SU Company Cost Structure Advanced Managerial & Cost Accounting Discussion
Discussion Topic: A Company's Cost StructureIn all respects, Companies A and B are identical except Company A's
costs are mostly variable, whereas Company B's costs are mostly fixed.
In your opinion, which company has a better cost structure?Please do the discussion then do the response each posted # 1 and 2 Garrison, R. H., Noreen, E. W., and Brewer, P. C. (2021). Managerial accounting: Seventeenth edition. Posted 1: Hello class,If
Companies A and B are identical in all respects except for their cost
structures, all quantitative and qualitative attributes of the companies
are identical except for their cost structures and any other attributes
that depend on the cost structures. I will further assume that
Companies A and B are distinct companies with completely separate
ownership and no balance sheet connections. As a consequence of these
assumptions and facts, the net incomes and any other financial ratios or
performance metrics that are independent of the initial cost structure
difference should be identical for Companies A and B, which suggests
that their overall financial positions and earnings performance are
quite similar (nearly identical?) despite their differing cost
structures. In my opinion, if I have correctly concluded that
the earnings and many of the performance metrics for the two companies
are identical in the current period, then there is insufficient data
available to determine which company has the better cost structure in
the current period. If the current period were all that mattered, I
would think that neither cost structure is better than the other because
the two cost structures have resulted in identical performance for
Companies A and B. Levels of fixed costs can be changed in the long-run
(Garrison, Noreen, & Brewer, 2021, p. 35), and the factors that
determine the optimal cost structure for a particular firm or industry
also vary over time. In my opinion, the company in this case that has
the best initial cost structure should have the best long-term
performance according to whatever criteria are deemed appropriate, which
would likely be earnings or shareholder value. Given a long enough
timeframe for comparative analysis, a comparative study of financial
ratios, performance metrics, and cost structures for Companies A and B
could support an opinion about which company has the better cost
structure. I
would expect that the company with the better cost structure would
significantly outperform the company with the worse cost structure, and
if both companies survive, their cost structures should converge to be
identical after a long time, with the company that initially had the
better cost structure showing the least change in its cost structure
over time. Given the uncertainties of the business environment, there
are a variety of factors that could cause the actual results to differ
from my expectation, e.g., technological change could change the optimal
cost structure of the industry from mostly variable to mostly fixed or
Company A could adopt an unexpected corporate strategy that would cause
them to exit the industry they were initially in and enter an industry
with completely different characteristics from the industry of Company
B. Posted 2:Good Evening, Class!The answer to this question is: it depends... on a lot of things.
However deciding on which one is better really boils down to two things:
Sales Volume (and of course all the other items that come along with
sales volume like trends, forecasts, etc...) and managements or owners
confidence/risk aversion.For sales: If sales vary widely from year to year and its hard to
project future sales, than a more variable cost structure may be best.
If sales are steady, stable and growth is expected, a fixed cost
structure would be best. Our text does a great job illustrating this
through the Blueberry farm example and how both farms with the same
sales volume with varying cost structures ended up making the same
profit. As mentioned above, the farm with more of a fixed cost structure
would do better if sales were to beat expectations. (Garrison et al.,
2021, p. 210) The reason is a more fixed-cost structure would do better
in that scenario because every sale made above breakeven (i.e. above the
fixed costs) goes directly to profit, whereas in a more variable-cost
structure environment, cost continue to increase overall (not per unit)
as sales rise. The other side of the coin in all of this is cash flow. IF (and that
is a big if) variable costs can be done without spending cash (unlike
manufacturing [instead think sub-contracting]), I'd go variable costs
all the way, if I needed to keep a tight control on cash. I say that
because fixed costs, also know as period costs are recognized and
reported in the period incurred, which means CASH is going out the door
regardless of sales! Now, I understand that companies with inventory
spend cash on raw materials to make inventory or buy inventory directly
from suppliers. So this theory doesn't work for manufacturing or heavy
inventory firms because they spend cash AND aren't able to show profit
until sales are made (so they better have a lot of cash). However, for
many other organizations, costs (and the resulting cash-outflow) do not
occur until a sale is made, hence making variable cost structures more
attractive in those cases. For Risk-Aversion: There's a lot of psychology in all this... how
much risk, or perceived risk is someone willing to take to have stellar
profits (via high sales and fixed costs) or take less risk through
controlling costs and most likely lower profits (via average sales and
variable costs).