Costs (Cambridge (CIE) A Level Business): Flashcards
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What can happen if a business underestimates its costs when setting prices?
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What can happen if a business underestimates its costs when setting prices?
It may set prices too low and make a loss.
Comparing actual costs with _____ helps a business identify areas of overspending and take action.
Comparing actual costs with budgets helps a business identify areas of overspending and take action.
Define fixed costs.
Fixed costs are costs that do not change with output, such as rent, management salaries and insurance.
Define variable costs.
Variable costs are costs that rise proportionally with output, such as raw materials and the wages of production workers.
True or False?
A business's total costs can never be zero.
True.
All organisations have some fixed costs, which must be paid even when output is zero, so total costs cannot be zero.
Define direct costs.
Direct costs are costs that can be traced directly to a specific product, service or department, such as raw materials used to make a product.
True or False?
Indirect costs are always fixed costs.
False.
Indirect costs can be fixed or variable. They are costs shared across products or departments that cannot be traced to one unit of output.
Why is total cost information useful for planning?
It shows how much money is needed to produce at a certain level of output, which is vital for budgeting and cash flow forecasting.
Define average cost.
Average cost is the cost of producing one unit of output.
Average cost = Total cost ÷ Quantity of output
Define marginal cost.
Marginal cost is the cost of producing one extra unit of output.
Marginal cost = Change in total cost ÷ Change in quantity
A business increases output from 12,400 to 13,000 units, which raises total costs by $2,750. It sells each unit for $4.75. Should it increase output?
The business should increase output, because the marginal cost of $4.58 ($2,750 ÷ 600) is below the $4.75 selling price, so each extra unit adds to profit.
What is the minimum that prices must cover during discounts and promotions?
Even during sales or promotions, prices must at least cover variable costs to avoid making a loss.
How does cost information help a business respond to competitors' prices?
It shows how low prices can be cut without making a loss, which is essential in price wars or competitive markets.
How can cost analysis help a business improve its efficiency?
It highlights waste in labour, materials or energy, helping the business lower its costs over time.
Define full costing.
Full costing is a costing method that allocates all costs, direct and indirect, to the products a business makes.
Define contribution costing.
Contribution costing is a costing method that allocates only direct costs to products, with indirect costs paid for out of the contribution each product makes.
How is the full cost per unit calculated for a business that makes one product?
The full cost per unit is found by adding total direct and indirect costs and dividing by the level of output.
True or False?
When a business makes several products, deciding how to allocate indirect costs is usually straightforward.
False.
Each product may use a different proportion of indirect costs, such as workers, machinery or factory space, so allocation decisions are unlikely to be straightforward.
The method of allocating indirect costs should remain ________ so that performance can be compared over time.
The method of allocating indirect costs should remain consistent so that performance can be compared over time.
Why can full costing lead to inaccurate pricing decisions?
Full costing often uses predicted output levels, so if actual output differs, the cost per unit is wrong and prices based on it may reduce profit.
How is contribution per unit calculated in contribution costing?
Contribution per unit is calculated using this formula:
Contribution per unit = Selling price − Direct cost per unit
True or False?
A product that makes a small positive contribution should always be phased out.
False.
Phasing out a product with a positive contribution would reduce profit, so it may be kept if this meets business objectives. Only products with a negative contribution should be phased out.
At what point does contribution start to become profit?
Contribution becomes profit once indirect costs have been fully covered.
True or False?
Contribution costing guarantees that a business will make a profit.
False.
Because indirect costs are not considered in the calculations, there is no guarantee that the business will make a profit.
Which qualitative factors can contribution costing overlook?
It can overlook the value of keeping a full product range, the image a product gives the business and a product's future potential.
Why might a business accept a special order at a price below its full unit cost?
If the business has spare capacity and the price is above direct costs, the order makes a positive contribution to indirect costs.
True or False?
A special order is harder to justify if accepting it increases indirect costs.
True.
If the order raises indirect costs, its contribution may not cover them, so it may not increase profit.
