MODULE 2 - COST CLASSIFICATION

Questions and Answers

What characterizes relevant costs in decision making?

They are based on sunk costs and fixed costs.

They are future cash flows directly resulting from a decision. (correct)

They must always be cash inflows only.

They include all past costs incurred.

Why are sunk costs considered irrelevant in decision making?

They represent potential future revenues.

They are future projections of costs.

They cannot be changed by any future decision. (correct)

They only include one-time charges.

What type of costs should decision making primarily focus on?

Irrecoverable costs that have already been spent.

Fixed costs that will remain unchanged.

Total costs including both fixed and variable costs.

Incremental cash flows that occur only from the decision. (correct)

Which of the following statements best defines avoidable costs?

Costs that would not be incurred if a certain activity did not exist. Signup and view all the answers

In the example of an employee whose basic wage will continue regardless of work, what is the nature of the $100 wage?

A sunk cost that is irrelevant to the decision. Signup and view all the answers

Which of the following types of costs should be ignored in decision-making processes?

Depreciation expenses. Signup and view all the answers

Why should committed costs be considered in decision-making?

They will be incurred regardless of decisions made. Signup and view all the answers

What is a key difference between relevant costs and avoidable costs?

Relevant costs are focused on future cash flows, while avoidable costs depend on the activity's existence. Signup and view all the answers

What are avoidable costs typically made up of?

Variable costs and some specific costs Signup and view all the answers

Which statement accurately describes opportunity cost?

It reflects the value of the alternative not chosen. Signup and view all the answers

In decision-making, why are sunk costs considered irrelevant?

They have already been incurred and do not affect future costs. Signup and view all the answers

What differentiates controllable costs from uncontrollable costs?

Controllable costs can be influenced by management decisions. Signup and view all the answers

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

Development costs incurred in the past for a now-abandoned project. Signup and view all the answers

What is the relevant cost of materials if they are in inventory and can be replaced?

Their current replacement cost. Signup and view all the answers

How are differential costs defined?

The difference in total cost between alternatives. Signup and view all the answers

If a material has no resale value and no alternative use, what is its relevant cost?

The relevant cost is nil. Signup and view all the answers

For which of the following materials would the current resale value be relevant to its cost?

Material C, with no other use. Signup and view all the answers

What should be considered when evaluating variable costs?

They are always relevant unless they are sunk costs. Signup and view all the answers

How is the relevant cost of labor calculated when labor must be hired from outside?

Total variable costs incurred. Signup and view all the answers

Which of the following describes attributable fixed costs?

They could increase or decrease based on a specific decision. Signup and view all the answers

Which type of costs typically remain non-relevant despite operational changes?

General fixed overheads Signup and view all the answers

What is the relevant cost of labor if there is spare capacity available?

The direct labor cost excluding spare capacity. Signup and view all the answers

What is the relevant cost of materials with no scrap value that have already been paid for?

Zero, if treated as sunk. Signup and view all the answers

When assessing whether to accept a new customer's offer for a machine, what would be the relevant cost of materials already purchased?

Scrap value of $2000. Signup and view all the answers

Which of the following describes deprival value of an asset?

The cost of replacing the asset in its current condition. Signup and view all the answers

What is absorbed overhead?

Costs not influenced by the decision at hand. Signup and view all the answers

What is the relevant cost of labor in a situation where there is a loss of contribution due to not producing existing products?

Loss of contribution from foregoing existing production. Signup and view all the answers

When considering which option to choose, why is differential benefit important?

It shows the profit margin in relation to alternatives. Signup and view all the answers

Which of the following is NOT a characteristic of fixed costs?

They always increase with higher output. Signup and view all the answers

If further labor costs amount to $8000 while switching to another job would earn $30,000 revenue, what is the opportunity cost?

$30,000. Signup and view all the answers

When determining relevance of costs, which of the following is crucial?

Future costs and benefits should be evaluated. Signup and view all the answers

What is the relevant cost of using material D if it can be substituted for material E costing $5 per unit?

The cost of $6 per unit. Signup and view all the answers

What will the relevant cost of labor be if hiring requires paying the usual rate regardless of capacity?

The wages for all hours worked. Signup and view all the answers

What impact does the resale value of a material have on its relevant cost?

It can reduce the relevant cost if it is higher than replacement cost. Signup and view all the answers

When determining the relevant cost for accepting a contract, which costs would typically be excluded?

