SEC C – DECISION ANALYSIS.

1. Cost/volume/profit analysis data can be used in a wide variety of decision-making situations such as raising or
lowering existing prices, introducing a new product or service, setting prices for new products and services,
expanding product and service markets, deciding whether to replace an existing piece of equipment, and deciding
whether to make or buy a product or service.
2. The CVP model assumes that total revenues and total costs are linear within a relevant range of activity level. Stated
another way, within a limited range of output, total costs are expected to increase at an approximately linear rate.
3. CVP analysis is most useful when certain assumptions of the model hold true. However, “changes in activity and
other factors affect costs” is not one of the underlying assumptions. 
4. The relevant range refers to the activity levels over which cost relationships hold constant.
5. activity level refers to the number of units produced or the number of units sold. Activity level nomenclature can
vary across industries. Instead of units, airlines use passenger miles, hospitals may use patient days or beds
occupied, hotels use rooms occupied, and colleges and universities use student credit hours.
6. Cost behavior patterns refer to how fixed and variable costs react to changes in business activity levels. For fixed
costs, the total costs remain constant within the relevant range of activity while the unit cost increases or decreases
with changes in activity.
7. The contribution margin ratio is calculated by dividing the contribution margin by sales (or alternatively by dividing
the contribution margin per unit by the sales price per unit). Normally stated as a percentage, this ratio represents
the portion of each sales dollar available to first cover fixed costs and then to add to the profits of the company. For
example, a company with a contribution margin ratio of 30% would generate $0.30 of every $1.00 in sales to first
cover fixed costs and then to add to profits. 
8. An increase in direct labor cost (a variable cost) would decrease the contribution margin (Selling Price − Variable
Costs) and result in an increase in the breakeven point (Fixed Cost ÷ Contribution Margin).
9. Margin of safety is the excess of actual or budgeted sales over sales at the breakeven point. It is the amount by
which sales could decrease before a loss occurs. An increase in the breakeven point, resulting from an increase in
direct labor cost, would cause a decrease in margin of safety.
10. breakeven pricing is used to establish a frame of reference; it is not a stand-alone method for setting a price.
Breakeven pricing determines the number of units that must be sold at a set price to cover all fixed and variable
costs. Once the breakeven value is known, a firm can assess the feasibility of exceeding the breakeven price and
generating a profit.
11. Sensitivity analysis can be used to assess how an analysis will change (for example, how the breakeven point
changes) when one or more inputs are different from their expected values. Since changing the income tax rate does
not impact the breakeven point (since no taxes are due at the breakeven point), sensitivity analysis cannot be used to
assess the size of the change in units needed to break even.
12. Unit costs can increase by either an increase in unit variable costs or an increase in the level of fixed costs.
13. Increased unit variable costs decrease the unit contribution margin (price less unit variable costs), which decreases
the denominator and raises the breakeven in units [BE = (Fixed Costs) ÷ (Unit Contribution Margin)].An increase in
the level of fixed costs increases the numerator of the breakeven formula, which increases the breakeven in units.
This is true even when the unit contribution margin remains consistent.
14. Short-run profit maximization involves the maximization of total contribution margin per unit of capacity times the
capacity utilized. In this case, capacity is determined by the available machine hours.
15. When analyzing multiple products, the number of units for a breakeven point does not depend on the fixed and
variable costs and total sales. There is no unique number of units for a breakeven point, as the number depends on
the sales mix. A shift from low-margin items to high-margin items can cause the breakeven point in units to
decrease and operating income to rise, for example.
16. Contribution margin measures the amount of revenue remaining to contribute to covering fixed costs and income
after paying variable costs. Companies that sell multiple products have products that have higher contribution
margins and products that have lower contribution margins. These companies can calculate a weighted-average (or
composite) contribution margin. This is based on the individual contribution margins and the sales mix. The sales
mix measures what percentage of total units sold each product makes up. If more high contribution margin units are
sold than low contribution margin units are sold, the weighted-average contribution margin will be higher than if
fewer high contribution margin units are sold. This means more profit will be generated from each sale, resulting in
 higher contribution margin as more total units are sold. Since fixed costs do not change when more units are sold, a
greater contribution margin results in greater net profit.
