Cost-Volume-Profit Analysis Flashcards
Distinguish between variable, semi-variable, and fixed costs.
Variable: vary directly with the volume of output. They are a product cost - cost of raw materials and direct wages
Semi-variable: made up of two cost elements. They are partially affected by changes in the level of output - repairs and maintenance (wages for maint. people are fixed but repairs can vary according to MH)
Fixed: remain the same, irrespective of the level of output. They are a period cost, as they relate to an accounting period - lighting and heating, insurance, advertising.
Why is it important to distinguish between variable, semi-variable, and fixed costs?
According to volume of production, costs are going to behave differently - according if they are fixed or variable.
To calculate profit at different levels of production.
And most importantly, for Cost-Volume-Profit analysis.
Indicate the potential effect that a narrow margin of safety may have on profitability.
A narrow margin of safety means that there is a higher risk of making losses.
There is a small difference between current and break-even sales. We are currently very close to making 0 accounting profit, especially during a period where sales are going decreasing. If demand decreases, then we may break-even or even make a loss.
Describe TWO ways how the ‘Margin of Safety’ can be increased.
- Increase current sales through advertising
- Decrease break-even sales amount. This can be done either by decreasing fixed costs
Why is break-even analysis important?
Break-even analysis provides useful information for decision making.
The BEP (where TC=TR), is an integral part of the CVP analysis. Break-even analysis sets the scenario for more detailed CVP analysis.
What are two benefits of break-even analysis?
Managers use these relationships found from break-even analysis to plan, budget and make decisions.
It helps to establish what will happen to sales and costs as the volume of activity fluctuates. It is useful for a relevant range of output only. It analyses the relationship between sales revenue, cost and profit in the short-run.
