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Chapter 22

Cost-Volume-Profit Analysis

QUESTIONS

1. Cost-volume-profit analysis is especially useful in the planning phase for a business. This phase involves predicting the volume of sales activity, the costs to be incurred, revenues to be received, and profits to be earned. It is also useful in what-if (sensitivity) analysis.
2. A variable cost is one that varies proportionately with the volume of activity. For example, direct materials and direct labor (when the workers are paid for completed units) are treated as variable costs with respect to the number of units produced.
3. Variable costs per unit stay the same (remain constant) when output volume changes. This is because each unit consumes the same amount of variable costs within the relevant range of activity.
4. Fixed costs per unit decrease when output volume increases. This is because the total amount of fixed costs remains the same while it is being divided among more units within the relevant range of activity.
5. A step-wise cost remains constant over a limited range of output activity, outside of which it changes by a lump-sum amount, then remains constant over another limited range of output activity, and so on. A curvilinear cost gradually changes in a nonlinear manner in response to changes in sales volume.
6. A CVP analysis for a manufacturing company is simplified by assuming that the production and sales volumes are equal. This is the same as assuming no changes in beginning and ending inventory levels for the period.
7. The first is that although individual costs classified as fixed or variable might not behave precisely in those patterns, some variations of individual components in the group of fixed or variable costs may tend to offset each other. The second is that management might reasonably assume that costs are either fixed or variable within the relevant range of operations (or at least the period under analysis).
8.
By assuming a relevant range for operating activity, management can more justifiably assume either fixed or variable relations between costs and volume, and between revenue and volume. The assumption also helps limit the consideration of alternative strategies to those that call for volume levels that fall within the relevant range.


9.
Three common methods for measuring cost behavior are: the scatter diagram, the high-low method, and least-squares regression.



10. A scatter diagram is used to display the relation between past costs and sales volumes. Management then uses the scatter diagram to identify and measure the fixed and variable components of the cost being graphed.
11. At break-even, profits are zero. Break-even is the point where sales equals fixed plus variable costs.
12. This line represents total cost, which equals the sum of the fixed and variable costs at all volume levels within the companys current capacity (relevant range). (Note: The total cost line consists of mi