theoretical questions and answers

1 DISCUSSION QUESTIONS AND SUGGESTED ANSWERS – Chapter 3, 4, and 13 (Cornerstones of Managerial Accounting 3 rd edition, Mowen et al, 2009) Cost Cost Concepts and Classifications DQ 3.1. Knowledge of cost behavior allows a manager to assess changes in costs that result from changes in activity. This allows a manager to examine the effects of choices that change activity. For example, if excess capacity exists, bids that at least cover variable costs may be totally appropriate. Knowing what costs are variable and what costs are fixed can help a manager make better bids and, ultimately, better business decisions. DQ 3.4. Some account categories are primarily fixed or variable. Even if the cost is mixed, either the fixed component or the variable component is relatively small. As a result, assigning all of the cost to either a fixed or variable category is unlikely to result in large errors. For example, depreciation on property, plant, and equipment is largely fixed. The cost of telephone expense for the sales office, if it consisted primarily of long distance calls, could be seen as largely variable (variable with respect to the number of customers). DQ 3.5. Committed fixed costs are those incurred for the acquisition of long-term activity capacity and are not subject to change in the short run. Annual resource expenditure is independent of actual usage. For example, the cost of a factory building is a committed fixed cost. Discretionary fixed costs are those incurred for the acquisition of short-term activity capacity, the levels of which can be altered quickly. In the short run, resource expenditure is also independent of actual activity usage. Salaries of engineers is an example of such an expenditure. DQ 3.7. Mixed costs are usually reported in total in the accounting records. How much of the cost is fixed and how much is variable is unknown and must be estimated. CPV Analysis DQ 4.2. The units sold approach defines sales vol-ume in terms of units of product and gives answers in these same terms. The unit con-tribution margin is needed to solve for the break-even units. The sales revenue ap-proach defines sales volume in terms of revenues and provides answers in these same terms. The overall contribution margin ratio can be used to solve for the break-even sales dollars. DQ 4.3. Break-even point is the level of sales activity where total revenues equal total costs, or where zero profits are earned. DQ 4.4. At the break-even point, all fixed costs are covered. Above the break-even point, only variable costs need to be covered. Thus, contribution margin per unit is profit per unit, provided that the unit selling price is greater than the unit variable cost (which it must be for break even to be achieved). 2 DQ. 4.8. Packages of products, based on the expected sales mix, are defined as a single product. Selling price and cost information for this package can then be used to carry out CVP analysis. DQ 4.9. This statement is wrong; break-even analy-sis can be easily adjusted to focus on tar-geted profit. DQ 4.13. Operating leverage is the use of fixed costs to extract higher percentage changes in prof-its as sales activity changes. It is achieved by increasing fixed costs while lowering variable costs. Therefore, increased leverage implies increased risk, and vice versa. DQ 4.15. A declining margin of safety means that sales are moving closer to the break-even point. Profit is going down, and the possibility of loss is greater. Managers should analyze the reasons for the decreasing margin of safety and look for ways to increase revenue and/or decrease costs. Short-term Decision Making DQ 13.2. Depreciation is an allocation of a sunk cost. This cost is a past cost and will never differ across alternatives. DQ 13.3. The salary of the supervisor of an assembly line with excess capacity is an example of an irrelevant future cost for an acceptorreject decision. DQ 13.6. A complementary effect is the loss of revenue on a secondary product when the primary product is dropped. Thus, complementary effects may make it more expensive to drop a product. DQ 13.8. No. Joint costs are irrelevant. They occur regardless of whether the product is sold at the splitoff point or processed further. DQ 13.10. No. If a scarce resource is used in producing the two products, then the product providing the greatest contribution per unit of scarce resource should be selected. For more than one scarce resource, linear programming may be used to select the optimal mix. DQ 13.11. If a firm is operating below capacity, then a price that is above variable costs will increase profits. . 1 DISCUSSION QUESTIONS AND SUGGESTED ANSWERS – Chapter 3, 4, and 13 (Cornerstones of Managerial Accounting 3 rd edition, Mowen et al, 2009) Cost Cost Concepts and Classifications. is fixed and how much is variable is unknown and must be estimated. CPV Analysis DQ 4.2. The units sold approach defines sales vol-ume in terms of units of product and gives answers. safety and look for ways to increase revenue and/ or decrease costs. Short-term Decision Making DQ 13.2. Depreciation is an allocation of a sunk cost. This cost is a past cost and will