Cost-Volume- profit analysis

Question 1

What is the purpose of cost-volume-profit analysis?

Answer 1

Examines the impact on revenue, costs and profits of:

• the level (volume/quantity) of goods or services sold
• prices of these goods or services

Question 2

what does cost-volume-proit analysis rely on?

Answer 2

Relies on dividing costs between variable and fixed costs.

Question 3

Cost-volume-profit analysis relies in dividing costs between fixed and variable costs.

what are fixed costs?

Answer 3

are those that do not change in response to
changes in the level of activity (activity level can be measured by
either sales output or production output)

Question 4

Cost-Volume-Profit Analysis relies on dividing costs between variable and fixed costs

what are variable costs?

Answer 4

Variable costs: are those which vary directly and proportionately with the level of activity

Question 5

what is the break even point?t

Answer 5

the point at which total costs equal total
revenue

Question 6

what may fixed costs be affected by?

Answer 6

fixed costs are likely to be affected by inflation. eg. rent rises due to inflation –>fixed cost increase

Question 7

why may fixed costs ‘step up’ as activity levels increase?

Answer 7

as activity level increases, business will incur costs in efforts to expand eg. expansion requires larger premises

Question 8

fixed costs remain constant only

Answer 8

fixed costs remain constant within a particular range of output levels. beyond a particular point, output level, fixed costs will increase, consistent with higher output level.

fixed costs step up as activity levels increase

Question 9

Features of fixed costs

Answer 9

Fixed costs do not change as volume changes (i.e when there is a change in the level of activity)

 Fixed costs per unit of activity decrease as activity
increases

Question 10

examples of fixed costs

Answer 10

depreciation, insurance, rent and
salaries of permanent staff

Question 11

in what circumstances may the line not for variable costs not be straight?

Answer 11

when there is significant economies (bulk discounts, employ labour more efficiently) or diseconomies of scale (high demand cause shortage in commodity –> pushing prices up)

Question 12

features of variable costs

Answer 12

A cost is variable if it changes in response to changes in the level of activity.

 Variable costs per unit of activity remain constant as
activity increases

Question 13

examples of variable costs

Answer 13

Sales commissions vary with the number of sales

raw materials

wages

Question 14

what does the break even chart look like?

describe

Answer 14

at break even point, there is no profit

below break-even point, a loss will be incurred (further below, the higher the loss)

above break-even point, there will be a profit (further above, the higher the profit)

Question 15

Breakeven analysis

Break-even point occurs at…..

total revenues =

let b =

what is the formula for b?

what must it be expressed with respect to?

Answer 15

break-even point must be expressed with respect to a period of time eg. 250 baskets per month

Question 16

Breakeven analysis

what is contribution per unit?

break-even point in dollars can be calculated as

Answer 16

Question 17

What is margin of safety?

what does it indicate?

Answer 17

the difference between output or expected level of sales and the break-even point

It provides an indication of risks involved.

Question 18

Operating gearing is?

Answer 18

is the relationship between
contribution and fixed costs

One more, or one less product sold has a greater impact on profit if an activity has a higher level of operating gearing

Question 19

what kind of activities have a high level of operating gearing?

Answer 19

Activities that are capital intensive tend to have a
high level of operating gearing

this is because, renting a machine increases fixed costs, causing a dramatic increase in operating gearing

Question 20

When is there high operating gearing?

Answer 20

An activity with relatively high fixed costs compared with its
variable costs is said to have high operating gearing

Question 21

the use of break even analysis

Answer 21

1. Determine activity level required to cover all costs associated with the business
2. Assess activity level required to achieve profit targets
3. Assess margin of safety

Question 22

Describe in terms of breakeven point and operating gearing

Answer 22

Both have the same breakeven point. But Paris college has a higher level of operating gearing compared to Amanda
college

Question 23

 Imagine both colleges were at break even point i.e. they neither were making a profit or loss
Assume that: (1) student numbers increase by 20% so that both colleges now
have 48 students per week

 Analysis the impact of changes in student numbers on profit earned by the two colleges under the two circumstances.

Answer 23

Question 24

impact of operating gearing

Answer 24

Operating gearing works both ways.

If a firm has a high level of operating gearing (e.g., higher level of fixed costs):

• if volume of sales is increased, it will make more money than a firm with low operating gearing.
• if volume of sales is decreased, it will make less money than a firm with low operating gearing.

A firm with low operating gearing is far more able to handle downturns in markets.

Question 25

Impact of price and volume

Answer 25

Price and volume are important to both types of
firms
Gaining a higher price is better for a firm with low
operating gearing (i.e. lower level of fixed costs and
higher level of variable costs)
Gaining a higher volume is better for a firm with
high operating gearing(i.e. higher level of fixed
costs)

Question 26

Advantages of break even analysis

Answer 26

carrying out a Cost Volume Profit Analysis enables
an organisation to have an idea of the pattern of its cost structure and the attitude it should take towards prices and sales volume

Question 27

limitations of break-even analysis

Answer 27

1. Non-linear relationships: break even analysis assumes, relationship between sales revenue, variable costs and volume are straight line linear relationships. however, relationships between sales revenues, variable costs and volume are unlikely to be straight-line (linear) but not a problem since break even analysis conducted in advance of activity taking place
2. Stepped fixed costs - most costs are not fixed over all volumes of activity.
3. Some costs involve both fixed and variable costs elements.
4. Multi-product businesses: multiple products make break-even analysis difficult as fixed costs tend to relate to more than one activity, making division of fixed costs across products arbitrary, and consequently the break-even analysis becomes questionable

Question 28

when conducting a break-even analysis, what are the calculations based

Answer 28

calculations are based on expected costs rather than historic costs