Question

How does assuming that operating activity occurs within a relevant range affect cost-volume-profit analysis - is this realistic? Be sure to include a discussion of cost behavior patterns and how that impacts this whole process.

Answer 1

From the point of view of cost behavior, costs ba variable or fixed.

Variable costs are those costs that vary directly and proportionately with the output. There is a constant ratio between the change in cost and change in the level of output. If output is zero units, Variable cost too would be zero. Examples: Costs of direct materials, labor costs of assembly line workers etc.

Fixed cost on the other hand, is a cost which does not change in total for a given range of output or for a given time period. Therefore, if the operating activity if within the given range of output, the same total fixed cost would prevail, though the fixed cost per unit decreases with increased levels of operating activity within the range.

Let us consider an example where the fixed cost for a range of 10,000 units to 25,000 units remains fixed at $ 20,000. And the variable per unit is $ 10.

Activity Level	10,000	15,000	22,000
Total Fixed Cost	$ 20,000	$ 20,000	$ 20,000
Total Variable Cost	100,000	150,000	220,000
Total Cost	$ 120,000	$ 170,000	$ 240,000
Total Cost per Unit	$ 12.00	$ 11.33	$ 10.91

Please note that the unit cost decreases with increased output as long as the operating activity lies within a range of 10,000 to 25,000 units.