Question

WHAT is cost behavior and WHY is it important? (at least 4 sentences each)

WHAT is sunk cost and WHY is it important? (at least 4 sentences each)

WHAT is relevant range and WHY is it important? (at least 4 sentences each)

Answer 1

The tendency of cost to change based on the level of activity or production is called cost behavior. Cost behavior helps to classify the cost into three categories-Variable cost, Fixed cost and Semi-Variable cost. Variable cost changes in proportion to the volume of production. Thus variable cost per unit is always same. Fixed cost remain constant irrespective to any change in production. Semi-variable cost remains fixed upto certain level and then changes. Such classification helps to segregate the cost so we can find out the contribution margin and break-even point. This helps in selecting the profitable product mix, taking shut down decision, etc. The marginal costing technique is totally dependent on cost behavior.

Sunk cost refers to those cost which have already been incurred in the past and cannot be recovered. For example the capital expense incurred to purchase any fixed asset is a sunk cost. These are historic cost. It is important because it helps to identify the actual expense for the year as per accrual basis of accounting. Though these expense have been incurred in past but the benefits derived from these cost are still enjoyed in this year. Thus these cost are allocated to charge evenly throughout the years.

Relevant range is the bandwidth of activity in which a minimum and maximum levels is assigned. Within these range, certain revenue and expense are expected. It helps in identifying the cost behavior. It gives an estimation of the production as per the range. It is a very important aspect of managerial accounting.

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