17. As the sales mix shifts towards a product with a lower contribution margin, operating income will decrease if the
total number of units sold remains constant.
18. An increase in direct labor cost (a variable cost) would decrease the contribution margin (Selling Price − Variable
Costs) and result in an increase in the breakeven point (Fixed Cost ÷ Contribution Margin).
19. Margin of safety is the excess of actual or budgeted sales over sales at the breakeven point. It is the amount by
which sales could decrease before a loss occurs. An increase in the breakeven point, resulting from an increase in
direct labor cost, would cause a decrease in margin of safety.
20. The margin of safety is defined as the difference between budgeted or actual sales and breakeven sales. It can be
stated in total dollars or as a percentage of budgeted or actual sales. It measures the amount that sales can drop with
the company still being able to break even. A company with a higher margin of safety can afford to lose more
business before experiencing financial difficulties when compared to a company with a lower margin of safety.
21.  2C3-CQ05 2C1-AT03 2C1-AT04  2C1-AT02 2C1-AT01
22. Market-based pricing allows firms little latitude in setting prices above or below the market rate. Through market-
based pricing, a firm considers what customers expect and want, determines the intensity of competitive rivalries,
and anticipates how customers and competitors will react to its pricing.
23. Several factors influence how a firm sets a price for its products. These factors are generally categorized as internal
or external. Service costs are an example of an internal factor.
24. Several factors influence how a firm sets a price for its products. These factors are generally categorized as internal
or external. Distribution channels are an example of an external factor.
25. Cost-plus pricing involves setting the price of a product so as to earn a set markup percentage on sales. The cost-
plus pricing approach is expressed using the following formula:(Unit Cost) × (1 + Markup % on unit cost) = Selling
Price.Another version of the formula, which results in the same answers, is Unit Cost + (Markup % on Unit Cost ×
Unit Cost) = Selling Price.
26. In cost-plus pricing, a company determines its selling prices by figuring out the cost to provide and deliver a good
or service and then adds a markup to the cost to cover desired profitability. In target costing, a company starts with
the price customers are willing to pay for a good or service. It then subtracts its desired profit to determine the
maximum amount it can cost to deliver the product or service and still attain the desired profitability. This
determines whether the company can offer the product or service at a certain price.
27. In market-based pricing, companies make decisions about product and service features as well as pricing decisions
based on anticipated customer and competitor reactions. Minimal competition lends itself to cost-based pricing.
28. When using value added pricing a firm sets a price for its product or service based on unique characteristics that it
thinks consumers value and for which they are willing to pay a premium price. Differentiation can come from a
variety of factors, such as product features, service, and quality.
29. Cost-based pricing is appropriate for relatively unique products. The other choices deal with relatively standard
products.
30. Value-based pricing, sometimes referred to as customer-focused pricing, is setting the price of a product or service
based on what the price setter believes regarding the customer's perceived value of the product.
31. Companies that manufacture made-to-order industrial equipment typically use cost-based pricing. The cost-based
pricing (or cost-plus pricing) approach looks at the costs to develop a product or service and sets a price to recoup
those costs and make a desired profit. Cost-based pricing is appropriate when some level of product or service
differentiation exists and a company can exercise modest discretion in setting prices.
32. The challenge of cost-based pricing is accurately accounting for all the costs that should be allocated to products or
services. Firms have a tendency to overlook legitimate items (e.g., research costs, customer goodwill, and overhead
expenses) that should be factored into the cost calculation.
33. The advantages of incorporating full product costs in pricing decisions include all the following: full product cost
recovery, the promotion of price stability, a pricing formula that meets the cost-benefit test. It is difficult
and/or arbitrary to attach fixed costs to individual products.
34.  allowable cost is the difference between the target price and the target profit. In effect, the allowable cost represents
the maximum cost that a firm can commit to a product to achieve the company's profit objective.
35. Traditional pricing is based on the idea that price equals cost plus profit margin. Target costing offers a
fundamentally different way to look at the relationship of price and costs. The underlying concept of target costing
is that cost equals competitive price minus profit margin.
36. In target costing, the target price represents the maximum allowable price that can be charged for the product or
service. The target price is an estimate of the amount that potential customers would be willing to pay based on their
value perceptions. A target price also reflects the firm's understanding of the market competition. In the final
outcome, a target price should result in an acceptable price to customers as well as an acceptable return to the
organization.
