Question

1. List the 3 main types of costs and describe their cost behavior in terms of (a) Total Cost, and (b) Unit Cost.
2. When do you use the high-low method? What is the formula for the high-low method?
3. Describe in your own words the concept of contribution margin.
4. What is the formula to calculate Break Even Point in Units?
5. What is the formula to calculate Break Even Point in Dollars?
6. If a company’s goal is to make a profit, why do we calculate break even point first? What is the importance of break even point?
7. What is sensitivity analysis?
8. What are 3 ways in that CVP analysis can be used by managers to make decisions?
9. How does variable costing differ from absorption costing?
10. If units produced = units sold, is the net income under variable costing or absorption costing greater?
11. If units produced> units sold, is the net income under variable costing or absorption costing greater?
12. If units produced< units sold, is the net income under variable costing or absorption costing greater?

Answer 1

1. The 3 main types of costs along with their cost behavior is as follows:
   a) Variable Cost-
   It is the cost that rises with an increase in units, it tends to increase or decrease with the level of activity.
   -Total Variable Cost will keep on rising with increase activity, but Variable Cost per unit will remain the same.
   b) Fixed Cost-
   This is the cost which is incurred for a whole period and is constant in nature, like rentals.
   -Total Fixed Cost will remain constant with fall or rise in business activity, but Fixed Cost per Unit would reduce with the increase in activity and vice-versa.
   c) Semi-Variable Cost-
   These costs contain both fixed and variable cost elements, hence they are affected by the level of activity only partially.
   -Total Semi-variable Cost would increase with the level of activity, and would also be incurred at 0 level of activity. And, the per-unit cost would reduce with the level of activity but would become constant after certain level.
   
2. High-Low method is used to calculate the fixed portion and the variable portion of the mixed cost, i.e. Semi-variable cost. It takes the factor that at highest activity level and lowest activity level, fixed portion would remain the same, and the increase is variable cost.
   Formula-
   Variable Cost per unit = (Total Cost at High level - Total Cost at low level) / (High level units - Low Level units)
   After getting variable cost per unit, we can calculate fixed cost taking any level of units.
   
3. Contribution Margin refers to the balance amount available to bear the fixed costs and generate profits.
   It is calculated by reducing the variable costs from sales revenue.
   Calculating Contribution Margin is important as it helps in analyzing whether the product is profitable or not for the company, and whether it is producing enough margins to cover all our fixed costs or not.
   
4. Break-even Point (in units) = Fixed Cost / Contribution per unit
   where Contribution per unit = Sale Price per unit - Variable Cost per unit
   
5. Break-even Point (in amount) = Fixed Cost / Contribution Margin
   where Contribution Margin = (Sale Price per unit - Variable Cost per unit) / Sales Price per unit
   
6. Any company needs to know upon producing how many units it is recovering all its costs, whether fixed or variable. Break-even analysis provides that data to the company.
   Upon achieving a break-even company is relaxed about incurring losses, as it has recovered all its costs.