Chapter 13

Question 1

Margin of safety

Answer 1

Indicates the percentage by which, forecast revenue exceeds or falls short of that required breakeven 

Question 2

Assumptions of breakeven analysis

Answer 2

Constant fix costs at any output level (i.e. no stepped costs).

Constant variable cost per unit and constant selling price per unit. This leads to straight lines on the graph.

No change in inventory levels (i.e. sales volume equals production, volume)

The model can only be applied to a single product or constant product mix scenario. 

Question 3

Multiproduct breakeven analysis

Assumptions 

Answer 3

Constant product mix

Or

All products have identical C/S ratios

Question 4

Operational gearing and breakeven analysis

Answer 4

Operational gearing is the proportion of costs that are fixed. Operational gearing can be measured by calculating the percentage of fix costs in relation to total costs.

Businesses with high operational gearing I likely to have high CS ratios, as variable costs will be relatively low.

Kiran will be partly determined by the industry. The business is in, for example, service businesses with significant salary costs are likely to have a high operational gearing.

High operational gearing will result in a high breakeven point as a greater amount of contribution will be needed to cover fix costs .

Profitability will be very elastic in terms of sales, with small changes in sales resulting in loss changes in profit.

High operational gearing will also mean that the business has a steeper profit line on its P/V chart. 

Question 5

Operational gearing calculation

Answer 5

Fixed cost divided by total costs

Question 6

Reducing operational gearing

Answer 6

Increase CS ratio and decrease the amount of fixed costs in the business

Question 7

Increasing operational gearing

Answer 7

Increase the amount of fixed costs in the business and increase the CS ratio