37. By definition, the cost-based pricing (or cost-plus pricing) approach looks at the costs to develop a product or
service and sets a price to recoup those costs and make a desired profit. Cost-based pricing is appropriate when
some level of product or service differentiation exists and a company can exercise modest discretion in setting
prices.
38.
39. In target costing, a company starts with the price customers are willing to pay for a good or service. It then subtracts
its desired profit to determine the maximum amount it can cost to deliver the product or service and still attain the
desired profitability. This maximum amount is called the target cost. This means the target cost is the difference
between the market price of a product and a company’s desired profit.
40. Target costing involves determining the allowable cost of a product given its selling price and potential volume. The
target costing process focuses on all of the elements in the firm's value chain, not just on the production piece.
41. The cross-functional participation of research and design, engineering, production, marketing, and accounting are
necessary to ensure that the proposed product or service when sold generates the desired profit margin. Stated
another way, the cross-functional team is given the responsibility to design and develop the product or service so
that it can be made for the target cost.
42. By definition, the target rate of return on investment is the target operating income a firm must earn divided by its
invested capital. Companies often specify a target rate of return on investments.
43. Firms use value engineering to close the gap between current cost and allowable cost. A prime way to reduce costs
without eliminating valuable features is to reduce or eliminate non-value-adding costs. Differentiating between
value-added costs and non-value-adding costs facilitates this process .
44. Price skimming sets a high price to primarily target high-end and less price-sensitive customers while maximizing
short-term profits. This strategy will work because the business is in a low-competition market. 
45. Target costing and restarting the product in a new market would be a rational pricing strategy as a product moves
into the decline stage of its lifecycle. 
46. Once target cost objectives are set, achieving them involves the formation of cross-functional teams; the
implementation of quality practices such as concurrent engineering, value engineering, and quality function
deployment; and cost reductions through kaizen and life-cycle costing. A target price is established early based on
market needs and competition.
47. Any firm will maximize profits if it produces an output where marginal cost is equal to marginal revenue and
marginal cost is rising.
48. Product profitability does not consistently increase over a product’s life cycle. It tends to increase from market
introduction to growth, peaking at maturity. However, it decreases in the saturation and decline phase.
49. The progression of PLC classifications is: embryonic, growth, shakeout, maturity, and decline. Shakeout occurs
when the level of customer sophistication increases due to exposure and first-hand use of a new product. Suppliers
and customers concentrate around market leaders, forcing marginal players to drop out of the market.
50. Peak load pricing involves charging more or less for a product based on demand and physical capacity limits. Prices
are different for different market segments even though the costs in the different segments are similar.
51. The PLC model can be used in international markets with adaptation. Globalization presents additional dimensions
and many different opportunities and threats. The life cycle stages, for example, may differ depending on the
country. An industry may be in rapid growth in one country while declining in other countries. The leap-frogging of
technologies in some countries may increase the complexity of the PLC's use.
52. Price elasticity of demand measures the sensitivity of the quantity demanded to a change in price. The basic formula
is “percent change in quantity demanded ÷ percent change in price.” Values above 1 indicate elastic demand, which
means that the percent change in quantity demanded is larger than the percent change in price. This means that
decreasing the price of a product with an elastic demand will increase total revenue since the percentage increase in
quantity demanded will more than offset the smaller percentage decrease in price.
53. Price elasticity of demand measures the sensitivity of the quantity demanded to a change in price. The basic
formula is “percent change in quantity demanded ÷ percent change in price.” The midpoint formula
 estimates the percent change in quantity demanded as “change in quantity demanded ÷ average quantity
demanded.” The percent change in price is estimated in a similar way. 
54. The cross elasticity is calculated as - % Change in QTY demanded ÷ (divided) % change in price.
55. Price elasticity (E) is the percent change in a product's quantity demanded given a percent change in the
product's price. Elastic demand occurs when the percent change in demand is greater than the percent
change in price (E>1).
56. Unit elastic demand means the percent change in price is exactly the same as the percent change in quantity
demanded.
