444 Accounting: Business Reporting for Decision Making
Summary of learning objectives
10.1 Define fixed, variable and mixed costs.
Fixed costs are commonly identified as those that remain the same in total (within a given range of
activity and timeframes), irrespective of the level of activity. Variable costs are commonly identi-
fied as those that change in total as the level of activity changes. Mixed costs are those that appear
to possess fixed and variable characteristics.10.2 Prepare a break-even analysis for single-product and multi-product entities.
CVP analysis commonly requires the use of the contribution margin concept to calculate the break-
even number of units. Data are needed on fixed and variable costs in order to execute the calcu-
lation. When calculating break-even for multi-product or service entities, we need to calculate the
weighted average contribution margin before calculating the break-even units.10.3 Apply the contribution margin ratio to CVP calculations.
The contribution margin ratio can be used to perform break-even calculations by focusing on the
ratio of the contribution margin to sales. This can be particularly useful when seeking the total
break-even sales dollars, rather than the per unit numbers.10.4 Explain the key assumptions underlying CVP analysis.
The key assumptions underlying CVP analysis include the assumption that the behaviour of costs
can be neatly classified as fixed or variable — which may not be the case, as some costs do not
behave as expected; cost behaviour is generally assumed to be linear (see figures 10.1 and 10.2);
fixed costs are believed to remain ‘fixed’ over the time period and/or a given range of activity
(often referred to as the relevant range); unit price and cost data are assumed to remain constant
over the time period and relevant range; and, for multi-product entities, the sales mix between the
products is assumed to be constant.10.5 Discuss the uses of break-even data.
Break-even data can be used in a number of ways, including identifying the number of products
or services required to be sold to meet break-even or profit targets; planning products and
allocating resources by focusing on those products that contribute more to profitability; deter-
mining the impact on profit of changes in the mix of fixed and variable costs; and pricing
products.10.6 Outline the concept of operating leverage.
The margin of safety is commonly regarded as the excess of revenue (or units of sales) above
the break-even point. It provides an indication of how much revenue (sales in units) can decrease
before reaching the break-even point. Operating leverage refers to the mix between fixed and vari-
able costs in the cost structure of an entity. A knowledge of operating leverage helps in under-
standing the impact of changes in revenue on profit.10.7 Assess the profitability of output when there are resource limitations.
For some businesses, sales are not limited by market demand, but by production/operational limi-
tations including shortage of any factor such as labour, materials, space or equipment. For each
output, the contribution margin per limiting factor needs to be calculated to identify the most
profitable use of the limited resource.10.8 Assess relevant information for decision making.
Relevant costs and relevant income are those that differ among alternative courses of action, with
the focus being on identifying incremental income and incremental costs, which represent the
additional income/costs as a result of taking an alternative course of action. It is also important
to identify if there is an opportunity cost (i.e. what is given up if one alternative is chosen over
another) as a result of the decision.