Question

In activity–based costing, costs are classified into unit level, batch level, product level and facility level. How these categories are typically handled in CVP analysis, where there are only two categories available: fixed or variable?

Answer 1

The cost-volume-profit (CVP) model was designed to be used in conjunction with a traditional cost accounting system.

ABC differs from traditional cost accounting systems because it allocates the cost of overhead to activities and then to products through identified cost drivers. ABC treats all costs as variable when calculating a unit cost, but production level changes and relevant ranges test this assumption.

•The starting point for any CVP analysis is the computation of a product quantity needed to break even and earn a specific level of profitability. In contrast to traditional accounting systems, an ABC system’s use of batch-level activities creates a step-type cost and profit function.

•Unit- level costs are volume based, so no difference from traditional CVP.

•Facility-level costs are not avoidable in a short-term planning horizon as they take months or yearsto change, so they are treated as fixed costs under both volume-based and ABC-based CVP.

•Traditional volume-based CVP classifies batch and product level costs as indirect costs that do notvary with volume and thus are fixed costs. However, batch-level costs change with the number ofbatches and and product-level costs with the number of product changes.So, ABC-based CVPtakes this into account

•A product-level cost, such as a change in product design or features, is a cost that has a shorterplanning period because these changes can be incorporated into the manufacturing process in ashorter period of time, perhaps several months to a year before the change affects total costs. Ifthe planning period is a year or less, then product- level costs will normally not be considered as acost that can change in either CVP. If the planning period is extended to more than a year, thenproduct- level changes may be included in ABC-based CVP

.•In contrast, many batch-level costs (product setup, inspection, purchasing, etc.) can be changed inthe short term, so batch- level costs can be considered in a short- term planning horizon.