Question

Distinguish between full, direct, and indirect costs. Distinguish among average, fixed, and variable costs. What can a manager do if a break-even analysis indicates that a venture will lose money? (2-3 paragraphs)

Answer 1

Direct Expenses

• Direct expenses are those which are directly related to the purchase /production of goods or rendering services.
• These expenses are shown on the debit side of the trading account.
• These expenses are identified to calculate gross profit.
• These expenses may differ according to the type of business concern such as manufacturing, trading or service, etc.
• These expenses can be allocated to a product or department
• Examples: purchase cost of raw material, wages paid to factory workers, factory rent, etc.

Indirect Expenses

• Indirect expenses are those which are not directly related to the purchase/production of goods or rendering services.
• These expenses are shown on the debit side of profit and loss account or income statement.
• These expenses are identified to calculate the net profit.
• These expenses may also differ according to the type of business concern such as manufacturing, trading or service, etc.
• These expenses cannot be allocated to a specific product or department and are shared among different products or departments.
• Examples; Printing and stationery, legal fee, accounting and auditing fee, miscellaneous expenses, etc.

Fixed cost is the cost incurred by the producer on the purchase of fixed factor inputs used in short run production function. Fixed cost remain fixed with every increasing level of output, it don't vary with the change in output level. Whereas variable cost is the cost incurred by the producer on the purchase of variable factor inputs used in short run production function, it's vary with the change in output level. Initially variable cost increase with diminising rate then it increase with increasing rate that's due to law of variable proportion. Average cost is the cost per unit of output produced and marginal cost is the change in total cost due to variable cost. Both AC and MC are U Shaped.

Companies calculate their break-even point to determine if they will lose money under certain conditions. From an accounting perspective, the break-even point is where revenue equals total costs. At this point, the organization is neither losing nor making money. Determining the break-even point tells a company how much of a product it must sell, and at what price, to break even. The break-even analysis considers total costs (both fixed and variable). Other than simply providing a break-even point, a break-even analysis highlights income and expenses to show a company its areas of improvement to reduce costs and increase profit.

Break-even analysis provides a lot of useful information. For example, if the break-even analysis demonstrates that the sales price of the unit is too low, then the company might consider whether its costs are too high or whether the unit's sales price can be increased. However, increasing the unit's sales price may make the unit more expensive than similar products on the market. In that case, competition may harm the total sales of the units, and the company will likely not come near to breaking even.