MGT223H5 Study Guide - Final Guide: Total Absorption Costing, Fixed Cost, Variable Cost

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Published on 16 Oct 2011
School
UTM
Department
Management
Course
MGT223H5
Professor
1. Discuss five assumptions that underlie breakeven and cost-volume-profit
analysis. (5 marks)
a. The company is operating within the relevant range of activity specified in
determining the revenue and cost information.
b. All variable cost and revenue behaviour patterns are constant per unit and
linear within the relevant range.
c. Total fixed cost is a constant amount within the relevant range.
d. Mixed costs can be accurately separated into their fixed and variable
elements.
e. Sales and production are equal; thus, there are no material fluctuations in
inventory levels.
f. In a multi-product firm, the sales mix will remain constant.
g. There is no inflation.
h. Labour productivity, production technology, and market conditions will not
change during the period under consideration.
2. What is the importance of the contribution margin in relationship to CVP
analysis?
Give two (2) examples/combination of factors of how profits can be improved as
discussed in class. (5 marks)
CVP analysis seeks the most profitable combination of VC, FC, SP, and sales
volume. Profits can sometimes be improved by reducing the CM if fixed costs
can be reduced by a greater amount. The way to improve profits is to increase
the total CM. Sometimes this can be done by reducing the SP and thereby
increasing volume; sometimes it can be done by increasing the FC (such as
advertising) and thereby increasing volume; sometimes it can be done by trading
off VC and FC with appropriate changes in volume.
Many other combinations of factors are possible.
3. The audited financial statements are prepared using Absorption costing (which is
still GAAP). However, for evaluation of performance Variable (Direct) Costing is
a better measure. Absorption costing motivates overproduction because this will
increase profits. The reason this occurs is that manufacturing fixed costs are
treated as a product cost. Therefore, when production is greater than sales,
profit under absorption costing is greater because part of the manufacturing fixed
costs remain in inventory. When variable costing is used, all manufacturing (and
selling & admin) fixed costs are expensed in the period in which they are
incurred. Under variable costing, profits are a function of sales only. Under
absorption costing, profits are a function of production and sales.
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Document Summary

Discuss five assumptions that underlie breakeven and cost-volume-profit. In a multi-product firm, the sales mix will remain constant. f: there is no inflation, labour productivity, production technology, and market conditions will not change during the period under consideration. What is the importance of the contribution margin in relationship to cvp. Give two (2) examples/combination of factors of how profits can be improved as discussed in class. (5 marks) Cvp analysis seeks the most profitable combination of vc, fc, sp, and sales volume. Profits can sometimes be improved by reducing the cm if fixed costs can be reduced by a greater amount. The way to improve profits is to increase the total cm. Many other combinations of factors are possible: the audited financial statements are prepared using absorption costing (which is still gaap). However, for evaluation of performance variable (direct) costing is a better measure. Absorption costing motivates overproduction because this will increase profits.