Historical fixed costs. Signup and view all the answers

What is the correct approach when calculating the relevant cost of labor if it is scarce?

Ensure to account for potential loss of contribution. Signup and view all the answers

Which of the following is considered a variable cost?

Direct material costs Signup and view all the answers

What characterizes a step-fixed cost?

It remains constant until a certain level of activity is reached Signup and view all the answers

How does the number of units produced affect variable costs?

Total variable costs will increase with increases in output Signup and view all the answers

Which of the following would NOT be classified as a fixed cost?

Sales commission based on units sold Signup and view all the answers

If a car company incurs costs that rise only after exceeding a production level, which cost type does this represent?

Step-fixed cost Signup and view all the answers

Which of the following represents a semi-variable cost?

Utility costs, which include a fixed monthly charge plus usage fees Signup and view all the answers

The depreciation of an asset is typically classified as a:

Fixed cost Signup and view all the answers

Which factor is NOT a direct example of a cost driver?

Quality of the produced items Signup and view all the answers

When costs increase with the level of production, this is known as:

Variable cost behaviour Signup and view all the answers

In the context of management accounting, budgeting requires an understanding of:

Cost behaviour Signup and view all the answers

What is the deprival value of an asset calculated from the future revenues and the replacement cost?

$9,000 Signup and view all the answers

What is the primary component of a variable cost?

Total cost fluctuating with changes in production volume Signup and view all the answers

What will happen to per-unit fixed cost as production increases?

It will decrease Signup and view all the answers

Which type of cost is represented by the initial purchase price of a machine that has already been acquired?

Sunk cost Signup and view all the answers

Which of the following costs is described as part-fixed and part-variable?

Utilities that include a flat rate and additional usage charges Signup and view all the answers

When evaluating the relevant cost of keeping a machine that generates net income of $90,000, what should be considered?

Future cash flows from the machine Signup and view all the answers

In the context of decision making, which of the following costs would be considered irrelevant?

Historical material costs Signup and view all the answers

If an organization's costs incur largely due to a high volume of activity, which principle describes this situation?

Activity level principle Signup and view all the answers

Which cost should be included when calculating the relevant cost of material for a production job?

Cost of purchasing new materials Signup and view all the answers

What is the opportunity cost of not using labor that could otherwise be diverted for a profitable product?

Contribution from the product not made Signup and view all the answers

For a project requiring 600 kg of material X, what should be considered as the relevant cost?

$1,950, the current purchase price Signup and view all the answers

In decision making, how are variable costs generally treated compared to fixed costs?

Variable costs are relevant, fixed costs are irrelevant Signup and view all the answers

What is the total relevant cost of the machine to the contract if it can be sold for $1,200 and has a disposal cost of $800 later?

$1,200 Signup and view all the answers

If a project uses materials T and V, which materials' costs should be included based on their current usage and market price?

Current purchase price of both materials Signup and view all the answers

Which of the following is true regarding opportunity costs?

They are benefits foregone from a chosen alternative Signup and view all the answers

When considering the relevant costs of a new contract that requires labor from an existing workforce, which factor is the most relevant?

The rate for overtime work Signup and view all the answers

In evaluating the relevant cost of a project using existing raw materials, which factor is considered?

Replacement cost of materials Signup and view all the answers

If a company has decided against purchasing new machinery which they eventually would not have used, what would this decision represent?

An opportunity cost decision Signup and view all the answers

What does Graph 1 illustrate regarding costs in relation to activity levels?

Fixed costs remain unchanged regardless of activity levels. Signup and view all the answers

Which graph best represents a fixed cost structure over various activity levels?

Graph 1 Signup and view all the answers

What is the variable cost per unit if the total cost of making 20,000 units is $40,000?

$1.25 Signup and view all the answers

How can the labor cost of a worker who earns a salary plus a bonus per unit produced best be described?

Semi-variable cost Signup and view all the answers

Which graph demonstrates step fixed costs as activity levels increase?

Graph 3 Signup and view all the answers

What is the total relevant cost of material if 500 kg at $45 and 200 kg at $40 are considered?

$22,500 Signup and view all the answers

In decision-making, what type of cost should be specifically focused on?

Opportunity cost Signup and view all the answers

Which of the following best defines 'incremental cost'?

