Costs of Production
July 2011
Topics to be Discussed
Measuring Cost: Which Costs Matter? How do Cost Curves Behave? – Cost in the Short Run – Cost in the Long Run How to Minimize Cost? How to draw Implications for Business Strategy?
Topics to be Discussed
Production with Two Outputs: Economies of Scope Dynamic Changes in Costs: The Learning Curve Estimating and Predicting Cost
Measuring Cost: Which Costs Matter? Accountants tend to take a retrospective view of firms’ costs, whereas economists tend to take a forward-looking view Accounting Cost – Actual expenses plus depreciation charges for capital equipment Economic Cost – Cost to a firm of utilizing economic resources in production, including opportunity cost
Costs
…show more content…
HOW does it MOVE? Extent of Rise in Cost Depends on the nature of the PRODUCTION PROCESS – Extent to which production involves DIMINSHING RETURNS to VARIABLE FACTORS If MARGINAL PRODUCT OF LABOUR DECREASES significantly as more labor is hired – Costs of production increase rapidly – Greater and greater expenditures must be made to produce more output
Determinants of Short Run Costs
Assume Labour: only Variable Input Assume the wage rate (w) is fixed relative to the number of workers hired Variable costs is the per unit cost of extra labor times the amount of extra labor: wL
∆VC w∆L MC = = ∆Q ∆Q
A Firm’s Short Run Costs
Inference: MC decreases initially with increasing returns (0 through 4 units of output) MC increases with decreasing returns (5 through 11 units of output)
TC
Cost 400
($ per year)
300
Total cost is the vertical sum of FC and VC.
VC
200
Variable cost increases with production and the rate varies with increasing and decreasing returns.
100
Assuming that the company’s goal is to maximize profits, the current cost system is not an appropriate tool for strategic planning. The ambiguity of the overhead costs per product makes it difficult to accurately analyze the cause and effect relationships of changes and/or improvements to specific product line.
Total Variable Cost = (Number of Workers * Worker’s Daily Wage) + Other Variable Costs
The Law of diminishing returns states that if one factor of production is increased while the others remain constant, the overall returns will relatively decrease after a certain point. The total fixed cost is the same regardless of the output; the total variable costs will change with the level of output resulting in the total cost as the sum of the fixed cost and variable cost at each level of output. Over the 0 to 4 range of output, the TVC and TC curves slope upward. They reflect a decreasing rate due to the increasing minor returns. The slopes curves will increase due to these diminishing marginal returns.
While we are performing our analysis on different aspects of the company, we look at the three main types of cost. When we remain devoted to improving our costs, and the faults related, we show our same devotion to our consumers. This is portrayed by the quality of products we put on the shelves. Prevention costs, appraisal costs and Failure costs are areas
c) It increases. This increase is the same at all values of capital per worker.
Cost measurement is the process of determining the dollar amount of direct materials, direct labor, and overhead that should be assigned to production. Cost accumulation is the process of associating costs with the units produced. Cost measurement is more about whether actual or estimated costs should be used, and cost assignment is about whether costs should be assigned to jobs or processes.
The Marginal Cost graph is a function of change in total cost divided by change in quantity produced. Marginal cost is the added cost of producing one additional unit of production, or the savings in not producing one additional unit. The graph decreases until the fourth unit of production, and then increases rapidly, as marginal cost is tied to total cost and is thus subject to the law of diminishing returns.
If a good cost-measurement system was set up, cost-plus contracts will demonstrate the advantages of cost-management better than fixed price contracts do. With a robust cost-measurement system, managers are able to know the real revenue drivers, to recognize the most valuable customers, and to offer more reasonable price bid. That is to say, cost-measurement system’s strength lies in differentiating clients’ value, projects’ value and operation processes’ value case by case. Under this circumstance, cost-plus contracts would surely dig more utilization and benefit more from such a system, because CitySoft would be able to charge different customers and projects for different prices, which is critical for increasing profitability.
Cost has traditionally being a major influence on all business as all businesses desire to achieve maximum efficiency as it is a vital factor for businesses in order to reach the ultimate goal and success. Businesses sees cost as the key value to success and aims to become as much cost efficient as possible, by implementing a cost-leadership style approach to the operations variable cost or fixed cost ,while maintain the expected profit margin, business is able to gain a competitive advantage over their competitors in their target market. This is called cost-based competition. By determining the break-even point and applying cost saving strategies, to reducing cost, businesses who apply cost-based competition in their operations is able to maximize the profits and lead business to success.
A variable cost is a corporate expense that varies with production output. Variable costs are those costs that vary depending on a company's production volume; they rise as production increases and fall as production decreases (Variable Cost, n.d.); in the case study for all cost per event such
Businesses – from manufacturing, merchandising and service industries alike – take careful considerations for their costing systems. Setting-up competitive prices in the market can be a result of proper costing methods. Misallocation of costs may lead to incorrect price estimates, continuous production of unprofitable products, and ineffective processing schedules. In this case study, we will discuss the costing methods Zauner Ornaments are currently using and upon conclusion, it will enable us to distinguish the advantages and disadvantages of each costing method.
INTRODUCTION Businesses – from manufacturing, merchandising and service industries alike – take careful consideration in the analysis of their costing systems in order to be able to set up competitive prices in the market. Misallocation of costs may lead to incorrect price estimates, continuous production of unprofitable products, and ineffective processing schedules. In this case study, we will discuss the costing methods which Zauner Ornaments have used or is currently using and, in conclusion, be able to distinguish the advantages and disadvantages of each costing method. CASE CONTEXT The case seeks to assist Zauner’s comptroller, Yu Chia-yi, in determining the best costing method for their overhead costs. In addition we also aim to
The purpose of this paper is to answer a few important questions: Why do companies allocate costs? How do companies allocate costs? And how this cost allocation can affect the decision making of the company. It is important for the companies to find the proper method to allocate the costs. Cost allocation is an important issue in many companies because many of the costs associated with designing, producing and distributing products and services are not easily identified with the products and services that are created. It would have been easier for companies to allocate cost if costs were directly traceable with the products and the cost allocation would have been minor issue for the company. The decision-making
Cost behavior refers to the way different types of production costs change when there is a change in level of production.
Under the new cost system, two broad sources of costs were identified: manufacturing and SM&A. All costs within these categories were reclassified as either volume driven or order driven. Hence, four cost pools were set up.