1.2 Cost Behavior and Cost-Volume-Profi Relationship

Question 1

Approach to predict and control costs is to identify

Answer 1

• key activities performed
• resources used in performing these activities
• cost of the resources used, and
• cost drivers, measures of activities that require the use of resources and thereby cause costs

In other words:

• Activities use resources and these resources have costs.
• We measure this relationship between activity and cost using cost drivers.

Question 2

Total Cost

Answer 2

C(x)=Cf+cv*x, where
𝑥: number of units produced,
𝐶􏰀f: total fixed costs
𝑐v􏰁: variable cost per unit
𝐶􏰁v(𝑥) = 𝑐􏰁v*𝑥: total variable cost when producing 𝑥 units

Question 3

Cost per part

Answer 3

C(x)=(C(x))/x=(Cf/x)+cv=cf(x)+cv, where

cf(x)=(cf/x): fixed costs per part when producing x units

Question 4

Complicating factors for Fixed and Variable Costs

Answer 4

• Fixed and variable cost may change if certain activity levels are exceeded or fallen short off
• The relevant range is the limit of cost-driver activity level within which a specific relationship between costs and the cost driver is valid.
• Even within the relevant range, fixed cost and unit cost for variable cost remain fixed only over a given period of time — usually the budget period

Question 5

Step Cost

Answer 5

A cost that changes abruptly at different intervals of activity because the resources and their costs come in indivisible
chunks.

Question 6

Mixed Cost

Answer 6

A cost that contains elements of both fixed- and

variable-cost behavior

Question 7

Cost-Volume-Profit Analysis

Answer 7

• Cost-volume-profit (CVP) analysis is the study of the effects of output volume on revenue (sales), expenses (costs), and net income (net profit).
• The break-even point is the level of sales at which revenue equals expenses and thus net profit (=sales - cost) is zero

Question 8

Target net profit and sales

Answer 8

Managers use CVP analysis to determine the sales – in units and dollars – needed to reach a target net profit.

Question 9

Impact of Changes in Fixed Expenses & Contribution Margin

Answer 9

• Increase in fixed expenses: Break-even sales volume increases
• Increase in unit contribution margin:
  Break-even sales volume decrease

Question 10

Additional Uses of CVP Analysis

Answer 10

1. Margin of Safety:Measure how far sales can fall below planned level before losses occur
   margin of safety in units = planned unit sales
   – break-even unit sales
   margin of safety in dollars = planned dollar sales
   – break-even dollar sales
2. Operating leverage and Best Cost structure:
   - Operating leverage is a firm’s ratio of fixed costs to variable costs
   - Highly leveraged firms have high fixed costs and low variable costs
   - Small change in sales volume results in large change in net income
   - Best Cost Structure: Best combination of variable and fixed-cost resources