1.1 What is the optimal number of units that should be produced
and sold each month?
1.2 Determine the values of D that represents the breakeven
point?
Examples
2. A manufacturing company leases a building for
$100,000 per year for its manufacturing facilities
in addition; the machinery in this building is being
paid for in installments of $20,000 per year. Each
unit of the product produced costs $15 in labor and
$10 in materials. The product can be sold for $40.
Use this information to answer the following
problems.
2.1. How many units per year must be sold for the
company to breakeven?
2.2. If 10,000 units per year are sold, what is the
annual profit?
Examples:
3.
A bicycle component manufacturer
produces hubs for bike wheels. Two
processes are possible for manufacturing,
and the parameters of each process are as
follows:
D
Volume (D)
TCA = TCB
Examples:
1.
Examples
Machine A has a fixed cost of $40,000
per year and a variable cost of $60 per
unit. Machine B has an unknown fixed
cost, but with this process 200 units can
be produced each month at a total
variable cost of $2,000. If the total
costs of the two machines break even at
a production rate of 2000 units per year,
what is the fixed cost of machine B?
2.
SELECTIONS IN PRESENT
ECONOMY
Present Economy involves the analysis
of problems for manufacturing a
product or rendering a service upon
the basis of present or immediate
costs. The period of time involved in
this study is relatively short and the
influence of time of money is not a
significant consideration
Examples:
2. The We Win Them All Formula-Car manufacturing
company needs spindles for their rolling chassis.
They can buy them from an outside manufacturer for
$200 per spindle plus shipping costs. Each spindle
weighs 18 lbs. and shipping costs are $1.50 per
pound.
The outside manufacturer will give a
discount for bulk orders (does not include shipping
costs). The first 50 spindles are at full price, the next
50 have 10% discount per spindle, and the next 50
have a 15% discount per spindle. Or they can make
spindles themselves. It costs $0.75/lb for aluminum,
takes 72 minutes per unit to machine, and the cost of
machine operator is $14 per hour. Assume there is
no scrap. Should the company produce or buy the
spindles if 125 are needed?
Examples:
4.