Optimization

When calculations are applied to the optimization purposes (optimal price, optimal product mix), some of the central terms in the previous chapter on costs must be revised, starting with the calculation task, i.e. they have to be "re-interpreted in terms of the calculation perspective:"

o Marginal costs, MC

According to the calculation perspective, a narrow production view can often result in a similar situation to that described in the following metaphor: the camel that eventually broke its back because the loaders kept saying: "If it can carry this, it can also carry that." A production can typically manage to manufacture one unit more or less without any consequences for the costs other than the direct product costs, such as materials and direct wages. Therefore, MC is often underestimated significantly, as so-called "sneaking costs" (such as decreasing efficiency) are rarely incorporated, even though they are significant for most production processes. Other important factors in this context include: management, repairs, internal transport, etc.

o Average Variable Costs, AVC

From the calculation perspective, "half-variables" (e.g. sales and administrative costs, machinery, production management, etc.) represent a difficult problem, as they are extremely time horizon dependent. Moreover, precision is lost when it is necessary to apply many, more or less dubious distribution plans in order to achieve a calculated AVC.

o Average Total Costs, ATC

ATC equals AVC + AFC. AFC is only marginally related to the actual production. AFC may be comprised of depreciation on historic goodwill, development costs, and other sunk costs.

o ABC - costs per cost-object, CCO

CCO estimates the costs attributed to a cost-object as having applied the ABC cost classification, and subsequently the division on cost-objects using the cost-drivers as too1. This; relationship will be explained later in greater dearth.

American economists often use the ATC, suggesting that in this way a long-term optimization is achieved, combined with a safeguard against the liability to compete recklessly, and not cover the fixed costs.

European calculation traditions are more devious, maybe because there is not the same tradition of tough competition between companies, as is found in the USA.

The calculation problem

When calculations are used in optimization (e.g. pricing and optimal product mix), it is important that costs are attributed to the relevant decision. Whether or not a product, a product line, or an activity is profitable depends on which costs are included in the action.

As not every cost can be attributed directly to the specific product unit (e.g. sales and administrative costs), one of the central problems involved in the calculation task is to deal with costs that are common to several products, product lines, and/or business sections. Should such joined costs be distributed to specific product units? And if yes, then how? It is also up to the calculations to solve the issue of how theoretical correct, meaningful, and objectively accurate, this distribution of the joined costs is executed.

Costs centers and cost bearers

The following terms are central for establishing a calculation:

o Cost centers focus on organizational work, process oriented, or production oriented elements in a business. A number of costs can be measured, attributed, or applied to these respective foci.

In order to determine the focus, the reporting system and the account plans of the firm must be adequate and approachable in their arrangement. A number of cost centers are presented below. These cost centers are described within the framework of a firm HKP, a woodworking factory with 5 employees, producing windows and doors with different measurements.

- Depreciation of the machinery value

- Cost of cleaning, service, and power for the woodworking section.

- Repairs, sharpening of cutting edges etc. for different machine sections.

- Wage costs for different tasks

- Total costs for office and accounting tasks

o Cost bearers are the production elements whose costs are to be analyzed and calculated. Typically, these are the firm's products, groups of products, and/ or services. Often these elements include many costs that cannot be measured directly (unlike the cost centers). Cost bearers can also be semi-manufactured goods, or internal services aiming to establish cost prices between the sections. Using the HKP case, cost bearers could include:

- The price of a window or an established number of windows of a specific type.

- The price for one woodworker's hour of labor, including wages attached to the estimation of special assignments

- The price of dip-impregnating a batch of wood.

- The price for installing a typical window in a typical house.

 
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