Differential Analysis Chapter 7 Quiz
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Questions and Answers

What type of decision is typically evaluated using differential analysis?

  • Budgeting decisions
  • Financial investment decisions
  • Human resource decisions
  • Make-or-buy decisions (correct)

Direct fixed costs are often considered differential costs.

True (A)

Define what is meant by an 'opportunity cost.'

An opportunity cost is the potential benefit that is missed when one alternative is chosen over another.

Differential analysis is primarily used in the evaluation of __________ decisions.

<p>financial</p> Signup and view all the answers

Match the following types of costs with their definitions:

<p>Avoidable Cost = Costs that can be eliminated if a particular decision is made Allocated Fixed Cost = Costs that remain fixed regardless of the decision made Opportunity Cost = The benefit lost when one option is chosen over another Direct Fixed Cost = Fixed costs directly associated with a specific product or service</p> Signup and view all the answers

Why are allocated fixed costs typically not considered differential costs?

<p>They are unchangeable regardless of decisions. (B)</p> Signup and view all the answers

What are two important assumptions to consider when evaluating special order scenarios?

<p>Capacity availability and incremental costs.</p> Signup and view all the answers

Cost-plus pricing is a method that involves determining the cost of producing a product and adding a markup.

<p>True (A)</p> Signup and view all the answers

What percentage of costs are fixed if a company has $150,000 in fixed costs and $50,000 in variable costs?

<p>75% (D)</p> Signup and view all the answers

Absorption costing treats fixed manufacturing overhead as a period cost.

<p>False (B)</p> Signup and view all the answers

What is the formula to convert target profit after tax to target profit before taxes?

<p>Target profit before taxes = Target profit after tax ÷ (1 – tax rate)</p> Signup and view all the answers

Variable costing allows managers to review contribution margin information, including the contribution margin ________.

<p>ratio</p> Signup and view all the answers

Why do companies analyze contribution margin per unit of constrained resource?

<p>To maximize profit under resource constraints (B)</p> Signup and view all the answers

Match the costing method to its treatment of fixed manufacturing overhead:

<p>Absorption Costing = Product Cost Variable Costing = Period Cost</p> Signup and view all the answers

Variable costing prevents managers from increasing production merely to inflate profits.

<p>True (A)</p> Signup and view all the answers

List two benefits of using variable costing for managers.

<p>CVP analysis, contribution margin income statements</p> Signup and view all the answers

What defines a fixed cost?

<p>A cost that remains constant regardless of activity level. (D)</p> Signup and view all the answers

A committed fixed cost can be easily changed in the short run.

<p>False (B)</p> Signup and view all the answers

Give two examples of variable costs.

<p>Direct materials and direct labor</p> Signup and view all the answers

The cost equation can be expressed as Y = __ + vX.

<p>f</p> Signup and view all the answers

Match the type of fixed cost with its description:

<p>Committed Fixed Cost = Long-term leases and contracts Discretionary Fixed Cost = Can be changed without major impact Variable Cost = Total costs change with production Mixed Cost = Combination of fixed and variable costs</p> Signup and view all the answers

Which of the following methods can be used to estimate fixed and variable costs?

<p>High-low method (D)</p> Signup and view all the answers

Per unit variable costs do change with changes in activity.

<p>False (B)</p> Signup and view all the answers

What are joint products?

<p>Products that are generated simultaneously from the same process.</p> Signup and view all the answers

The equation to estimate future costs is Y = f + v __.

<p>X</p> Signup and view all the answers

What could lead to inaccuracies when using the high-low method?

<p>It focuses only on the highest and lowest activity levels. (C)</p> Signup and view all the answers

Mixed costs change in direct proportion to changes in activity.

<p>False (B)</p> Signup and view all the answers

Describe the role of account analysis in estimating costs.

<p>It involves reviewing accounts to separate fixed and variable cost components.</p> Signup and view all the answers

Match the following term to its description:

<p>Total Fixed Costs = Remain constant in total regardless of activity Per Unit Fixed Costs = Change inversely with activity levels Total Variable Costs = Change in total with activity level Per Unit Variable Costs = Constant regardless of activity levels</p> Signup and view all the answers

Which of these costs can be categorized as a discretionary fixed cost?

<p>Advertising expenses (D)</p> Signup and view all the answers

What is the primary purpose of calculating the break-even point?

<p>To find the number of units that must be sold for zero profit (C)</p> Signup and view all the answers

The contribution margin ratio can change with fluctuations in the selling price per unit.

