Costing Questions - Short Answer Questions and Real World Example

This document explains the two major cost behaviour patterns, break-even point, relevant range, formulas for break-even sales in revenue and units, and ways to lower the breakeven point. It also provides a real-world example of cost-volume-profit analysis.

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Costing Questions

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Part I: Short Answer Questions
Solution 1:
The two major cost behaviour patterns are variable cost and fixed cost. Variable cost
refers to cost that change in direct proportion to the production level. It means when fewer units
are produced, variable cost will be less and when production units is more variable cost will be
more. On the other hand, fixed cost refers to the cost that has no relationship with the production
level and it remain same irrespective to change in production level (Jones, 2015). In case cost has
both the characteristics it will be termed as semi fixed cost that has some part as variable and
some part as fixed.
Solution 2:
Break-even point refers to the sales point when total costs (Fixed and variable cost) are
equal to total sales revenue. It mean at breakeven point there will be no profit and loss to the
company as total earnings is spent in payment of all expenses.
Solution 3:
Breakeven point refers to the sales point where cost is equal to sales amount. So it can be
said that breakeven point can be expressed in two ways and they are sales figure (value) and s
ales units. The two ways under which breakeven point can be expressed is in units (quantity) and
sales value (revenue).
Solution 4:
Relevant range refers to that activity level which is bounded by maximum and minimum
units or amount. In costing relevant range can be used for variable cost as well as fixed cost.
When there is constraint of relevant range, fixed costs remain to be same for particular interval
or range and will change when subject either increase or decrease in respect to respective range.
Similarly, relevant range can also be applied to variable cost as variable cost can change with
respect to range of sales units. For example, variable cost will be $50 for first 100 units than it
changes to $45 for next 100 units and so on.
Solution 5:
Formula of break even sales in revenue: (Fixed Cost /Contribution per unit)* Sales price per unit
Solution 6:
Formula of break even sales in units: Fixed Cost /Contribution per unit (Cunningham, Nikolai,
Bazley & Slaughter, 2014)
Solution 7:

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In order to achieve the desired level of income and to calculate the number of units
required to achieve the desired income, breakeven formula can be altered as follows:
Breakeven formula (In units):
Formula: (Fixed cost + Desired income)/ Contribution per unit
Formula is explained as under
The above formula is different from the normal breakeven formula as it includes fixed
cost as well as desired income in numerator. Desired income is included because it helps to
calculate the number of units that is required to sale in order to earn desired value of income.
Solution 8:
The benefit of lowering the breakeven helps to increase the profits and allows
management to spend more cash on product development, research & development and new
investment. Low breakeven point is very helpful for the business as it helps management to
lower the fixed cost and increase the overall income.
Solution 9:
Through mechanization and automation process breakeven point will reduce as there will
be reduction in fixed costs like salaries, workmanship cost etc. Fixed cost will lower the number
of units required to achieve the breakeven point.
Solution 10:
The three business ideas that can help to reduce the lower the breakeven point are as
under:
 Increase the selling price: Through increasing the selling price one can meet the fixed
expenses easily and it also increase contribution margin per unit which definitely lower
breakeven point.
 Lower the fixed cost: There are many ways through which fixed cost can be curtailed and
it is the most appropriate method to achieve the reduction of fixed cost.
 Option of up-sell and cross-sell: Up-sell and cross sell will allow management to not rely
on the same units of products in order to meet the fixed cost (Warren, Reeve & Duchac,
2011)
Example:
Let’s consider company produces 1000 units of F1 and sell it at selling price of $10 and
has variable cost of $6 and fixed cost of $2000. So the breakeven point will be $2000/$4 = 500
units. In this example if selling price is increase to $11 than breakeven point will change to
$2000/$5 = 400 units. So it is proved that increasing the selling price will reduce the breakeven
point.

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Part II: Real World Example
In this section real world example has been discussed that will explain implication of cost
volume profit analysis. In order to discuss the example it has been decided to choose a small
business situation that deals in one product and this product passes through many departments in
order to get processed.
Detail of example: A business firm produces a product called as X2, and it has following cost
information:
Cost Structure
Variable costs Cost Amount
Direct Material $20 per unit
Direct Labour $15 per unit
Variable overhead cost $5 per unit
Total Variable cost $40.00 per unit
Fixed Cost
Fixed Selling and
distribution cost
$ 40000
Fixed administration cost $20000
Total Fixed cost $ 60000
Selling price of the X2 product is $ 80 per unit.
At this point the breakeven point will calculated as follows:
Contribution per unit = $ 80.00 - $ 40.00 = $40.00
Total Fixed Cost = $60000
Breakeven point = Total Fixed cost /Contribution margin per unit
= $60000/$40 = 1500 units
Let’s say fixed cost of selling and distribution get reduced to $30000 and Fixed and
administration cost reduced to $ 6000 than there is change in breakeven point and it is as
follows:
Contribution per unit = $ 80.00 - $ 40.00 = $40.00
Total Fixed Cost = $ 30000 +$ 6000 = $36000
Breakeven point = Total Fixed cost /Contribution margin per unit

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= $36000/$40 = 900 units
So, this example proves that reduction in fixed cost will help to reduce the fixed cost (Krantz,
2016).

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References
Cunningham, B., Nikolai, L.A., Bazley, J. & Slaughter, G. 2014. Accounting: Information for
Business Decisions. Australia: Cengage Learning.
Jones, S. 2015. The Routledge Companion to Financial Accounting Theory. London: Routledge.
Krantz, M. 2016. Fundamental Analysis for Dummies. USA: John Wiley & Sons.
Warren, C.S., Reeve, J.M. & Duchac, J. 2011. Accounting. USA: Cengage Learning.