The additional cost incurred from a decision made. Signup and view all the answers

What is the nature of a cost that increases with output in a linear manner?

Variable cost Signup and view all the answers

What is the relevant cost formula for acquired materials if the items are already in regular use?

Replacement cost of the items needed. Signup and view all the answers

What is the variable cost per unit calculated in the high-low method based on the total costs at high and low activity levels?

$1 Signup and view all the answers

Which formula correctly calculates fixed costs at the high activity level?

Total cost at high activity level - Variable cost per unit × Total units at high activity level Signup and view all the answers

How does the presence of a step up in fixed costs affect the calculation of total cost for cleaning 14,500 square meters?

It requires an adjustment to high activity costs. Signup and view all the answers

Which total cost model applies to a situation where the total cost increases with the number of valuations conducted?

TC = $42000 + 95V Signup and view all the answers

Which type of costs is primarily unaffected by changes in activity levels?

Fixed costs Signup and view all the answers

For the cost elements of a product, which components are typically included?

Materials, labor, other expenses Signup and view all the answers

What distinguishes semi-variable costs from fixed and variable costs?

They contain both fixed and variable elements. Signup and view all the answers

What must be done to find total fixed costs for 14,500 sq. meters cleaned considering the step up?

Use the activity level of 15,100 sq. meters and adjust for the step up. Signup and view all the answers

What does a curvilinear relationship indicate regarding total variable costs?

Costs vary in a non-linear fashion with activity change. Signup and view all the answers

What would be the total variable cost for cleaning 14,500 sq. meters with a revised variable cost of $3.10?

$30,450 Signup and view all the answers

How does the fixed cost change in the scenario requiring an additional wage per square meter?

It increases by $1 per square meter. Signup and view all the answers

What is the calculation for total costs if fixed costs amount to $51,875 and total variable costs are $44,950?

$96,825 Signup and view all the answers

How can the fixed and variable components of semi-variable costs be identified?

By using the high-low method. Signup and view all the answers

What best describes a step-fixed cost?

It remains constant until a certain activity level is reached, after which it increases. Signup and view all the answers

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

Cost of raw materials Signup and view all the answers

What is a characteristic of a semi-variable cost?

It has a fixed component that does not change. Signup and view all the answers

What happens to the variable cost per unit as production levels rise?

It remains constant. Signup and view all the answers

Which of the following is a non-linear cost behavior?

Curvilinear variable costs. Signup and view all the answers

What is NOT a feature of fixed costs?

They vary with the level of production. Signup and view all the answers

In which situation is rent considered a step-fixed cost?

When additional space is rented as production increases. Signup and view all the answers

What does a curvilinear cost graph illustrate?

A varying rate of cost increase depending on output levels. Signup and view all the answers

Which of the following is NOT a common characteristic of variable costs?

They are unaffected by the level of output. Signup and view all the answers

What happens to fixed cost per unit as production increases?

It decreases. Signup and view all the answers

Which of the following statements about bonus payments is true?

They may become variable once a certain output level is achieved. Signup and view all the answers

Which of these is an example of a mixed cost?

Electricity bill with a fixed and variable component. Signup and view all the answers

What is a defining feature of total fixed costs when production increases?

They decrease per unit as more units are produced. Signup and view all the answers

Which of the following statements about direct labor costs is accurate?

They can vary based on the level of production activity. Signup and view all the answers

What is the characteristic of departmental costs within an organization?

They are mixed costs with fixed and variable elements. Signup and view all the answers

Which method relies solely on two historical cost records to estimate costs?

High-low method Signup and view all the answers

What is one major drawback of the high-low method?

It uses only two data points, which may not represent overall cost behavior. Signup and view all the answers

In the context of cost estimation, what is meant by 'semi-variable costs'?

Costs with both fixed and variable components. Signup and view all the answers

What does the regression analysis method use to establish cost relationships?

Statistical methods to analyze larger data sets. Signup and view all the answers

Which of the following statements best describes the account-classification method of cost estimation?

It requires subjective judgment and classification of costs. Signup and view all the answers

Which step in the high-low method involves determining variable cost per unit?

Calculating the total costs and total units for both periods. Signup and view all the answers

What formula is used to forecast future costs in regression analysis?

$y = a + bx$ Signup and view all the answers

What is a common characteristic of costs estimated using simple techniques?

