How to Deal with Vary-with-Profit Costs in QuickBooks - dummies

How to Deal with Vary-with-Profit Costs in QuickBooks

By Stephen L. Nelson

If your profit-volume-cost analysis includes more than a single vary-with-profit cost, you must deal with the possibility that your vary-with-profit costs are interrelated. In fact, vary-with-profit costs can have one of three relationships: independent-independent, independent-dependent, or dependent-dependent.

The independent-independent relationship is the easiest to deal with. If two vary-with-profit costs are independent of each other, you can just enter the percentages into the appropriate workbook cells and not worry about them. An independent-independent relationship exists when vary-with-profit costs have no effect on each other. For example, a partnership may have two profit-sharing plans — one for partners and one for employees — that aren’t related.

A slightly more complicated relationship between vary-with-profit costs is the case of an independent-dependent relationship. A good example of an independent-dependent relationship is the relationship of state and federal income taxes.

Because federal income taxes allow for a deduction based on state income taxes, the federal income tax expense depends on the state income tax expense. If the federal income tax percent equals 20 percent, and the state income tax percent equals 10 percent, you can’t simply enter the state income tax as 10 percent and the federal income tax as 20 percent. You need to adjust the federal income tax percentage for the effect of the state income tax.

Suppose that the state income tax rate is 10 percent of the pre-tax profits and that after the state income tax is deducted from the pre-tax profits, the federal income tax rate is 20 percent of what’s left over. The correct input percentage for the state income tax rate is 10 percent, because 10 percent of the pre-tax profits calculates the correct state income tax cost.

However, the federal income tax percentage must recognize the state income tax costs.

A third type of relationship is the dependent-dependent relationship. This relationship occurs when one vary-with-profit cost affects another vary-with-profit cost. For example, in the case of a typical employee profit-sharing plan, in which profits are based on after-tax profits, you need to know the profit-sharing plan expense in order to calculate the federal income taxes.

The profit-sharing plan expense is deductible for purposes of calculating federal income taxes. However, you must know the federal income tax expense in order to calculate the after-tax profits on which the profit-sharing plan is based. In cases of dependent-dependent relationships among vary-with-profit costs, you can calculate percentages that in effect adjust for the dependency. To do this, you need to employ a fair amount of high-school algebra.