5. Relevant Costs and Cost Volume Profit Analysis Flashcards
Definition of “Cost”:
Cost may be defined as the amount of resources, usually measured in monetary terms, sacrificed to achieve a particular objective.
What is a “cost object”?
A cost object is any activity for which a separate measurement of cost is desired. e.g. the cost of a product, the cost of rendering a service in a hotel, the cost of operating a particular department, etc.
What are “relevant costs”?
Relevant costs and revenues are those that will be changed by a decision
What are “sunk costs”?
Sunk costs are costs made by a decision taken in the past and cannot be changed by any decision taken in the future.
What are “opportunity costs”?
Opportunity costs measures the opportunity that is lost or sacrificed when the choice of an alternative course of action requires that another alternative course of action is given up
What are “irrelevant costs”?
Irrelevant costs and revenues are those that will remain the same irrespective of the decision.
What are “Fixed costs” (FC)?
Fixed costs (FC) remain constant over wide ranges of activity for a specified time period. Total FC remains constant for all level of activity, whereas unit FC decrease proportionally with the level of activity.
What are “Variable costs” (VC)?
Variable costs (VC): are costs that vary in direct proportion with the level of activity, i.e. doubling the level of activity will double the total variable cost. Total variable costs are linear and unit variable costs are constant.
What are “semi-fixed costs”?
Semi-fixed or step fixed costs are those costs that are fixed within a given time period or within specific activity levels, but they eventually increase or decrease by a certain amount at various critical activity level.
What are “semi-variable costs”?
Semi-variable costs (SVC) include both a fixed and variable element. (e.g. the cost of maintenance includes a planned maintenance that is undertaken whatever the level of activity, and variable element that is directly related to the level of activity.
What is a “Variable Costing System”?
“It is a management accounting system in which variable costs are charged to cost units and fixed costs of the period are written-off in full against the aggregate contribution. It has special value in decision making.”
Variable cost per unit :
- Direct materials 7
- Direct labour 8
- Variable overheads 4
–> Total variable cost 19
Variable costing is concerned with identifying only the relevant costs at unit level.
We do not try to find the fixed costs per unit. Fixed costs are deducted in full.
What is the “Cost Volume Profit Analysis”?
CVPA is a method of examining the relationship between changes in activity (i.e. output) and changes in total sales revenue, expenses and net profit in the short run.
What are the “Cost Volume Profit Analysis” assumptions?
CVP Analysis assumptions:
- Profits are calculated in a variable costing basis
- The analysis applies over the relevant range only
- Unit variable cost and selling price are constant per unit of output (within the relevant range).
- It’s always possible to split costs into variable an fixed costs within the relevant range
What is the “relevant range”?
Relevant range refers to the output range at which the firm is expected to operate within a short-term planning horizon (normally a year, but it can be shorter). The relevant range also broadly represents the output levels which the firm has had experience of operating in the past and for which cost information is available
What is “break-even (B/E) analysis”?
Break-even analysis is concerned with assessing the point at which neither a profit nor a loss is made.
B/E point tells us how many units must be sold in order to have:
Sales revenue = Total costs
