Week 8: Relevance and Behaviour of costs

Question 1

What is the definition of Cost?

Answer 1

The amount sacrificed to achieve a particular business objective.

Question 2

What are examples of Relevant Costs?

Answer 2

Relevant costs include:

• Any new costs associated with the decision
• Any costs that increase as a result of the decision
• Future costs you are committed to as a result of the decision
• Any amounts of income forgone/given up as a result of the decision (opportunity cost)

Question 3

What are examples of Irrelevant Costs?

Answer 3

Irrelevant costs include:

• Costs that won’t change as a result of the decision
• Costs already paid and can’t change (historic costs)

Question 4

What are Fixed Costs?

Answer 4

• A fixed cost does not vary in proportion to activity
• The total amount of fixed cost remains constant across the relevant range* of activity (e.g., if activity doubles, the total fixed cost will stay the same)

Question 5

What are Stepped Costs?

Answer 5

• Fixed costs only remain fixed over a relevant range
• Some change more regularly than others
• Such costs are called ‘Stepped Fixed Costs’

Question 6

What are Variable Costs?

Answer 6

• A variable cost varies in direct proportion to activity (e.g., if activity doubles, the total variable cost will double)
• RULE: If additional costs are incurred with just one extra unit of production, the cost is VARIABLE. If not, the cost is FIXED.

Question 7

What are Semi-Fixed (Semi-Variable) Costs?

Answer 7

These are costs that have a fixed component AND a variable component. (Example- a salesman’s salary).

Question 8

What happens at the Break-Even Point (B/E Point)?

Answer 8

At the ‘Break-Even Point’ (BEP):
- Total sales revenue equals total cost.
- the business makes neither a profit nor a loss.

Question 9

What is the Break-Even formula?

Answer 9

B/E = Fixed cost / (Sales revenue per unit – Variable cost per unit)

Question 10

What is the formula for Contribution?

Answer 10

Contribution per unit = Selling price per unit – Variable costs per unit

Question 11

What is the formula for Contribution Margin Ratio?

Answer 11

Contribution margin ratio=Contribution/Sales revenue * 100%

Question 12

What is the formula for Margin of Safety (MOS)?

Answer 12

MOS % = Expected sales – BEP/ Expected sales x 100%