A hotel is offered $400 per guest for a special order. Direct labour is $84 and direct materials are $72 per guest. What contribution does each guest make to indirect costs?
Each guest makes a contribution of $244 ($400 − $156) to indirect costs.
Define break-even analysis.
Break-even analysis is a financial tool used to find the point at which revenue equals costs, so the business makes neither a profit nor a loss.
Why is break-even analysis useful when communicating with investors or lenders?
It demonstrates the financial viability of the business and gives an insight into potential return on investment.
Define sales revenue.
Sales revenue is the value of the units sold by a business over a period of time.
Sales revenue = Quantity sold × Selling price
True or False?
Variable costs must be paid even when output is zero.
False.
It is fixed costs that must be paid whether output is zero or not. Variable costs vary directly with output, rising as output rises and falling as it falls.
Define contribution per unit.
Contribution per unit is the amount of the selling price left after the variable cost of one unit is paid, which goes towards paying fixed costs.
Contribution per unit = Selling price − Variable cost per unit
How is the break-even point calculated?
The break-even point is calculated using this formula:
Break-even point = Fixed costs ÷ Contribution per unit
A break-even output that is not a whole number should always be rounded __ to the next whole unit.
A break-even output that is not a whole number should always be rounded up to the next whole unit.
A business has annual fixed costs of £55,000. It charges £95 per unit and has variable costs of £19 per unit. What is its break-even output?
Contribution per unit is £76, so £55,000 ÷ £76 = 723.68, giving a break-even output of 724 units.
How does break-even analysis help with pricing decisions?
It helps a business find the minimum price needed to cover costs and achieve its desired level of profit.
How is break-even analysis used for sensitivity analysis?
It shows how changes in costs, prices or sales volumes affect the break-even point, revealing risks such as suppliers raising their prices.
True or False?
Break-even analysis is just as useful for a business that makes many different products as for one that makes a single product.
False.
Break-even analysis is less useful for businesses that produce multiple products.
Why might break-even analysis give misleading results in practice?
It assumes all output is sold, its accuracy depends on the quality of the data, and revenue and total costs do not always change in a straight line with output.
True or False?
Break-even analysis can help a business control its costs.
True.
It helps identify fixed and variable costs, so the business can evaluate its spending patterns and reduce unnecessary expenses.
What does a break-even chart show?
It shows fixed costs, total costs and revenue over a range of output, and the profit or loss made at each level of output.
Define margin of safety.
The margin of safety is the difference between the actual level of output and the break-even level of output.
Where is the break-even point on a break-even chart?
The break-even point is where the total costs line and the revenue line cross.
On a break-even chart, fixed costs are shown as a ________ line because they do not change as output increases.
On a break-even chart, fixed costs are shown as a horizontal line because they do not change as output increases.
True or False?
At zero output, revenue on a break-even chart is equal to fixed costs.
False.
At zero output, revenue is zero because nothing is sold. It is total costs that are made up entirely of fixed costs at zero output.
How is the profit at a given level of output shown on a break-even chart?
Profit is the space between the revenue line and the total costs line at that level of output, above the break-even point.
What happens to the break-even point when the selling price increases?
Revenue rises at each level of output, so the break-even point falls and fewer units need to be sold to break even.
True or False?
An increase in variable costs lowers the break-even point.
False.
Higher variable costs increase total costs at each level of output, so the break-even point rises.
What happens to the break-even point when fixed costs fall?
Total costs fall at each level of output, so the break-even point falls.
True or False?
A decrease in the selling price increases the break-even point.
True.
A lower price reduces revenue at each level of output, so more units must be sold to break even.
Why are break-even charts useful for "what if?" analysis?
They are easy to adjust, so managers can explore scenarios such as rising costs or price cuts before acting.
Why does assuming straight-line costs limit the usefulness of break-even charts?
Straight-line costs ignore bulk-buying discounts and overtime costs, so the chart may not reflect real costs.
Which assumption about sales limits the usefulness of break-even charts?
Break-even charts assume all output is sold, which may not happen in real life.
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