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“Managerial Accounting”
Please take three companies from the cement industries:
| Cement |
Look at their profit and loss account in the annual accounts and reports of the company for three years.
Please observe the patteren of fixed and variable costs.
Please assume Depreciation; Interest and Salaries as fixed costs.
All other expenses are variable costs.
Please find out whether profit of these companies have gone up or gone down.
What are the reasons as per your analysis on the profit behaviour
Choose any of the sector considering the companies should be three, so for example if consider “cement” as industry then three companies should be from cement industry needs to be analysed.
Please prepare a three page note (with another three page as annexure) on the industries cost behaviour
Expert Answer
The relevant range is where the cost behavior assumptions hold good. Within this range costs can either be fixed or variable. The total component cost is comprised of both Fixed and Variable element of cost. Sometimes costs are semi-variable meaning it includes a fixed portion and the remainder behaves like variable within relevant range.
A cement manufacturing plant has fixed costs such as rent, salaries and variable costs such as direct materials input cost and direct labor responsible for production only.
Fixed element of costs are that portion of total costs that never changes within the relevant range when there is a change in the quantity of cost driver. But these costs vary on per unit in proportion to activity, volume or other cost driver. Fixed cost remain fixed over the relevant range. But when the standard capacity to production increases due to say increase of plant space, equipment, the fixed cost will also rise. For example, if there is 1000 units of production with a fixed cost of $ 10000, fixed cost per unit comes to $ 10 per unit. If the production is now 2000 units, fixed cost will remain constant at $ 10000 but per unit of fixed cost will come down ($ 10000 / 2000 = $ 5 per unit).
However, if the production is 2500 units but for these production capacity has to be enhanced then fixed cost will also rise say from $ 10000 to $ 12500. Therefore, relevant range is important while considering the cost behavior.
Contrarily, variable costs will vary in proportion to activity, volume or other cost driver, but will remain constant on per unit basis. For a range of 1 to 2000 units variable costs per unit will remain constant. But the total variable cost will change as production is increasing. Say, for 500 units of production the variable cost is 500 x $ 8 = $ 4000. For producing 2000 units the variable cost will be $ 16000. But variable cost per unit of $ 8 does not change within the relevant range of 2000 units. However, if the production increases beyond 2000 units additional variable costs may have to be incurred.
