Question

1. Christine is a restaurant owner of Minipizza, which sells Italian pizzas and spaghetti. She recently employs Maggie as her accountant and requests her to prepare the annual budget of Minipizza. After Maggie submits the budget, Christine has raised out the following questions: a. Why is knowledge of cost behavior important for Christine’s decision making? Give an example to illustrate your answer. (20 marks) b. Since break-even analysis focuses on making zero profit, it is of no value in determining the units Minipizza must sell to earn a targeted profit. If you were Maggie, do you agree or disagree with this statement? Please explain your answer to Christine (20 marks)

Answer 1

a. Knowledge of cost behavior allows a manager to assess changes in costs that result from changes in activity. ... Relevant costs are the future costs which are used in making decisions. These are irrelevant for decision making and are ignored in every type of decisions taken by company.The cost information system plays an important role in .While costing is useful for setting a normal sales price, it is also useful for determining whether or not to take special orders at lower prices. In many cases, fixed costs of production, such as rent and management salaries, are already covered by normal production.Every organization within the decision-making process. An important task of management is to ensure the control over operations, processes, activity sectors, and not ultimately on costs.This knowledge gives you information about potential threats (e.g. fixed costs are rising gradually after exceeding proper level of activity ) and opportunities (e.g. economies of scale - if you double the size of production your costs will increase only by 70-80%).Knowledge of cost behavior allows a manager to assess changes in coststhat resultfrom changes in activity. This allows a manager to assess the effects ofchoices thatchange activity. For example,if excess capacity exists,bids thatminimally covervariable costs may be totally appropriate. Knowing what costs arevariable and whatcosts are fixed can help a manager make better bids.

For a restaurant, direct costs would be all the ingredients in the food, plus all the labor to make and serve the food.  Indirect costs are resources used for more than one product.  For instance in a restaurant, a stove is used for more than one menu item, so it would be an indirect cost for each item (and very difficult to allocate to either product).  To determine the total cost of a product, you need to calculate both the direct and indirect costs.  In the restaurant example, the cost of a hamburger includes all the direct costs  -- the ingredients plus the labor of the person who makes and serves it – and all the indirect costs of shared items – the stove, the cooking utensils, reusable plates, etc.

Cost behavior is affected by a number of factors, including volume, price, efficiency, sales mix, and production changes. Therefore, any analysis must be made with regard to its limitations. The benefit of cost–volume–profit relationships is in understanding the interrelationships affecting profits.

ood managers must not only be able to understand the conceptual underpinnings of cost behavior, but they must also be able to apply those concepts to real world data that do not always behave in the expected manner. Cost data are impacted by complex interactions. Consider the costs of operating a vehicle. Conceptually, fuel usage is a variable cost that is driven by miles. But, the efficiency of fuel usage can fluctuate based on highway miles versus city miles. Beyond that, tires wear faster at higher speeds, brakes suffer more from city driving, and so forth. Vehicle insurance is seen as a fixed cost; but portions are required (liability coverage) and some portions are not (collision coverage). Furthermore, a wreck or ticket can cause the cost of coverage to rise. The point is that assessing the actual character of cost behavior can be more daunting than might be suspected. Nevertheless, management must understand cost behavior, and this sometimes takes a bit of forensic accounting work. Begin by considering the case of “mixed costs.”

b.) No, I wouldn't agree with the statement that break-even analysis focuses on making zero profit and hence is of use for determining in units Minipizza must sell to earn a targeted profit. A key figure to know for operating a restaurant is your break-even point. The break-even is basically the amount of sales you need over a certain period of time not to lose money. The basic formula for break-even is fixed cost divided by 1 minus variable cost percentage.Break-even analysis, one of the most popular business tools, is used by companies to determine the level of profitability. It provides companies with targets to cover costs and make a profit. It is a comprehensive guide to help set targets in terms of units or revenue.

Break-even analysis enables a business organization to:

1. Measure profit and losses at different levels of production and sales.
2. Predict the effect of changes in sales prices.
3. Analyze the relationship between fixed and variable costs.
4. Predict the effect of cost and efficiency changes on profitability.

A break-even analysis tells a business planner how much they need to sell monthly, quarterly, or annually in order to cover the business costs. ... Typically it would involve making a chart that shows your fixed costs, variable costs, and what the revenue is per unit of sales