Question

1. List 5 reasons why a manager needs to know and understand cost behavior.

2. List and explain the five types of cost behavior.

3. Define and explain how activity based costing works.

4. How important is a cost driver. (define first the cost driver)

Answer 1

? Reasons why a manager needs to know and understand the cost behaviour:

1.To accurately predict costs.

2.To decide the selling price.

3.To estimate the profits.

4.To Evaluation of performance.

5.For preparation of budget.

6.To know the break even point.

7.To control cost.

? Types of Cost Behaviour:

Cost behaviour are broadly classified into 3 types.They are;

1.Variable cost: In this model, costs vary directly with changes in business activity.

Example: specific direct Material cost associated with each product sold.

2.Fixed cost: In this model, costs donot vary with the change in business activity levels.

Example: Rent on a building will not change even if the sales of the product falls drastically.

3. Mixed costs: This model contains the characteristics of both variable and fixed costs. Mixed costs are also known as semi variable costs or semi fixed costs.

Example: An internet access fee includes standard monthly fees(Fixed Nature) and also charges based on broadband data usage (Variable nature).

? Activity-based costing:

Definition: Activity-based costing is a costing methodology which indentifies activities in an organisation and assigns the cost of each activity with resources to all products and services according to the actual consumption by each.

=> The Activity-based costing system forstfi recognises the relationship between costs, overhead activities and manufacturing products, and then through this relationship,it assigns the indirect costs to products.

? Cost driver:

Definition: A cost driver is a factor that influences and/or contributes to the expense of certain business operations.

Importance of cost drivers:

Whatever determines the total cost of a particular activity should be analysed in depth to ensure that a proper allocation base is used. Cost drivers follow a cause-effect relationship, and if the relationship cannot be established then a more relevant cost driver should be looked for.