Questions and Answers
What characterizes relevant costs in decision making?
Why are sunk costs considered irrelevant in decision making?
What type of costs should decision making primarily focus on?
Which of the following statements best defines avoidable costs?
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In the example of an employee whose basic wage will continue regardless of work, what is the nature of the $100 wage?
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Which of the following types of costs should be ignored in decision-making processes?
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Why should committed costs be considered in decision-making?
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What is a key difference between relevant costs and avoidable costs?
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What are avoidable costs typically made up of?
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Which statement accurately describes opportunity cost?
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In decision-making, why are sunk costs considered irrelevant?
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What differentiates controllable costs from uncontrollable costs?
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Which of the following is an example of a sunk cost?
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What is the relevant cost of materials if they are in inventory and can be replaced?
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How are differential costs defined?
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If a material has no resale value and no alternative use, what is its relevant cost?
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For which of the following materials would the current resale value be relevant to its cost?
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What should be considered when evaluating variable costs?
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How is the relevant cost of labor calculated when labor must be hired from outside?
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Which of the following describes attributable fixed costs?
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Which type of costs typically remain non-relevant despite operational changes?
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What is the relevant cost of labor if there is spare capacity available?
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What is the relevant cost of materials with no scrap value that have already been paid for?
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When assessing whether to accept a new customer's offer for a machine, what would be the relevant cost of materials already purchased?
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Which of the following describes deprival value of an asset?
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What is absorbed overhead?
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What is the relevant cost of labor in a situation where there is a loss of contribution due to not producing existing products?
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When considering which option to choose, why is differential benefit important?
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Which of the following is NOT a characteristic of fixed costs?
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If further labor costs amount to $8000 while switching to another job would earn $30,000 revenue, what is the opportunity cost?
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When determining relevance of costs, which of the following is crucial?
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What is the relevant cost of using material D if it can be substituted for material E costing $5 per unit?
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What will the relevant cost of labor be if hiring requires paying the usual rate regardless of capacity?
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What impact does the resale value of a material have on its relevant cost?
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When determining the relevant cost for accepting a contract, which costs would typically be excluded?
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What is the correct approach when calculating the relevant cost of labor if it is scarce?
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Which of the following is considered a variable cost?
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What characterizes a step-fixed cost?
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How does the number of units produced affect variable costs?
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Which of the following would NOT be classified as a fixed cost?
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If a car company incurs costs that rise only after exceeding a production level, which cost type does this represent?
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Which of the following represents a semi-variable cost?
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The depreciation of an asset is typically classified as a:
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Which factor is NOT a direct example of a cost driver?
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When costs increase with the level of production, this is known as:
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In the context of management accounting, budgeting requires an understanding of:
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What is the deprival value of an asset calculated from the future revenues and the replacement cost?
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What is the primary component of a variable cost?
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What will happen to per-unit fixed cost as production increases?
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Which type of cost is represented by the initial purchase price of a machine that has already been acquired?
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Which of the following costs is described as part-fixed and part-variable?
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When evaluating the relevant cost of keeping a machine that generates net income of $90,000, what should be considered?
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In the context of decision making, which of the following costs would be considered irrelevant?
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If an organization's costs incur largely due to a high volume of activity, which principle describes this situation?
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Which cost should be included when calculating the relevant cost of material for a production job?
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What is the opportunity cost of not using labor that could otherwise be diverted for a profitable product?
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For a project requiring 600 kg of material X, what should be considered as the relevant cost?
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In decision making, how are variable costs generally treated compared to fixed costs?
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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?
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If a project uses materials T and V, which materials' costs should be included based on their current usage and market price?
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Which of the following is true regarding opportunity costs?
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When considering the relevant costs of a new contract that requires labor from an existing workforce, which factor is the most relevant?
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In evaluating the relevant cost of a project using existing raw materials, which factor is considered?
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If a company has decided against purchasing new machinery which they eventually would not have used, what would this decision represent?
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What does Graph 1 illustrate regarding costs in relation to activity levels?
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Which graph best represents a fixed cost structure over various activity levels?
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What is the variable cost per unit if the total cost of making 20,000 units is $40,000?
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How can the labor cost of a worker who earns a salary plus a bonus per unit produced best be described?
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Which graph demonstrates step fixed costs as activity levels increase?
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What is the total relevant cost of material if 500 kg at $45 and 200 kg at $40 are considered?
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In decision-making, what type of cost should be specifically focused on?
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Which of the following best defines 'incremental cost'?
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What is the nature of a cost that increases with output in a linear manner?
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What is the relevant cost formula for acquired materials if the items are already in regular use?
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What is the variable cost per unit calculated in the high-low method based on the total costs at high and low activity levels?
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Which formula correctly calculates fixed costs at the high activity level?
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How does the presence of a step up in fixed costs affect the calculation of total cost for cleaning 14,500 square meters?
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Which total cost model applies to a situation where the total cost increases with the number of valuations conducted?
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Which type of costs is primarily unaffected by changes in activity levels?
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For the cost elements of a product, which components are typically included?
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What distinguishes semi-variable costs from fixed and variable costs?
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What must be done to find total fixed costs for 14,500 sq. meters cleaned considering the step up?
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What does a curvilinear relationship indicate regarding total variable costs?
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What would be the total variable cost for cleaning 14,500 sq. meters with a revised variable cost of $3.10?
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How does the fixed cost change in the scenario requiring an additional wage per square meter?
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What is the calculation for total costs if fixed costs amount to $51,875 and total variable costs are $44,950?
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How can the fixed and variable components of semi-variable costs be identified?
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What best describes a step-fixed cost?
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Which of the following is an example of a variable cost?
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What is a characteristic of a semi-variable cost?
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What happens to the variable cost per unit as production levels rise?
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Which of the following is a non-linear cost behavior?
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What is NOT a feature of fixed costs?
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In which situation is rent considered a step-fixed cost?
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What does a curvilinear cost graph illustrate?
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Which of the following is NOT a common characteristic of variable costs?
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What happens to fixed cost per unit as production increases?
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Which of the following statements about bonus payments is true?
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Which of these is an example of a mixed cost?
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What is a defining feature of total fixed costs when production increases?
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Which of the following statements about direct labor costs is accurate?
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What is the characteristic of departmental costs within an organization?
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Which method relies solely on two historical cost records to estimate costs?
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What is one major drawback of the high-low method?
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In the context of cost estimation, what is meant by 'semi-variable costs'?
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What does the regression analysis method use to establish cost relationships?
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Which of the following statements best describes the account-classification method of cost estimation?
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Which step in the high-low method involves determining variable cost per unit?
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What formula is used to forecast future costs in regression analysis?
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What is a common characteristic of costs estimated using simple techniques?
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When utilizing the scatter graph method, what is a main advantage it has over the high-low method?
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What aspect of mixed costs is particularly emphasized within cost estimation techniques?
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Why might different cost estimation methods yield different results for fixed and variable costs?
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How is the fixed cost determined in the high-low method?
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What should be expected when estimating costs using historical data in a relevant range?
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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.