They are likely to be less reliable but more commonly used. Signup and view all the answers

When utilizing the scatter graph method, what is a main advantage it has over the high-low method?

It uses a larger dataset to estimate cost relationships. Signup and view all the answers

What aspect of mixed costs is particularly emphasized within cost estimation techniques?

They can increase linearly with activity levels. Signup and view all the answers

Why might different cost estimation methods yield different results for fixed and variable costs?

Data used varies in volume and accuracy. Signup and view all the answers

How is the fixed cost determined in the high-low method?

By subtracting total variable costs from total costs at high activity. Signup and view all the answers

What should be expected when estimating costs using historical data in a relevant range?

Estimates may deviate due to external factors. Signup and view all the answers

Study Notes

Relevant Costs Overview

Relevant costs are future cash flows directly resulting from a decision.
Decision-making should hinge on future incremental cash flows.

Relevant Costs Definition

Relevant costs include future costs, which are unaffected by past decisions (sunk costs).
Committed costs represent future outflows that will occur regardless of current decisions.
Only cash flows are relevant; non-cash costs like depreciation are ignored.
Incremental costs are additional expenses incurred due to a specific decision or action.

Avoidable Costs

Avoidable costs are costs that do not need to be incurred if a specific activity ceases.
Relevant in decisions about discontinuing products where only variable and specific costs would be avoided.

Differential Costs and Opportunity Costs

Differential costs represent the cost difference between alternative choices.
Opportunity costs reflect the benefits missed when choosing one alternative over another.

Controllable and Uncontrollable Costs

Controllable costs can be influenced by a manager in the short term.
Committed fixed costs (like rents) are usually unavoidable and thus uncontrollable.

Sunk Costs

Sunk costs are past expenditures irrelevant to current decision-making.
Managers should focus on future costs, disregarding sunk costs when evaluating alternatives.

Fixed and Variable Costs

Variable costs are generally relevant as they fluctuate with production volume.
Fixed costs often remain constant and are typically considered non-relevant unless they can change based on specific decisions.

Non-Relevant Variable Costs

Some variable costs could qualify as sunk costs, making them non-relevant.

Attributable Fixed Costs

Attributable fixed costs may change based on decision-making, unlike general overheads which are unaffected.

Absorbed Overhead

Notional accounting costs, like absorbed overheads, should be disregarded in decision-making; focus on incremental overheads instead.

Relevant Cost of Materials

The relevant cost for additional materials includes current purchase costs or replacement costs.
Materials already in inventory may be considered based on resale value or alternative use value.

Relevant Cost of Labour

Relevant cost of labour varies based on whether it must be hired externally or if spare capacity exists.
Contribution lost from not utilizing existing capacity must be factored in when resources are scarce.

Relevant Cost of an Asset

The relevant cost of an asset, or its deprival value, is assessed based on potential future revenues or alternative scrap value.
This value is essential for determining a firm's minimum acceptable return when deprived of the asset.

Key Module Points

Focus on future cash flows and avoid incorporating sunk costs in decision-making.
Understand the distinction between relevant and non-relevant costs, including variable and fixed classifications.

Quick Revision Questions

Questions test understanding of concepts like sunk costs, relevant costs of materials, and opportunity costs related to decision-making scenarios.### Cost Behaviour Principles
As activity levels increase, costs generally rise.
Higher production levels lead to increased costs; for example, producing 2000 units costs more than producing 1000.
Key accounting challenge: analyze cost drivers and predict cost variations with activity changes.
Focus on volume of production for measuring costs.

Costs Analysis Types

Costs classified into variable, fixed, and step-fixed.
Variable Costs: Change with activity level, e.g., fuel and oil costs per kilometer, repair costs linked to mileage.
Fixed Costs: Remain unchanged within certain activity levels; examples include depreciation and routine maintenance.
Step-Fixed Costs: Fixed within specific activity ranges but increase once certain thresholds are exceeded, such as tire replacement costs after a set distance traveled.

Fixed and Variable Costs

Fixed Costs: Do not vary with output; include rent and straight-line depreciation.
Variable Costs: Adjust according to production volume; examples include direct material costs and sales commissions.
Semi-Variable Costs: Contain both fixed and variable components, e.g., utility bills or sales staff salaries.

