Chapter 28 (costs)

Question 1

What are the costs of production?

Answer 1

Direct costs

Indirect costs

Fixed costs

Variable costs

Marginal costs

Question 2

What are Direct costs?

Answer 2

Direct costs are costs that can be clearly identified with each unit of production and can be allocated to a cost centre

Question 3

What are Indirect costs?

Answer 3

Indirect costs are costs that cannot be clearly identified with each unit of production or allocated accurately to a cost centre

Question 4

What are Fixed costs?

Answer 4

These costs do not vary with output in the short run, such as rent of premises.

Question 5

What are Variable costs?

Answer 5

These costs vary with output, such as the direct cost of materials used in making a washing machine.

Question 6

What are Marginal costs?

Answer 6

These costs are the extra cost of producing one more unit of output.

Question 7

what is Break-even analysis?

Answer 7

The break-even point of production is the level of output at which total costs equal total revenue – neither a profit nor a loss is made

Question 8

what is a Margin of safety

Answer 8

The margin of safety is the amount by which the sales level exceeds the break-even level of output

Question 9

Break-even analysis – further uses

Answer 9

break-even techniques can also be used to assist managers in making key decisions.

• A marketing decision e.g. the impact of a price increase
• An operations-management decision e.g. the purchase of new equipment with lower variable costs
• Choosing between two locations for a new factory

Question 10

what is the usefulness of break-even analysis?

Answer 10

• Charts are relatively easy to construct and interpret
• Analysis provides useful guidelines to management on break-even points, safety margins and profit/loss levels at different rates of output

-Comparisons can be made between different options by
constructing new charts to show changed circumstances.

• The equation produces a precise break-even result.
• Break-even analysis can be used to assist managers when taking important decisions, such as location decisions, whether to buy new equipment and which project to invest in.

Question 11

what are the limitations to break-even analysis?

Answer 11

• The assumption that costs and revenues are always represented by straight lines is unrealistic. Not all variable costs change directly or ‘smoothly’ with output. The revenue line could be influenced by price reductions made necessary to sell all units produce at high output levels.
• Not all costs can be conveniently classified into fixed and variable costs. The introduction of semi-variable costs will make this technique much more complicated.
• There is no allowance for inventory levels on the break-even chart. It is assumed that all units produced are sold. This is unlikely to always be the case in practice.

-It is also unlikely that fixed costs will remain unchanged at
different output levels up to maximum capacity.