<p>True (A)</p> Signup and view all the answers

What does margin of safety represent?

<p>The excess of projected sales over the break-even point.</p> Signup and view all the answers

The equation to calculate the break-even point in units is: (Total fixed costs + Target profit) ÷ (Selling price per unit - Variable cost per unit), where the denominator is known as the _______.

<p>contribution margin per unit</p> Signup and view all the answers

Which of the following is an example of a fixed cost?

<p>Equipment depreciation (C)</p> Signup and view all the answers

The contribution margin per unit is the same as the contribution margin ratio.

<p>False (B)</p> Signup and view all the answers

What is sensitivity analysis used for in cost-volume-profit analysis?

<p>To show how changes in model variables affect profit.</p> Signup and view all the answers

To find the break-even point in sales dollars, the equation is: (Total fixed costs + Target profit) ÷ _______.

<p>Contribution margin ratio</p> Signup and view all the answers

Match the following terms with their definitions:

<p>Fixed Costs = Costs that do not change with activity level Variable Costs = Costs that vary with the level of production Break-even Point = Point where total revenues equal total costs Contribution Margin Ratio = Percentage representing the contribution of each sales dollar to covering fixed costs</p> Signup and view all the answers

Which of the following statements about target profit is correct?

<p>Target profit can be expressed in both units and sales dollars. (A)</p> Signup and view all the answers

Cost structures only include variable costs.

<p>False (B)</p> Signup and view all the answers

What changes in the break-even equation for a company with multiple products?

<p>The denominator uses the weighted average contribution margin per unit.</p> Signup and view all the answers

In CVP analysis, the assumption that costs can be separated into fixed and _______ components is crucial.

<p>variable</p> Signup and view all the answers

What may prompt a manager to decide against introducing a new product?

<p>Low margin of safety (A)</p> Signup and view all the answers

What is the purpose of the scattergraph method?

<p>To estimate costs based on data points (A)</p> Signup and view all the answers

The scattergraph method requires that a line touches all data points.

<p>False (B)</p> Signup and view all the answers

What is referred to as 'outliers' in the scattergraph method?

<p>Unusual data points</p> Signup and view all the answers

The profit equation is: Profit = Total sales – Total variable costs – Total _____.

<p>fixed costs</p> Signup and view all the answers

Which of the following describes the term 'relevant range'?

<p>The level of activity for accurate cost estimates (C)</p> Signup and view all the answers

Variable costs remain constant regardless of the level of activity.

<p>False (B)</p> Signup and view all the answers

How is the variable cost per unit calculated in the scattergraph method?

<p>By solving for variable cost in the equation using total fixed costs and the data point.</p> Signup and view all the answers

Regression analysis provides total fixed costs (f) and variable cost per unit (v) output in the form of the equation Y = ____ + vX.

<p>f</p> Signup and view all the answers

Match the following types of statements to their purposes:

<p>Contribution margin income statement = Internal reporting with fixed and variable costs Traditional income statement = External reporting with functional area costs Scattergraph method = Graphical cost estimation technique Regression analysis = Mathematical fitting of data points</p> Signup and view all the answers

Which of the following costs can behave in a nonlinear way?

<p>Direct materials costs (C)</p> Signup and view all the answers

The contribution margin is calculated by adding variable costs to sales.

<p>False (B)</p> Signup and view all the answers

What is the role of the line drawn during the scattergraph method?

<p>To estimate fixed and variable costs by fitting closely to the data points.</p> Signup and view all the answers

The equation for profit can be expressed as: Profit = Total sales - Total ____ - Total fixed costs.

<p>variable costs</p> Signup and view all the answers

What do accountants use to assess the reasonableness of data points in the scattergraph method?

<p>Computer programs like Excel (A)</p> Signup and view all the answers

Costs can remain fixed outside of the relevant range.

<p>False (B)</p> Signup and view all the answers

Flashcards

Differential Analysis

The difference in revenue and cost between two alternatives.

Avoidable Costs

Costs that can be avoided by choosing one alternative over another.

Opportunity Cost

The potential benefit lost by choosing one option over another. It's a cost associated with the forgone opportunity.

Differential Analysis Model

A decision-making process that compares the revenues and costs of different alternatives to identify the most profitable option.

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Make-or-Buy Decision

A common business decision where a company decides whether to produce a good or service internally or outsource it to an external supplier.

