3 - Cost behaviour

Question 1

what is cost behaviour

Answer 1

the way in which a cost changes as activity level (volume of output) changes

Question 2

why is cost behaviour necessary

Answer 2

for businesses to know how costs behave with outputs so predictions can be made

expected that costs increase as output increases, but the way in which it does that is different

Question 3

how is level of activity, or output, measured

Answer 3

• volume of production in a period
• no of items sold
• no of invoices issued
• no of units of electricity consumed

Question 4

what is a fixed cost

Answer 4

a cost incurred for an accounting period that, within certain output or turnover limits, tends to be unaffected by fluctuations in levels of activity

Question 5

what is a stepped cost

Answer 5

= cost which is fixed in nature, but only within certain levels of activity

depending on time frame being considered, it may appear as fixed or variable

Question 6

what is a variable cost

Answer 6

varying with volume of output

variable cost per unit is the same amount for each unit produced whereas total variable cost increases as volume of output increases

Question 7

what is a semi variable, semi fixed or mixed cost

Answer 7

cost which is part fixed and part variable so is therefore partly affected by a change in the level of activity
a cost that has both fixed and variable components

Question 8

why would a graph be curvilinear

Answer 8

because each extra unit is adding more/less to total variable cost than the previous unit

Question 9

what is the relevant range

Answer 9

refers to activity levels which an organisation has had experience of operating at in the past and for which cost information is available

Question 10

what is the linear assumption

Answer 10

states that total fixed costs remain constant, and variable costs are a constant amount per unit

Question 11

what is the impact of timescale

Answer 11

the longer the timescale, the greater the proportion of costs that can be considered as variable

Question 12

methods of estimating fixed and variable costs from total costs

Answer 12

1. high low method
2. line of best fit method
3. linear regression method

Question 13

what is the high low method

Answer 13

involves extrapolating (extending) a line drawn between the highest and lowest data items (activity levels)

Question 14

what is the linear regression analysis method

Answer 14

finds line of best fit using mathematical formulae and calculates best estimates

Question 15

regression analysis equation

Answer 15

y = a + bx

where:
y = dependent variable - costs
a = intercept on vertical axis - fixed costs
b = slope, gradient, of the line - variable cost per unit
x = independent variable - output

Question 16

how can the reliability of the regression line be tested

Answer 16

the correlation coefficient indicates the strength of the linear relationship between two variables

BUT doesnt prove a cause and effect relationship

Question 17

what is the coefficient of determination

Answer 17

where
- value between 0 and 1
- value indicates proportion of change in y explained by change in x
- value only indicative and doesn’t prove a cause and effect relationship

Question 18

limitations of linear regression analysis

Answer 18

• assumes linearity between x and y
• observations may be untypical
• historic data is used and patterns may change in future
• each observation should be independent from others
• forecasting usually involves extrapolation outside given range of observations where working conditions and cost patterns may change