Costs and calculations

Question 1

What is cost behaviour?

Answer 1

The relationship between a cost and the level of activity that causes this cost.

Question 2

Define relevent costs:

Answer 2

Relevant costs are those that will change as a result of a particular decision e.g. if an organisation extend its hours of operation then extra wages will need to be paid. The wage costs that fluctuate as a result of the decision are the relevant costs. Relevant costs will occur in the future and they will differ between alternative courses of action.

Question 3

Define variable costs:

Answer 3

Variable costs are the costs that change as a result of changing production or service volume. That is, they vary as the volume of activity changes. The activity might be measured in terms of units of a product or service, machine hours, labour hours etc.

Question 4

Why do variable costs often change per unit?

Answer 4

Costs are not always linear. The organisation might become more efficient as they start producing more products. This is known as economies of scale. Or costs per unit might be relatively low at the initial production level, but then start to rise as production rises. This is known as diseconomies of scale.

Question 5

Define fixed costs:

Answer 5

Fixed costs are considered to be those costs that do not change in a particular period as the volume of production or services changes.

Question 6

Define mixed costs:

Answer 6

Costs that have fixed and variable components. These costs are referred to as semi-fixed or semi-variable costs, or mixed costs.

Question 7

What is the contribution margin?

Answer 7

How much the sale of a unit of the product/service contributes to overall profit.

Question 8

What is the equation for calculating the total contribution margin of a product or service?

Answer 8

Sales revenue - variable costs.

Question 9

What is the equation for calculating the contribution margin per unit?

Answer 9

Revenue per unit - variable cost per unit.

Question 10

What is the contribution margin ratio?

Answer 10

Contribution per unit / sales per unit. E.g. 350 / 1000 = 0.35. So 35 cents of every $1 of sales goes towards absorbing fixed costs.

Question 11

What is the typical relationship between turnover rates and contribution margins?

Answer 11

Typically, items with a higher turnover would be expected to have a lower contribution margin per unit and vice versa.

Question 12

What is the break-even point?

Answer 12

The break-even point occurs when the total financial costs equal the total financial revenues, resulting in the profit for a period being zero. It will generally be calculated in number of units of the product or service.

Question 13

How is the break-even point calculated?

Answer 13

Break-even point = total fixed costs / contribution margin per unit.

Question 14

What is the margin of safety?

Answer 14

The number of sales being made, or expected to be made, above the break-even point. It calculates the number of units of a product or service that can be lost before an organisation reaches a level of activity that results in the organisation making a loss.

Question 15

How is the margin of safety calculated?

Answer 15

MoS = Actual or predicted level of activity in units - break-even level of activity in units.

Question 16

How can the margin of safety be expressed as a percentage?

Answer 16

(MoS in dollars / total actual sales) x 100. E.g. (5,000 / 30,000) x 100
= 16.67%

Question 17

What is the operating leverage?

Answer 17

The operating leverage is used as a measure of the sensitivity of profits to changes in sales.

Question 18

How is operating leverage calculated?

Answer 18

Contribution margin / profit.

Question 19

What does it mean if the operating leverage is high/low?

Answer 19

If the operating leverage is low then there is more variable costs than fixed costs. If the number is high then there is more fixed costs than variable costs.

Question 20

What is the effect of having a high operating leverage?

Answer 20

It can be advantageous to businesses because it means that with more fixed costs, there is more sales and more contribution. But the risk is that if sales decline it can quickly impact profit i.e. the profit number is more sensitive to sales fluctuations.

Question 21

How is the target profit decided?

Answer 21

The target profit considers various factors, such as the expectations of owners, the risks inherent in the operations, and the opportunity costs of alternative options.

Question 22

What is the calculation for the number of units needing to be sold to reach the target profit?

Answer 22

(Desired profit + total fixed costs) / contribution margin per unit.