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Cost-Plus Pricing

The process of determining the selling price of a product or service by adding a predetermined markup to the cost of production.

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Direct Fixed Costs

Direct fixed costs are usually considered differential costs because they can be avoided by choosing one alternative over another.

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Allocated Fixed Costs

Allocated fixed costs are usually not considered differential costs because they cannot be avoided by choosing one alternative over another.

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Fixed Cost

A cost that remains constant regardless of the level of activity. For example, rent on a factory building.

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Committed Fixed Cost

Fixed costs that are difficult to change in the short term, like long-term leases or employee contracts.

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Discretionary Fixed Cost

Fixed costs that can be adjusted in the short term, like advertising budgets or charitable donations.

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Variable Cost

A cost that changes proportionally with the level of activity, such as direct materials. The cost per unit stays constant.

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Mixed Cost

A cost that has both fixed and variable components. For example, a salesperson's salary plus commission based on sales.

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Cost Equation

The mathematical equation that represents the relationship between total costs and activity level: Y = f + vX. Y is total cost, f is total fixed cost, v is variable cost per unit, and X is the activity level.

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Estimating Future Costs

The process of using the cost equation to predict future costs. First, find fixed costs and variable cost per unit, and then plug in the expected activity level.

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Cost Behavior

Understanding how costs change with different activity levels. Managers need this information to make accurate predictions and decisions.

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Account Analysis

A method for estimating costs by analyzing historical data. A manager reviews accounts to identify fixed and variable costs.

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High-Low Method

A method for estimating costs using the highest and lowest activity levels. It's simple but can be inaccurate if those points are unusual.

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Joint Products

Products produced from the same raw materials or production process. For example, gasoline, diesel fuel, and kerosene all come from crude oil.

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Joint Costs

The cost incurred to produce joint products up to the split-off point. It's difficult to allocate these costs individually.

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Sales Value at Split-Off Method

A method for allocating joint costs based on the relative sales value of the joint products at the split-off point.

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Physical Measure Method

A method for allocating joint costs based on the physical measure of the joint products at the split-off point.

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Split-Off Point

The point in the production process where joint products become identifiable and can be sold separately.

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Scattergraph Method

A graphical method that uses data points to estimate fixed and variable costs by visually fitting a line to the data points.

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Total Fixed Costs on Scattergraph

The point where the line fitted to the data points in the scattergraph method intersects the y-axis. Represents the total fixed costs.

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Variable Cost per Unit on Scattergraph

The slope of the line fitted to the data points in the scattergraph method. Represents the cost per unit of activity.

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Unusual Data Points on Scattergraph

Data points that are significantly higher or lower than the general trend of the data points on the scattergraph. They can distort the cost estimates.

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Regression Analysis

A statistical method used to find the best possible fit of a straight line to a set of data points to estimate fixed and variable costs.

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Relevant Range

The range of activity levels for which the cost equation developed through scattergraph or regression analysis is likely to be accurate.

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Contribution Margin Income Statement

A format for the income statement that separates costs into fixed and variable components.

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Contribution Margin

The amount remaining after deducting variable costs from sales. Represents the amount available to cover fixed costs and generate profit.

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Traditional Income Statement

A traditional format for the income statement that presents costs by functional area (cost of goods sold, selling, administrative). Doesn't distinguish between fixed and variable costs.

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Profit Equation

The equation that links total sales, total variable costs, and total fixed costs to determine profit: Profit = Total Sales - Total Variable Costs - Total Fixed Costs.

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Non-linear Cost Behavior

When a cost does not change in a consistent linear fashion. Can occur with variable costs due to factors like learning curves or capacity constraints.

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Total Sales

The selling price per unit (S) multiplied by the quantity of units produced and sold (Q).

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Total Variable Costs

The variable cost per unit (V) multiplied by the quantity of units produced and sold (Q).

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Contribution margin per unit

The additional profit generated by producing and selling one more unit of a product.

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Contribution margin per unit of constraint

The contribution margin per unit of a product divided by the amount of the constrained resource used to produce that unit.

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Target profit after taxes

The profit a company aims to achieve after deducting income taxes.

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Target profit before taxes

The profit a company aims to achieve before deducting income taxes.

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Absorption costing

A costing method where fixed manufacturing overhead is treated as a product cost and included in inventory until sold.

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Contribution margin ratio

The ratio of contribution margin to sales, indicating the percentage of each sales dollar that contributes to covering fixed costs and generating profit.