57. Cartels occur when there are relatively few sellers as it would be more difficult to get a higher number of sellers to
cooperate to lower competition and increase prices. Industries with relatively few sellers are called oligopolistic
industries.( Oligopolies are industries with only a few large firms. Because there are so few firms in an oligopoly,
each firm’s pricing decisions are dependent on the prices charged by other firms in the industry.)
58. The elasticity of demand for a product is a measure of the change in demand for the product given a change in price,
a change in consumer income, or a change in the prices of substitute or complementary products. The elasticity of
demand increases with the number of substitutes available.
59. A perfectly inelastic demand means that demand does not change as a result of a price change. A line of
perfect inelasticity is vertical. Necessary items, such as health supplies, will show perfectly inelastic demand.
60. A relatively inelastic demand means that a percentage change in price will result in a smaller percentage
change in quantity demanded. It is shown by a steep demand curve, which is not quite perfectly vertical.
61. Price elasticity is the percent change in quantity demanded given a percent change in price. When the
demand for a product is price inelastic, a change in price will not affect the demand for the product.
Therefore, a price increase will result in increased product revenue and operating profits.
62. In a purely competitive market, sellers have no power to dictate prices. Prices are determined solely by the
interaction of supply and demand. The short-run equilibrium price is equal to average revenue, marginal revenue,
and marginal cost.
63. Profit maximizing prices based on marginal revenue equaling marginal cost are features of pure competition,
monopolistic competition, and monopoly markets.
64. In the short-run, certain costs will be incurred whether or not a product is sold. These costs are not relevant to the
pricing decision and therefore can be excluded from the decision. 
65. At the long-run profit maximizing equilibrium of a firm in a perfectly competitive market, price equals marginal
cost, price equals average total cost, and marginal cost equals marginal revenue and economic profit is zero.
66. In a monopolistic competition environment, profit is maximized when marginal revenue equals marginal cost.
Because products are somewhat unique between sellers, it is not necessary for the price to also be the same as
average total cost, like it is under pure competition.
67. Elasticity of resources is affected by the following.
Rate of decline in rate of marginal product: Rapid decline in marginal product indicates less elasticity in resource
demand.
Ease of resource substitution: A large number of substitutes makes the demand for the resource more elastic.
Elasticity of product demand: Demand for resources is a derived demand. If the demand for the product the
resource produces is elastic, the demand for the resource will also be elastic.
Resource cost/total cost ratio: The lower the proportion of total production costs the resource represents, the
lower its elasticity of demand.
68. A quantity demanded is said to be relatively elastic when the change in the amount people buy is greater than
the change in price, either higher or lower; a price change will cause an even larger change in quantity
demanded.
69. Companies selling an undifferentiated product similar to the products others are selling are known as price takers
because they have little influence on the price they receive for their products. They “take” the price the market pays.
Companies selling a unique product are known as price setters because the unique nature of their product allows
them to dictate the price buyers are going to pay. They “set” the price to be paid. 
70. Firms often take costs into consideration when setting prices. In the short-run, certain costs will be incurred whether
or not a product is sold. These costs are not relevant to the pricing decision and therefore can be excluded from the
decision. On the other hand, all costs need to be taken into consideration in long-run pricing decisions since costs
can be changed in the long run based on whether or not a product is sold.
71. A cartel is a formal agreement among firms in an oligopolistic industry. Cartel members may agree on such matters
as prices, total industry output, market shares, allocation of customers, allocation of territories, bid-rigging,
establishment of common sales agencies, and the division of profits or combination of these.(Eg:Members of a
cartel work together to lower competition, which allows them to charge higher prices and increase profits.
72. Sunk costs are unchanged by the decision, and are never relevant. Typically, these are past costs made prior to the
decision. However, sunk costs are not always in the past. Future costs can also be “sunk” if these costs are
unavoidable and unchanged by the decision. For example, costs committed to be paid due to a contract signed for
some old equipment are sunk costs, even if the old equipment is replaced by new equipment.
73. Marginal product is the increase in the total number of products with the addition of the last unit of resource (in this
case, workers). Average product is total product divided by the number of workers.
74. When evaluating a make-or-buy decision, a company compares the relevant cost to make the product to the amount
the company will pay to buy it. The relevant cost to make the product are the costs that will be avoided if the
product is made.
