Activity-Based Costing - Essay Example

Operating leverage is the lowest in merchandising companies. Such companies mainly engage in the buying and selling of goods. Their fixed costs include mainly storage and selling costs. A higher proportion of their costs is variable costs such as packaging of goods and transportation costs. In between, service companies have a higher proportion of fixed costs and hence higher operating leverage than manufacturing companies. Service companies, such as hair salons, incur a fixed amount of rent, staff salary, and facility and equipment cost regardless of whether there are any customers.

Variable costs, such as shampoo, are a very low proportion. Manufacturing companies have lower operating leverage than service companies and e-commerce companies but higher operating leverage than merchandising companies. Their fixed costs include land, equipment, machinery, plants, and facilities. However, they also have a high level of variable costs such as direct labor and direct material.2b. Operating leverage can be increased so that the impact of the increase in sales goes almost entirely to the profits. 3a. An example is the determination of the units of products to sell in order to break even. 3b. If the 10% increase in sales is caused by the increase in sales price, then the revenue line is shifted upwards to the left.

The breakeven point would be decreased and the profits would be increased assuming that the company sells the same volume. If the 10% increase in sales is caused by the increase in volume, this represents a shift to the right along the revenue line. The breakeven point would still remain the same but profit is now increased as the gap between the revenue line and the total costs line increases. If the company has been operating at a loss, then, the loss is now decreased as the gap between the revenue line and the total costs line decreases.