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Break-even point in units

The specific amount of units that need to be sold to cover all fixed costs and break even.

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Break-even point in sales dollars

The total sales revenue (in dollars) required to cover all fixed costs and achieve zero profit.

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Target profit in units

The number of units a company needs to sell to achieve a specific profit target.

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Target profit in sales dollars

The total sales revenue (in dollars) required to achieve a predetermined profit target.

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Margin of safety

The difference between projected sales and the break-even point, representing the amount of sales that can decline before the company experiences a loss.

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Cost structure

The proportion of fixed and variable costs in an organization's total cost structure.

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Sensitivity analysis

A method used to examine how changes in different variables affect the cost-volume-profit (CVP) model, such as fixed costs, variable costs, or sales price.

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Weighted average contribution margin per unit

When calculating break-even or target profit for companies with multiple products, this is used in the denominator to reflect the contribution margin of each product relative to the sales mix.

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Weighted average contribution margin ratio

When calculating break-even or target profit for companies with multiple products, this is used in the denominator to reflect the contribution margin of each product relative to the sales mix.

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Constant sales mix

Refers to the assumption in CVP analysis that the sales mix, or the proportion of different products sold, remains constant.

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Constant contribution margin ratio

The assumption in CVP analysis that the contribution margin ratio remains constant for each product or segment, meaning that the relationship between selling price and variable costs doesn't change with sales volume.

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Fixed and variable cost separation

This assumption states that costs can be classified as either fixed costs, which remain constant regardless of the activity level, or variable costs, which change proportionally with the activity level.

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Cost-volume-profit (CVP) analysis

The process of analyzing how changes in cost or volume (activity level) affect a company's profitability.

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Study Notes

Differential Analysis Model

  • This model organizes data to aid in various business decisions.
  • Common applications include: make-or-buy decisions, product-line decisions, customer retention, and special orders.

End-of-Chapter Questions (Chapter 7)

  • These questions facilitate self-assessment of learning.
  • Answers will be provided in a separate section.
  • Students should create a dedicated "End-Of-Chapter Questions" section in the learning journal for answers.
  • These questions are not graded but support learning and aid understanding of the material.
  • Comparing answers with the correct answers reinforces learning and improves performance in graded quizzes and exams.

Differential Revenues and Costs

  • Differential revenues and costs are the changes in revenues and costs relevant to decision-making.

Differential Analysis

  • Differential analysis is a decision-making technique focusing on relevant revenues and costs.

Make-or-Buy Decisions

  • These decisions involve choosing whether to produce a good internally or outsource it.
  • Differential analysis helps in evaluating relevant costs and benefits.

Avoidable Cost

  • An avoidable cost is a cost that can be eliminated by a specific decision.

Product Line Decisions

  • Differential analysis helps in deciding which product lines to continue or discontinue.

Direct Fixed Costs as Differential Costs

  • Direct fixed costs are frequently differential costs as these change when a product line is removed or added.

Allocated Fixed Costs as Non-Differential Costs

  • Allocated fixed costs are usually not differential costs since they aren't directly impacted by a product line change.

Opportunity Cost

  • Opportunity cost is a potential benefit lost when choosing one option over another.
  • Opportunity costs act as differential costs because they represent the net cash loss from alternative options.

Customer and Product Line Decisions

  • Differential analysis approaches customer and product line decisions similarly. The critical comparison is the same: net benefits.

Special Order Decisions

Assumptions for special orders:

  • Capacity constraints will not limit acceptance of the special order.
  • Special order won't negatively impact regular sales.

Cost-Plus Pricing

  • Cost-plus pricing is a pricing method where a markup is added to the cost of production.

Target Costing Steps

  • Target costing has four steps.

Theory of Constraints Steps

  • The theory of constraints uses five steps to manage constraints.

Qualitative Advantage of Keeping Unprofitable Customers

  • Qualitative advantages of keeping unprofitable customers include maintaining customer relationships and potential future profitability.

Joint Products and Joint Costs

  • Joint products are two or more products produced from a shared process. Joint costs are those incurred during the shared process.

Joint Cost Allocation Methods

  • Two methods exist for allocating joint costs: the physical units method, and the sales value at split-off method.

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Test your understanding of differential analysis concepts, including make-or-buy decisions, differential revenues and costs, and their applications in business decision-making. This chapter’s end-of-chapter questions are designed for self-assessment and reinforce your learning.

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