Question

1.
(a) What is cost behavior analysis?
(b) Why is cost behavior analysis important to management?
2.
(a) Scott Winter asks your help in understanding the
term "activity index." Explain the meaning and
importance of this term for Scott.
(b) State the two ways that variable costs may be
defined.
3. Contrast the effects of changes in the activity level on
total fixed costs and on unit fixed costs.

4. J. P. Alexander claims that the relevant range concept
is important only for variable costs.
(a) Explain the relevant range concept.
(b) Do you agree with J. P.'s claim? Explain.

5. "The relevant range is indispensable in cost behavior
analysis." Is this true? Why or why not?

Answer 1

Question 1

a. Cost behaviour is the relationship between cost and the activity level. Cost functions are how a cost changes with change in the level of activity relating to that cost.

Cost functions are usually given in the form of y = mx + b, where y = Total cost

m = variable cost per unit

x = total no of units

b = fixed cost

These costs may include direct materials, direct labor, and overhead costs that are incurred from developing a product. Based on behavior, costs are categorized as either fixed, variable or mixed.

Variable costs will change proportionately with the change in activity, while total fixed costs will remain the same irrespective of the level of activity and mixed costs are the combination of variable and fixed cost, but it wont change proportionately with the change in activity, it shall be apportioned using the high-low method.

b. Cost behaviour analysis is important to management to understand the performance of the entity. The break even point of the entity is based on type of the costs in the cost sheet, by which the entity can understand the profitability of the entity. The entity is capable of making decisions which aid in further control of the costs.

Question 2

a.  The meaning of term activity index for Scott in the cost behavior analysis refers to the factor which in a way has a direct impact to the amount of cost which is in this case variable cost or has no effect at all on a cost, specifically the fixed costs. The importance of activity index is to help the managers in organizations identify the activities causing a change in costs' behavior.

b. The 2 ways that variable cost can be defined:

- Variable cost are the cost that proportionately change with the change in production activity. It raises as production increase and reduces as production decrease.

- Variable cost remains constant for per unit, but changes in total with change in production activity.