Variable costs are costs that change in total proportion to the level of production. Examples include raw material costs, direct labor costs, and some types of overhead items like electricity.

Fixed costs are those costs that remain constant in total over a range of activity and production. Examples of these costs include rent, property taxes and the depreciation expense of a building.

Usually as revenue increases (through an increase in the number of units sold), net income also increases (and usually by a larger percentage than sales revenue). For example, suppose a company sells 5000 units of a good at $10 each. The cost of each good is $4 to the company and fixed expenses are $20,000. A contribution margin income statement would look like this:

Now suppose the units sold doubles to 10,000 units. A contribution margin income statement looks like this:

Note that while sales revenue went up by 100%, net income increases by 400% ($40,000 divided by $10,000).

Look up management analysis of Dell Computer's financial reports (part 1  and part 2)to help answer the following questions.

1. Begin by reading the "Net Revenue" section. Did sales revenue/volume increase or decrease between 1997 and 1998?

2. Now read the section under "Operating Expenses." This section states that "selling, general and administrative expenses increased in absolute dollar amounts but decreased as a percentage of total revenue."

   1. What are some types of fixed costs that are selling, general and administrative?

   2. Why did this amount decrease in terms of percentage of net revenue?

3. Now scan down to the section "Operating Income." Explain why annual revenue increased by 59% but net income increased by 84% in 1998 (hint - use the example provided in the narrative at the top of this project)?

Now visit the Boeing web site and a discussion of its 1997 financial results.

4. See the top of the page that reads "Boeing Reports 1997 Full Year and 4th Quarter Results." What happened to Boeing's net income and sales revenue in 1997? Was this similar to the results found from Dell?

5. Scan down to the fifth (5th) paragraph, which begins "Production problems being experienced…", Read this paragraph. In order for net income to increase when sales revenue increases, variable unit cost should remain constant. Did this happen at Boeing in 1997?

6. List three reasons why the variable cost per unit did not remain constant for Boeing? Did these things cause the variable cost per unit to increase or decrease?

7. Do you think these problems will continue into 1998 or 1999?

© 2002 by Prentice-Hall, Inc.A Pearson Education Company, Upper Saddle River, New Jersey 07458

PHLIP was originally conceived and developed for Prentice Hall with the expertise of Dan W. Cooper of Active Learning Technologies, Inc.and Scott R. Lyman.

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