Step in for step costs?

V Pattabhi Ram and A V Vedpuriswar

Wafers was in a spot of bother. She had bunked the week’s classes and her friend’s notebook hardly told her anything about step costs that the good professor had taught. There were some smart diagrams, some natty rules, some cute problems solved -– her pal was gung ho about them — but to Wafers they were all Greek and Latin. She must somehow master them Wafers told herself as she sipped her coffee.

Now munching at Chennai club the gang was planning a reunion of old school friends. China (studying at IIT), Muscles (doing his medical internship), Wafers (battling CA), Rinku (the scribe), Boka and Flowers (both reading at a top b-school) would all be part of the fun trip. Another thirty were expected to join the sojourn, scheduled for April 05. Rinku was taking the initiative to get it organized. It was a tough job: conceptualizing, e-mailing, arranging — vintage PERT and CPM that he had read back at college.

Rinku was now sharing the details with the group. Sterling Ooty would be the rendezvous. Each member would assemble at Chennai and from there they would travel to Coimbatore by train. Thereafter it would be by road to Ooty. “Shouldn’t we travel by the toy train?” asked Wafers. She had been told that the train journey was a scenic beauty. “Oh no” said China. “Five hours in the train can be killing.”

“Each ticket to Coimbatore would cost Rs 500/-“, pointed Rinku. “That’s Rs 1,000/- per person ‘up and down’; a variable cost” Wafers told herself. A van would pick them up at Coimbatore. It would cost Rs 1,400 and could accommodate up to 6 people. “If one person travelled it would cost Rs 1400, if three went it would be Rs 1400, if 6 ferried it would still be Rs 1,400. But if a 7th person travelled we would have to hire a second van and the total cost would be Rs 2,800” said Rinku. For Wafers the coin clicked. “Ha, a step cost” she screamed. The gang stared at her. “1-6 persons 1 van, 7-12 is 2 vans, 13-18 is 3 vans,” she remarked. China was the first to realize that something that had been taught in the class had become clear to Wafers. “Tube light,” he hissed. “The cost is moving in class intervals; hence it is a step cost. It is constant within a class interval; hence it is step fixed cost” continued Wafers, joyous at her new understanding of cost accounting.

Rinku began to reel the numbers. “In a Sterling “twin cottage” 6 people can stay. The cost is Rs 500 per day or Rs 2,000 for four days of stay. I know someone there; we can get a 25% discount making it Rs 1500/-.” Another step fixed cost thought Wafers. “How do the boarding numbers stack up”, asked Muscles (the Mr. Puny with the hungry look). Wafers wondered why he wanted to know. “Do you ever eat anything?” she asked. “Dieting,” he said mischievously. Rinku whipped up the scribbling pad that he carried with him even when he slept. “With group discounts it would cost Rs 1,000 per person for the four days,” he said. Ha, a variable cost thought Wafers. “We will have to engage a van with a seating capacity of six for sight seeing,” said China. “Yes that would be Rs 1,500 per van” purred Rinku. “Let’s not forget the fixed cost of Rs 7,000 to be spent on advertisements and emailing to get in touch with the old boys” pointed out Muscles.
How much should each of us chip in asked Wafers. After all, she had to ask her mom for the money. “Rs 3,200” said Rinku. China was surprised. “Hey, at that price the trip is a steal.” Muscles volunteered, “Will we break even?” They all turned to Wafers, the bean counter. Before she could gather her wits, Rinku said “23”. Wafers did her math. The train ticket at Rs 1,000 per person and the boarding charges at Rs 1,200/- per person meant that the variable cost was Rs 2,200/-. With collection being Rs 3,200 per person the contribution was Rs 1,000 per head. At 23 heads it added up to Rs 23,000/-.

She then culled out the step fixed costs. The van cost (accommodating six) was Rs 1,500, the stay (accommodating six) was Rs 1,500 and the sight seeing (accommodating six) was Rs 1,000 all adding up to Rs 4,000/- per 6 persons. 23 people would mean a block of four. So the step cost would be Rs 4,000 X 4 = 16,000/-. Add to that the fixed cost of Rs 7,000 and you had a total cost of Rs 23,000. “Rinku is right”, screamed Wafers.

Muscles asked, “What if we get 26 people?” “Ofcourse we would make profits,” said Wafers recalling her precious knowledge of Break Even Point (BEP). “Beyond the BEP you make only profits and profits” she remarked. “Ofcourse not” said China. Wafers scribbled on the tissue paper. 26 people meant a contribution of Rs 26,000/-. It also meant 5 vans and 5 cottages. So, the step cost would be Rs 20,000/-. The fixed cost was Rs 7,000/-Total 27,000/-. Loss: Rs 1,000/-. As usual China was right.

He smiled at her and remarked, “Try 28 people”. Contribution 28,000/; Step cost Rs 20,000/-; Fixed Costs Rs 7,000/-Profits Rs 1,000/-. Wafers blinked. “What does this mean?” she asked looking heavenwards, too proud to look into China’s eyes. China said, “It means that there is a second breakeven point.” Rinku chipped in “And may be a third as well.” Ha, multiple BEPs. Was her class notes becoming clearer?

“How do I find the BEPs?” she asked. And suddenly remembered Step 1 from the notes, “Compute tentative BEP for each class interval.” She did that by considering the step fixed cost as another fixed cost. The BEP for the first class interval of 6 students turned out to be 11. Wasn’t that funny? And suddenly she remembered Step 2; “Check the validity of the computed BEP.” Her friend’s notes screaming Step 2(a) stared at her face. “A tentative BEP is valid only if it falls within the class interval for which it is computed.” In her Sterling example the numbers were 23, 27 and 31.

But what was she to make of the BEP that fell to the right of the computed class interval. “That’s a loss zone” said China surprising her. She recalled Step 2(b), “If the tentative BEP falls to the right of the class interval for which it is computed, the class interval represents a loss.” Meaning every number in that class interval would be a loss. In her Sterling example the first three class intervals were loss zones. And when would she make profits and profits, she thought. “Well if you landed up with the first full profit zone” said China, stunning her. In her professor’s lingo it was Step 2 (c). “If the tentative BEP falls to the left of the class interval for which it is computed, the class interval represented by it is in the full loss zone.” For her gang, beyond a group of 31 it was profits and profits.

Ha some practical use for step cost Wafers told herself.


About Pattabhi Ram

A chartered accountant by profession, a writer by passion and a teacher by accidental choice.
This entry was posted in Racy Cases and tagged , , , , , . Bookmark the permalink.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s