Cost volume profit analysis

Question 1

Explain the term cost volume-profit analysis

Answer 1

It refers to the managerial accounting technique that enables managers to examine the relationships between costs, volume and profit at various levels of activity (i.e. output)

Question 2

True or False

CVP analysis is based on the relationship between volume and sales revenue, costs and profit in the long term

Answer 2

False

CVP analysis is based on the relationship between volume and sales revenue, costs and profit in the short term

Question 3

True or False

CVP allows the entity to predict what will happen to the financial results if a specific activity level or volume fluctuates. This information is vital to management since one of the most important variables influencing total sales revenue, total fixed costs and profits are output or volume

Answer 3

False

CVP allows the entity to predict what will happen to the financial results if a specific activity level or volume fluctuates. This information is vital to management since one of the most important variables influencing total sales revenue, total costs and profits are output or volume

Question 4

What does CVP depend on?

Answer 4

The ability to estimate cost at different activity levels

Question 5

True or False

The knowledge CVP provides on this relationships enables management to identify critical output levels, such as the level at which neither a profit nor loss will occur (i.e. break-even point)

Answer 5

True

Question 6

State the various types of cost

Answer 6

• Variable cost
• Fixed cost
• Semi-variable/semi-fixed/mixed cost

Question 7

What does the term contribution refer to?

Answer 7

The contribution made to fixed costs and profit when subtracting the variable costs from sale revenue

Question 8

True or false

The variable costs per unit and the selling price per unit are assumed to be constant, the contribution margin per unit is also assumed to be constant

Answer 8

True

Question 9

When can CVP be only be used?

Answer 9

For decisions that results in outcomes within the relevant range. Outside the range, the unit selling price and the variable cost are no longer deemed to be constant per unit, and any results obtained from the formulae that fall outside the relevant range will be incorrect.

Question 10

Where is the concept of CVP most appropriate?

Answer 10

For production setting, but it can apply within non-production setting

Question 11

What does margin of safety indicate?

Answer 11

How much sales may decrease before a loss occurs

Question 12

True or False

Lower margins of safety are associated with less risky activities, which implies that sales may fall, but the company or the project may still be profitable

Answer 12

False

Lower margins of safety are associated with more risky activities, which implies that sales will fall, and the company or the project may will not be profitable

Question 13

True or False

Companies can sometimes influence the proportion of fixed and variable expenses in their costs structures

Answer 13

True

(Operating leverage)

Question 14

State the cost volume-profit analysis assumptions and limitation

Answer 14

1. All other variables remain constant
2. A single product or constant sales mix
3. Total costs and total revenue are linear functions of output
4. Profits are calculated on a variable costing basis
5. Costs can be accurately divided into their fixed and variable elements
6. The analysis applies only to the relevant range
7. The analysis applies only to a short term time horizon

Question 15

True or False

Volume is the only factor that will cause costs and revenues to change

Answer 15

True

Question 16

Define operating leverage

Answer 16

A measure of the sensitivity of profits to change in sales

Question 17

Define relevant range

Answer 17

The output range at which an organization expects to be operating with a short term planning horizon