CHAPTER REVIEW
Cost Behavior Analysis
1.(L.O. 1) Cost behavior analysis is the study of how specific costs respond to changes in the level of business activity. A knowledge of cost behavior helps management plan operations and decide between alternative courses of action.
2.The activity index identifies the activity that causes changes in the behavior of costs; examples include direct labor hours, sales dollars, and units of output. Once an appropriate activity index is chosen, costs can be classified as variable, fixed or mixed.
Variable and Fixed Costs
3.(L.O. 1) Variable costs are costs that vary in total directly and proportionately with changes in the activity level. Examples of variable costs include direct materials and direct labor, cost of goods sold, sales commissions, and freight-out. A variable cost may also be defined as a cost that remains the same per unit at every level of activity.
4.Fixed costs are costs that remain the same in total regardless of changes in the activity level. Examples include property taxes, insurance, rent, supervisory salaries, and depreciation. Fixed costs per unit vary inversely with activity; as volume increases, unit cost declines and vice versa.
Relevant Range
5.The range over which a company expects to operate during the year is called the relevant range. Although a linear (straight-line) relationship for costs may not be realistic, the linear assumption produces useful data for CVP analysis as long as the level of activity remains within the relevant range.
Mixed Costs
6.(L.O.2) Mixed costs are costs that contain both a variable element and a fixed element; they increase in total as the activity level increases, but not proportionately. For purposes of CVP analysis, mixed costs must be classified into their fixed and variable elements.
7.The high-low method uses the total costs incurred at the high and low levels of activity. The difference in costs represents variable costs, since only the variable cost element can change as activity levels change.
8.The steps in computing fixed and variable costs under the high-low method are:
a.Determine variable cost per unit from the following formula:
Change in / ÷ / High minus Low / = / Variable CostTotal Costs / Activity Level / per Unit
b.Determine the fixed cost by subtracting the total variable cost at either the high or the low activity level from the total cost at that activity level.
Cost-Volume-Profit Analysis
9.(L.O.3) Cost-volume-profit (CVP) analysis is the study of the effects of changes in costs and volume on a company’s profits. It is a critical factor in such management decisions as profit planning, setting selling prices, determining product mix, and maximizing use of production facilities.
10.CVP analysis considers the interrelationships among the following components: (a) volume or level of activity, (b) unit selling prices, (c) variable cost per unit, (d) total fixed costs, and (e) sales mix.
Basic CVP Components
11.The following assumptions underlie each CVP analysis:
a.The behavior of both costs and revenues is linear throughout the relevant range of the activity index.
b.Costs can be classified accurately as either variable or fixed.
c.Changes in activity are the only factors that affect costs.
d.All units produced are sold.
e.When more than one type of product is sold, the sales mix will remain constant. That is, the percentage that each product represents of total sales will stay the same.
Contribution Margin
12.Contribution margin is the amount of revenue remaining after deducting variable costs. The formula for contribution margin per unit is:
Unit Selling / – / Unit Variable / = / Unit ContributionPrice / Costs / Margin
13.Contribution margin per unit indicates the amount available to cover fixed costs and contribute to income. The formula for the contribution margin ratio is:
Contribution / ÷ / Unit Selling / = / Unit ContributionMargin Per Unit / Price / Margin
The ratio indicates the portion of each sales dollar that is available to apply to fixed costs and to contribute to income.
Break-Even Analysis
14.(L.O.4) The break-even point is the level of activity at which total revenue equals total costs (both fixed and variable). Knowledge of the break-even point is useful to management when it decides whether to introduce new product lines, change sales prices on established products, or enter new market areas.
15.A common equation used for CVP analysis is as follows:
Sales - Variable Costs - Fixed Costs = Net Income
16.Under the contribution margin technique, the break-even point can be computed by using either the unit contribution margin or the contribution margin ratio.
17.The formula, using unit contribution margin, is:
Fixed / ÷ / Unit Contribution / = / Break-evenCosts / Margin / Point in Units
18.The formula using the contribution margin is:
Fixed / ÷ / Contribution / = / Break-evenCosts / Margin Ratio / Point in Dollars
19.A chart (or graph) can also be used as an effective means to determine and illustrate the break-even point. A cost-volume-profit (CVP) graph is as follows:
Target Net Income
20.(L.O.5) Target net income is the income objective for individual product lines. The following equation is used to determine target net income sales:
Required Sales - Variable Costs - Fixed Costs = Target Net Income
21.Using the contribution margin technique, we can compute in either units or dollars the sales required to meet a target net income. To compute the sales required in units the following formula is used:
(Fixed Costs + Target Net Income) ÷ Unit Contribution Margin = Required Sales in Units
To compute the sales required in dollars, the contribution margin ratio is used rather than the unit contribution margin, as follows:
(Fixed Costs + Target Net Income) ÷ Contribution Margin Ratio = Required Sales in Dollars
Margin of Safety
22.Margin of safety is the difference between actual or expected sales and sales at the break-even point.
a.The formula for stating the margin of safety in dollars is:
Actual (Expected) / – / Break-even / = / Margin of SafetySales / Sales / in Dollars
b.The formula for determining the margin of safety ratio is:
Margin of Safety / ÷ / Actual (Expected) / = / Margin ofin Dollars / Sales / Safety Ratio
The higher the dollars or the percentage, the greater the margin of safety.
20 MINUTE QUIZ
Circle the correct answer.
True/False
1.The range over which a company is expected to operate is called the relevant range of the activity index.
TrueFalse
2.A mixed cost contains both selling and administrative cost elements.
TrueFalse
3.Variable costs are costs that remain the same per unit at every level of activity.
TrueFalse
4.If a salesperson incurs $2,000 of expenses in servicing two customers and $4,000 of
expenses in servicing four customers, the fixed costs are $1,000.
TrueFalse
5.If revenue = $80 and variable cost = 40% of revenue, then contribution margin = $48.
TrueFalse
6.The contribution margin is the amount of revenue remaining after deducting fixed costs.
TrueFalse
7.Sales mix is the percentage that each product represents of total sales.
TrueFalse
8.If the unit contribution margin is $300 and fixed costs are $240,000 then the break-even point in units would be 800 units.
TrueFalse
9.In a CVP income statement, contribution margin is reported in the body of the statement.
TrueFalse
10.Margin of safety is the difference between actual sales and contribution margin.
TrueFalse
Multiple Choice
1.Which of the following is a false statement regarding assumptions of CVP analysis?
a.Total fixed costs remain constant over the relevant range.
b.Unit selling prices are constant.
c.Changes in volume or level of activity increase variable costs per unit.
d.All units produced are sold.
2.Mixed costs may be separated into fixed costs and variable costs by using
a.the relevant range method.
b.the high-low method.
c.the contribution margin method.
d.all of the above.
3.If the unit selling price is $500, the unit variable cost is $300, and the total monthly fixed costs are $300,000, then the contribution margin ratio is
a.30%.
b.40%.
c.50%.
d.60%.
4.If activity level increases 25% and a specific cost increases from $40,000 to $50,000, this cost would be classified as a
a.variable cost.
b.mixed cost.
c.fixed cost.
d.none of the above.
5.If total fixed costs are $900,000 and variable costs as a percentage of unit selling price are 40%, then the break-even point in dollars is
a.$1,500,000.
b.$360,000.
c.$2,250,000.
d.not determinable with the information given.
ANSWERS TO QUIZ
True/False
1. True 6.False
2. False 7.True
3. True 8.True
4. False 9.True
5. True 10.False
Multiple Choice
1. c.
2. b.
3. b.
4. a.
5. a.