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’scosts 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,

IfCompanies A and B are identical in all respects except for their coststructures, all quantitative and qualitative attributes of the companiesare identical except for their cost structures and any other attributesthat depend on the cost structures. I will further assume thatCompanies A and B are distinct companies with completely separateownership and no balance sheet connections. As a consequence of theseassumptions and facts, the net incomes and any other financial ratios orperformance metrics that are independent of the initial cost structuredifference should be identical for Companies A and B, which suggeststhat their overall financial positions and earnings performance arequite similar (nearly identical?) despite their differing coststructures.

In my opinion, if I have correctly concluded thatthe earnings and many of the performance metrics for the two companiesare identical in the current period, then there is insufficient dataavailable to determine which company has the better cost structure inthe current period. If the current period were all that mattered, Iwould think that neither cost structure is better than the other becausethe two cost structures have resulted in identical performance forCompanies A and B. Levels of fixed costs can be changed in the long-run(Garrison, Noreen, & Brewer, 2021, p. 35), and the factors thatdetermine the optimal cost structure for a particular firm or industryalso vary over time. In my opinion, the company in this case that hasthe best initial cost structure should have the best long-termperformance according to whatever criteria are deemed appropriate, whichwould likely be earnings or shareholder value. Given a long enoughtimeframe for comparative analysis, a comparative study of financialratios, performance metrics, and cost structures for Companies A and Bcould support an opinion about which company has the better coststructure.

Iwould expect that the company with the better cost structure wouldsignificantly outperform the company with the worse cost structure, andif both companies survive, their cost structures should converge to beidentical after a long time, with the company that initially had thebetter cost structure showing the least change in its cost structureover time. Given the uncertainties of the business environment, thereare a variety of factors that could cause the actual results to differfrom my expectation, e.g., technological change could change the optimalcost structure of the industry from mostly variable to mostly fixed orCompany A could adopt an unexpected corporate strategy that would causethem to exit the industry they were initially in and enter an industrywith completely different characteristics from the industry of CompanyB.

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 withsales volume like trends, forecasts, etc…) and managements or ownersconfidence/risk aversion.

For sales: If sales vary widely from year to year and its hard toproject future sales, than a more variable cost structure may be best.If sales are steady, stable and growth is expected, a fixed coststructure would be best. Our text does a great job illustrating thisthrough the Blueberry farm example and how both farms with the samesales volume with varying cost structures ended up making the sameprofit. As mentioned above, the farm with more of a fixed cost structurewould do better if sales were to beat expectations. (Garrison et al.,2021, p. 210) The reason is a more fixed-cost structure would do betterin that scenario because every sale made above breakeven (i.e. above thefixed costs) goes directly to profit, whereas in a more variable-coststructure 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 thatis a big if) variable costs can be done without spending cash (unlikemanufacturing [instead think sub-contracting]), I’d go variable costsall the way, if I needed to keep a tight control on cash. I say thatbecause fixed costs, also know as period costs are recognized andreported in the period incurred, which means CASH is going out the doorregardless of sales! Now, I understand that companies with inventoryspend cash on raw materials to make inventory or buy inventory directlyfrom suppliers. So this theory doesn’t work for manufacturing or heavyinventory firms because they spend cash AND aren’t able to show profituntil sales are made (so they better have a lot of cash). However, formany other organizations, costs (and the resulting cash-outflow) do notoccur until a sale is made, hence making variable cost structures moreattractive in those cases.

For Risk-Aversion: There’s a lot of psychology in all this… howmuch risk, or perceived risk is someone willing to take to have stellarprofits (via high sales and fixed costs) or take less risk throughcontrolling costs and most likely lower profits (via average sales andvariable costs).