Question

1. What is meant by “cost structure?” Explain how a company's cost structure affects its break-even point. In your opinion, what is the best level of cost structure? Explain
2. J. P. Alexander claims that the relevant range concept is important only for variable costs. Explain the relevant range concept.  Do you agree with J. P.'s claim? Explain
3. What are the principal differences between activity-based costing (ABC) and traditional product costing? Which is the preferred method? Explain.

Answer 1

Cost structure means the types of cost which an enterprise incurs. Cost incurred by a local grocery shop will be different as compared to costs incurred by a painting shop. The list of expenses which an enterprise incurs is called as cost structure. Eg, in local grocery shop, the costs incurred would be rent, staff salaries, purchase price of grocery items, packing costs etc. These are cost structures. There are two types of cost within a cost structure. These are fixed costs and variable costs.

Fixed cost is the cost which does not change in response to change in volume of production (Eg -Rent) wheras variable cost is the cost which changes in response to change in volume of production (eg, packing costs etc.)

Break-even point = Total Fixed Costs/Contribution Margin per Unit. The contribution margin per unit is the product's selling price minus its variable costs and expenses.

To reduce a company's break-even point, amount of fixed costs can be reduced.Break-even point can also be reduced by increasing the contribution margin per unit. This will happen if there is a reduction in variable costs and expenses per unit.

Part 2:

The relevant range concept shows the expected range of activities over which the company operates in a financial year and over which revenue/expense will remain constant. Outside of that relevant range, revenues and expenses will likely differ from the expected amount.

X Co. assumes that the cost of a a chocolate is $10.00 within a relevant range of no less than 50,000 units per year and no more than 150,000 units per year. If the actual unit is < 50,000 units, cost of materials increases to more than $10. Similarly, if the actual chocolate volume is higher than 150,000 units, cost of materials decreases to less than $10.

It includes both variable costs as well as fixed cost.Variable cost and fixed cost, both are considered for the CVP analysis (Cost-volume-profit). Therefore, disagree with the claim of JP Alexander on the relevant range concept that the concept in only for variable cost.

Part C:

Activity-based costing and traditional costing are two different methods for allocating indirect (overhead) costs to products.

ABC	Traditional system
More accurate than traditional system	Less accurate than ABC system
Precise breakdown of indirect cost is provided based on activities driving the cost	Indirect costs are allocated to products based on a predetermined overhead rate.
Accurate	Not as accurate as Traditional system
Costly to implement and hence suited for large organisations	Simpler and easy to implement hence suitable for smaller organisations

Due to advantages of ABC system, it is clear that ABC is the preferred method of allocation of overheads. It is accurate and allocation is done based on activities which drive the cost. It is more suited to companies that manufacture different types of products since overheads can be allocated more accurately due to ABC system.

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