Cost Behaviour Patterns

Fixed costs remain stable, variable costs change proportionately with output.
Curvilinear Costs: Total variable costs may exhibit non-linear behaviour under specific circumstances, leading to increasing or decreasing variable costs.

Semi-Variable Costs

Include both fixed (e.g., basic salary, rent) and variable costs (e.g., commission on sales).
Examples comprise electricity bills and running costs of vehicles.

Cost Estimation Techniques

Account-Classification Method: Organizes costs as fixed, variable, or semi-variable based on historical data; relies heavily on managerial judgment.
High-Low Method: Assesses cost behaviour using the highest and lowest activity levels; calculates variable and fixed costs.
Scatter Graph Method: Uses historical data points to visually estimate cost relationships.

High-Low Method Steps

Identify periods of highest and lowest activity.
Calculate the total costs and units for identified periods.
Determine variable costs per unit and fixed costs accordingly.

Practical Example Using High-Low Method

Given data from DG Co., estimated variable cost calculated as $1 per unit.
Fixed costs determined to be $80,000.
Forecast total costs for an output of 85,000 units as $165,000.

Step-Fixed Costs and Examples

Fixed costs may rise after specific output levels; for instance, added supervisory costs occur once production exceeds certain thresholds.
Examples include increased rental expenses or employee salaries as output rises.

Addressing Variable Cost Changes

External factors, such as wage negotiations, can alter variable costs, which should be taken into account when forecasting.

Cost Behaviour Assumptions

Costs generally assumed linear within normal ranges of activity.
Departmental costs typically considered mixed, displaying both fixed and variable characteristics.
Assumptions guide estimations but should remain flexible for real-world variations in cost behaviour.### Cost Classification and Analysis
Costs are classified into fixed, variable, and semi-variable costs based on their behavior regarding changes in activity levels.
Fixed Costs: Incurred regardless of activity level; remain constant within a relevant range.
Variable Costs: Change directly with the level of production; the variable cost per unit remains constant.
Step-Fixed Costs: Fixed within certain activity levels but increase in steps beyond those levels.
Semi-Variable (Mixed) Costs: Contain both fixed and variable components and are influenced by activity changes.

Cost Elements

Total cost of a product or service is composed of:
- Materials: Directly attributable to production.
- Labour: Can include both fixed salaries and variable wages based on output.
- Other Expenses: Indirect costs related to production.
Costs can also be categorized as direct (identifiable with a specific product) or indirect (not directly traceable to a single product).

Cost Behaviour Insights

Cost behaviour indicates that costs typically rise with increased activity; producing more output leads to higher total costs.
Curvilinear costs indicate a non-linear relationship between total variable costs and activity levels; this relationship is visually represented with curved lines in graphs.

High-Low Method Application

The high-low method is used to separate fixed and variable components of semi-variable costs by identifying costs at the highest and lowest levels of activity.
Example calculations involve identifying the variable cost per unit by comparing total costs at different activity levels (i.e., using activity data of valuations recorded).

Cost Estimation Models

Cost estimation must capture the model for total costs, represented as TC = Fixed Costs + Variable Costs,
Different variations of this model exist, such as:
- Option A: TC = $42,000 + $95V
- Option B: TC = $46,500 + $85V
- Option C: TC = $46,500 - $85V
- Option D: TC = $51,500 - $95V

Relevant Costs in Decision Making

Relevant costs are crucial for decision-making and include opportunity costs (the benefit lost by choosing one option over another).
Sunk costs are past expenditures that should not affect future decisions due to their irrelevance.

Practical Examples of Cost Calculations

Cost for producing a specific quantity can be determined through direct calculation; for instance, if the total cost of 20,000 units is $40,000, the variable cost per unit can be derived accordingly.
A production worker's compensation may involve a combination of fixed salary and variable pay per unit produced, categorizing it as a semi-variable cost.

Graphical Representations

Different graphs illustrate how costs behave:
- Linear relationships depict variable costs (Graph 1).
- Fixed costs remain constant in various activity levels (Graph 2).
- Step-fixed costs increase in discrete increments (Graph 3).

Key Concept Review

Understanding and analyzing cost components and their behavior is essential for effective management accounting and financial decision-making.

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Description

This quiz explores the key concepts of relevant costs and their significance in decision making. It addresses the nature of sunk costs, avoidable costs, and the focus on certain types of costs to make effective decisions. Test your understanding of how these financial principles apply in real-world scenarios.