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Unformatted text preview: CHAPTER 20 DISCUSSION QUESTIONS 1. Understanding cost behavior patterns as- sists management in making important oper- ating decisions. For example, knowing that certain costs are fixed within a range of activity level may help management decide to accept a special order with a price that will cover the variable costs. As the impact of costs on various operating decisions is better understood, management will more easily achieve its goals of total quality and profitability. 2. Level of activity may be measured in terms of output or input. For a manufacturing firm, level of activity is often measured in terms of output—that is, number of units produced. Input measures, such as direct labor hours worked, may also be used. A merchandising firm may use the number of orders taken or number of complaints received, in addition to the traditional sales volume measure- ment. A service firm may use output meas- ures such as client hours billed or input measures such as number of payroll hours. 3. Within the relevant range, total variable costs are assumed to increase at a rate dir- ectly proportionate with changes in the activ- ity level throughout the normal operating level of production. 4. Stepped costs should be treated as fixed costs if the steps are relatively wide as com- pared with the normal range of operating activity (relevant range). If the steps are rel- atively small as compared with the relevant range, the stepped costs should be treated as variable costs and approximated with a variable cost line. 5. All mixed costs should be segregated into their fixed and variable components so that useful decisions, predictions, and perform- ance evaluations can take place. When mixed costs are not segregated, it is extremely difficult to predict how they will vary with changes in activity level and what the impact will be on profits. 6. The major weakness of the scattergraph, or visual-fit, method is that the determined fixed and variable costs are only visual es- timates. There is no guarantee that the line drawn through the points is the best fit since the line will be drawn subjectively by the individual making the assessment. 7. The major limitation of the high-low method is that only the two extreme points are used in the calculation. If these points are not rep- resentative of the costs that would be incurred at all levels, the computed fixed and variable cost relationships can be mis- leading. 8. The basic C-V-P equation is: Sales revenue – variable costs – fixed costs = target income. The more detailed C-V-P equation is: (Sales volume × per-unit price) – (sales volume × per-unit variable cost) – fixed costs = target income. 9. The contribution margin is the amount of sales revenue remaining after variable costs have been deducted from sales. This margin can then be applied to cover fixed costs and provide a profit. If managers know the con- tribution margins of their products, they can evaluate how much profits will increase or decrease with changes in sales volumes. decrease with changes in sales volumes....
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This note was uploaded on 04/28/2008 for the course ACCT 2301 taught by Professor Conn during the Spring '08 term at St. Edwards.

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