Chapter 5 Notes

Chapter 5 Notes - Chapter 5: Cost-Volume-Profit...

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Chapter 5: Cost-Volume-Profit Cost-Behavior Analysis: The study of how specific costs respond to changes in the level of business activity. Some costs change; others remain the same A knowledge of cost behavior helps management plan operations and decide between alternative courses of action Cost behavior analysis applies to all types of entities Starting point in cost behavior analysis is measuring key business activities Activity levels may be expressed in terms of: o Sales dollars (in a retail company) o Miles driven (in a trucking company) o Room occupancy (in a hotel) o Dance classes taught (by a dance studio) Many companies use more than one measurement base For an activity level to be useful: o Changes in the level or volume of activity should be correlated with changes in costs The activity level selected is called the o activity or volume index The activity index: o Identifies the activity that causes changes in the behavior of costs o Allows costs to be classified according to their response to changes in activity as either: Variable Costs Fixed Costs Mixed Costs Variable Costs:
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Variable costs are costs that vary in total directly and proportionately with changes in the activity level Example: If the activity level increases 10 percent, total variable costs will increase 10 percent Example: If the activity level decreases by 25 percent, total variable costs will decrease by 25 percent Variable costs remain the same per unit at every level of activity. Damon Company manufactures radios that contain a $10 digital clock The activity index is the number of radios produced For each radio produced, the total cost of the clocks increases by $10: If 2,000 radios are produced, the total cost of the clocks is $20,000 (2,000 X $10) If 10,000 radios are produced, the total cost of the clocks is $100,000 (10,000 X $10) Fixed Costs: Fixed costs are costs that remain the same in total regardless of changes in the activity level. Fixed costs
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Chapter 5 Notes - Chapter 5: Cost-Volume-Profit...

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