1.2. Cost Behaviour and Cost-Volumne-Profit Relationship

Question 1

When we want to control and predict costs we identify…

1.
2.
3.
4.

Answer 1

• key activities performed
• resources used in performing these activities
• cost of the resource used and
• cost drivers (!)

Question 2

What are cost drivers?

Answer 2

measures of activities that require the use of resources and thereby cause costs (how much people are coming to the party that will use the resources?)

-> activities use resources and resources have costs. we measure this reltionship between activity and cost using cost drivers

we measure the relationship between activity and cost using cost drivers

Question 3

What are complicating factors for fixed and variable costs?

1.
2.
3.

Answer 3

• they may change if certain activity levels are exceeded or fallen short off
• many costs cannot accurately be describes as simply fixed or variable
• even within the relevant range, fixed costs and unit costs for variable cost remain fixed only over a given period of time - usually the budget period

Question 4

What is the Relevant Range?
What is the Budget Period?

How are they connected?

Answer 4

• Relevant Range: The limit of a cost driver activity level in which a specific relationship between cost and the cost driver is valid
• Budget Period: Period in which fixed cost and unit cost for variable cost remain fixed over
• Even within the Relevant Range, fixed cost and unit cost for variable cost remain fixed only over a given period of time (the budget period)

Question 5

What is a 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

What is a mixed cost?

Answer 6

• a cost that contains elements of both fixed and variable cost behaviour

Question 7

What do you do in a cost-volumne profit analysis?

Answer 7

• you study effects of output volumne x on revenue R, costs C and net income (net profit) P

Question 8

What is meant by variable cost behaviour?

Answer 8

• per unit variable cost remains unchanged per unit of the cost driver
• total variable costs change on direct proportion to the cost driver activity

Question 9

What do Managers use CVP (Cost Volume Profit) analysis for?

1.
2.
3.

Answer 9

• to determine the in units and dollar needed to reach a target net profit
• margin of safety
• operating leverage

Question 10

What is meant by fixed cost behaviour?

Answer 10

• total fixed costs remain unchanged regardless of changes in the cost driver activity
• per unit fixed cost depend on the cost driver activity

Question 11

What is the break even point?

Answer 11

• level of sales volumne x at which net profit (=revenue - cost) is zero

Question 12

What is the break even point equation?

And what is its economic interpretation?

Answer 12

x(uCM) = fixed cost / contribution margin per unit = FC / uCM

If uCM changes by one, the break even point x changes by approximately FC / uCM^2
The smaller uCM the larger gets the change in break even point!

Question 13

Uses of CVP | What is the Margin of Safety?

1.
2.
3.

Answer 13

• measures how far sales can fall below planned level before losses occur
• margin safety in units = planned unit sales - break even nit sales
• margin of safety in dolla = planned dollar sales - creak even dollar sales

Question 14

Uses of CVP | What is the operating leverage?

1.
2.
3.

Answer 14

• operating leverage is a firms ratio of fixed costs to variable costs
• highly leveraged firms have high fixed costs and low variable costs -> high contribution margin per unit | small change in sales volumne results in large change in net income
• companies to select best combination of variable and fixed cost resources (best cost structure)

Question 15

Exaplain the variable cost behavior

Answer 15

• per unit: remain unchanged per unit of cost driver
• total: change on direct proportion to cost driver activity
• c(x) * x = C(x)

Question 16

What happens if to the break even sales volume if….

1. fixed expenses increase
2. unit contribution margin increases

Answer 16

1. break even sales volume increaes
2. break even sales volume decreases