accounting
Chapter 2 Discussion Questions
1. What is the meaning of cost behavior and how does the variable cost behave differently than fixed cost (per unit & total)?
Cost behavior is the change of cost relative to change in some extent of activity. The total fixed cost remains constant regardless of change in the volume of activity. However, the fixed cost per unit is inversely related to the change in the volume of activity. As the change in the volume of activity increases, the fixed cost per unit decreases, and as the change in the volume of activity decreases, the fixed cost per unit increases. The total variable cost is directly proportional to the change in the volume of activity. As the change in the volume of activity increases, the total variable cost increases proportionately, and as the change in the volume of activity decreases, the total variable cost decreases proportionately. The variable cost per unit remains constant regardless of the change in the volume of activity.
2. How is cost behavior used to analyze risk and profitability for companies? What is the role of operating leverage?
Cost behavior is used to analyze risk and profitability with operating leverage and shifting the cost structure. The cost structure should depend on sales growth expectations. A fixed cost structure should be used for expectations of revenues to increase; however if sales growth is ambiguous a variable cost structure is more plausible. Shifting cost structure from fixed to variable reduces risk and also profitability. Companies with higher fixed costs have more volatility in earnings. Generally companies with high fixed cost structure will show higher net income than low fixed cost structure companies. Rewards are greater at high activity level when costs are fixed and risks are greater at low activity levels. Converting fixed costs to variable costs reduces risk and profitability.
The operating leverage (based on fixed costs) is a percent that explains how a
1. What is the meaning of cost behavior and how does the variable cost behave differently than fixed cost (per unit & total)?
Cost behavior is the change of cost relative to change in some extent of activity. The total fixed cost remains constant regardless of change in the volume of activity. However, the fixed cost per unit is inversely related to the change in the volume of activity. As the change in the volume of activity increases, the fixed cost per unit decreases, and as the change in the volume of activity decreases, the fixed cost per unit increases. The total variable cost is directly proportional to the change in the volume of activity. As the change in the volume of activity increases, the total variable cost increases proportionately, and as the change in the volume of activity decreases, the total variable cost decreases proportionately. The variable cost per unit remains constant regardless of the change in the volume of activity.
2. How is cost behavior used to analyze risk and profitability for companies? What is the role of operating leverage?
Cost behavior is used to analyze risk and profitability with operating leverage and shifting the cost structure. The cost structure should depend on sales growth expectations. A fixed cost structure should be used for expectations of revenues to increase; however if sales growth is ambiguous a variable cost structure is more plausible. Shifting cost structure from fixed to variable reduces risk and also profitability. Companies with higher fixed costs have more volatility in earnings. Generally companies with high fixed cost structure will show higher net income than low fixed cost structure companies. Rewards are greater at high activity level when costs are fixed and risks are greater at low activity levels. Converting fixed costs to variable costs reduces risk and profitability.
The operating leverage (based on fixed costs) is a percent that explains how a