Question 1

A low operating leverage is normal for highly automated industries.

Accepted Answer

Highly automated industries typically have high fixed costs due to the expensive equipment and technology required, leading to high operating leverage. Low operating leverage is more characteristic of service-oriented businesses with variable costs.

Question 2

Only a single line, which represents the difference between total sales revenues and total costs, is plotted on the profit-volume chart.

Accepted Answer

The profit-volume chart plots both total sales revenues and total costs, as well as the difference between the two (which represents the profit or loss).

Question 3

Only a single line, which represents the difference between total sales revenues and total costs, is plotted on the cost-volume-profit chart.

Accepted Answer

A cost-volume-profit (CVP) chart typically includes multiple lines representing various elements such as total sales revenue, total fixed costs, total variable costs, and the total cost line, which is the sum of fixed and variable costs, not just a single line.

Question 4

Cost-volume-profit analysis can be presented in both equation form and graphic form.

Accepted Answer

Cost-volume-profit analysis can be presented in equation form (breakeven analysis) as well as graphic form, using a break-even chart or a profit-volume chart.

Question 5

If the volume of sales is $6,000,000 and sales at the break-even point amount to $4,800,000, the margin of safety is 25%.

Accepted Answer

The margin of safety is calculated as (Current Sales - Break-even Sales) / Current Sales. So, ($6,000,000 - $4,800,000) / $6,000,000 = $1,200,000 / $6,000,000 = 0.2 or 20%.

Question 6

The adoption of variable costing for managerial decision making is based on the premise that fixed factory overhead costs are related to productive capacity of the manufacturing plant and are normally not affected by the number of units produced.

Accepted Answer

Variable costing only considers variable manufacturing costs, such as direct materials, direct labor, and variable factory overhead costs, as product costs, while fixed factory overhead costs are treated as period costs. This is because fixed costs are not affected by changes in production levels and, therefore, should not be allocated to the products.

Question 7

Even if a business sells six products, it is possible to estimate the break-even point.

Accepted Answer

The number of products a business sells does not affect its ability to estimate the break-even point. The break-even point is determined by analyzing the fixed and variable costs of the business, and comparing them to the price per unit of the product.

Question 8

If the volume of sales is $7,000,000 and sales at the break-even point amount to $4,800,000, the margin of safety is 45.8%.

Accepted Answer

The margin of safety is calculated as (Current Sales - Break-even Sales) / Current Sales. So, it would be ($7,000,000 - $4,800,000) / $7,000,000 = $2,200,000 / $7,000,000 = 0.3143 or 31.43%, not 45.8%.

Question 9

In an absorption costing income statement, the manufacturing margin is the excess of sales over the variable cost of goods sold.

Accepted Answer

In an absorption costing income statement, the manufacturing margin is the excess of sales over the total cost of goods sold, which includes both variable and fixed manufacturing costs.

Question 10

Garmo Co. has an operating leverage of 5. Next year's sales are expected to increase by 10%. The company's operating income will increase by 50%.

Accepted Answer

The degree of operating leverage (DOL) formula is %Δ in operating income ÷ %Δ in sales or DOL = (Δ EBIT ÷ EBIT) ÷ (Δ Sales ÷ Sales). Given that the operating leverage is 5, we can solve for the change in EBIT using the formula: 5 = (Δ EBIT ÷ EBIT) ÷ 0.1. Solving for Δ EBIT, we get a 50% increase in operating income (Δ EBIT ÷ EBIT = 0.5 or 50%). Therefore, the answer is A) True.

Question 11

If the unit selling price is $40, the volume of sales is $3,000,000, sales at the break-even point amount to $2,500,000, and the maximum possible sales are $3,300,000, the margin of safety is 14,500 units.

Accepted Answer

The statement cannot be determined based on the given information. Margin of safety is typically calculated as the difference between actual sales and sales at the break-even point, expressed as a percentage or a dollar amount. The information provided in the question does not allow for the calculation of the margin of safety in either of these formats.

Question 12

Assuming no other changes, operating income will be the same under both the variable and absorption costing methods when the number of units manufactured equals the number of units sold.

Accepted Answer

When the number of units manufactured equals the number of units sold, there is no change in inventory levels, and therefore no difference between the variable and absorption costing methods in terms of allocation of fixed manufacturing overhead costs. As a result, operating income will be the same under both methods.

Question 13

If fixed costs are $650,000 and the unit contribution margin is $30, the sales necessary to earn an operating income of $30,000 are 14,000 units.

Accepted Answer

To calculate the sales necessary to earn a specific operating income, you use the formula: (Fixed Costs + Desired Operating Income) / Unit Contribution Margin. Plugging in the numbers: ($650,000 + $30,000) / $30 = 22,667 units, not 14,000 units.

Question 14

If a business sells two products, it is not possible to estimate the break-even point.

Accepted Answer

It is possible to estimate the break-even point for a business with two products by calculating the total fixed costs and the contribution margin for each product, and then finding the point where the sum of the contribution margins equals the total fixed costs.

Question 15

Absorption costing is required for financial reporting under generally accepted accounting principles.

Accepted Answer

Absorption costing is the accepted method of costing for financial reporting under generally accepted accounting principles.

Question 16

If a business sells four products, it is not possible to estimate the break-even point.

Accepted Answer

It is possible to estimate the break-even point for a business selling four products by calculating the fixed and variable costs associated with each product and then determining the point at which the total revenue from sales equals the total cost of producing and selling those products.

Question 17

The reliability of cost-volume-profit analysis does NOT depend on the assumption that costs can be accurately divided into fixed and variable components.

Accepted Answer

The reliability of cost-volume-profit analysis depends heavily on the accuracy of cost classification into fixed and variable components. If costs are inaccurately classified, the results of the analysis may be misleading and unreliable. Therefore, the assumption that costs can be accurately divided into fixed and variable components is crucial for the reliability of cost-volume-profit analysis.

Question 18

If fixed costs are $450,000 and the unit contribution margin is $50, the sales necessary to earn an operating income of $50,000 are 10,000 units.

Accepted Answer

To calculate the sales necessary to earn an operating income of $50,000, we use the formula: 
Operating Income = (Unit Contribution Margin x Units sold) - Fixed Costs
$50,000 = ($50 x Units sold) - $450,000
$50 x Units sold = $500,000
Units sold = 10,000. Therefore, the answer is A, True.

Question 19

If the unit selling price is $40, the volume of sales is $3,000,000, sales at the break-even point amount to $2,500,000, and the maximum possible sales are $3,300,000, the margin of safety is 11,500 units.

Accepted Answer

The margin of safety is not measured in units, but in dollars. The correct formula for calculating the margin of safety is:

Margin of Safety = (Actual or Projected Sales - Break-Even Sales) / Actual or Projected Sales

Substituting the given values in the formula:

Margin of Safety = (3,000,000 - 2,500,000) / 3,000,000
Margin of Safety = 0.1667 or 16.67%

Therefore, the statement is false.

Question 20

Companies with large amounts of fixed costs will generally have a high operating leverage.

Accepted Answer

This statement is true because fixed costs, such as rent or equipment, do not vary with changes in production or sales volume. Therefore, as sales increase, the percentage increase in profits will be larger for companies with high fixed costs, leading to a higher operating leverage. On the other hand, companies with high variable costs will have a lower operating leverage because profits will increase proportionally with sales.

Quiz 21: Cost Behavior and Cost-Volume-Profit Analysis