75. To assess a sell-or-process-further scenario, it is necessary to compare the incremental revenue received from
processing further to the incremental costs incurred while processing further. The joint costs are not relevant to the
analysis. Costs incurred prior to the split-off point are not relevant to this decision because they are incurred
whether the product is sold or processed further. Costs incurred after the split-off point are relevant because they are
only incurred if the product is sold.
76. When deciding whether to eliminate a division or product, companies need to compare the revenue lost if the
division or product is eliminated to the costs avoided if the division or product is eliminated.
77. If there is excess capacity (more than enough to cover the order), a firm needs to identify variable costs associated
with the special order that are not normally incurred. Such variable costs are relevant costs and determine the
minimum acceptable (breakeven) price. If the price offered for the special order is greater than the unit cost, the
order is profitable and should be accepted.
78. In order to avoid pitfalls in relevant-cost analysis, management should focus on anticipated revenues and costs that
differ for each alternative
79. The costs to be considered in the special order acceptance decision are the avoidable and opportunity costs
associated with the order. They are variable costs of the product, avoidable direct fixed costs associated with the
order, and opportunity cost of the temporarily idle capacity. Fixed costs are unavoidable and irrelevant.
80. an avoidable cost (or escapable cost) is one that can be eliminated in whole or in part by choosing one alternative
over another in the decision-making process. An avoidable cost might be eliminated by ceasing to perform an
activity or by improving the efficiency of the activity.
81. The relevant costs in a make-versus-buy decision are the opportunity costs to manufacture the product. The
opportunity cost per unit consists of avoidable variable and avoidable fixed costs per unit and the unit cost of any
lost opportunities.
82.  a relevant cost is a cost yet to be incurred; it is a future cost. A relevant cost is different for each option available to
the decision maker. Costs that have already been incurred or committed are irrelevant in decision making because
there is no longer any discretion associated with them.
83. A differential cost is by definition a cost that differs for each decision alternative. Thus, a decision maker considers
only differential costs in the decision-making process; the costs that do not change among alternative courses of
action are considered irrelevant for the decision.
84. Absorption costs include an allocation of fixed costs as well as the relevant variable costs. Fixed costs will not
change with the acceptance or rejection of the special order and are not relevant to the decision.
85. cost traceability refers to the ability to assign a cost to a cost object in an economically feasible way by means of a
cause-and-effect relationship. Direct costs are easily traced; indirect costs are not easily and accurately traced. Firms
need to trace costs directly to cost objects and/or business segments during decision making when it is feasible to do
so.
86. Costs that are set by management decision or budget are called discretionary costs. Management may choose to
incur or to not incur these costs. Advertising and promotion may be set or budgeted as management desires.
87. Marginal analysis (also known as incremental analysis or differential analysis) is a method of analyzing decision
problems that emphasizes incremental cost increases or decreases rather than total costs and benefits associated with
an action (or set of alternative actions).
88. In a purely competitive market, the individual firm is the price taker. 
89. The terminology “make versus buy” refers to outsourcing. Reaching a decision about whether to make or buy
generally involves a comparison of the relevant costs to make the item internally with the cost to purchase
externally. In some situations, opportunity costs and qualitative factors also need to be considered.
90. The firm's short-run goal is to maximize profit. Maximizing short-run profit is equivalent to maximizing
contribution margin per unit of the constraining factor. The constraining factor here is capacity. The firm maximizes
profit by producing the products with the highest contribution per unit of capacity.
91. By definition, differential revenue is the difference in revenue between any two alternatives. The change in revenue
may be in amount or timing.
92. A firm should produce and sell a product if the price multiplied by the number of units sold is at least equal to its
cost. The product's cost is its opportunity cost. The opportunity cost consists of avoidable variable and avoidable
fixed costs incurred by producing and selling the product, plus any cash flows foregone by producing and selling the
product. The foregone cash flow is normally the lost contribution margin from some alternative product that cannot
be produced and sold.
93. The relevant make costs in a make-or-buy decision are the opportunity costs to manufacture a product and the costs
of purchasing. The opportunity cost to manufacture a product consists of avoidable variable and avoidable fixed
costs and the cost of any lost opportunities.
94. Marginal cost is the cost of the next unit produced. It is calculated by taking the change in costs between two levels
of output (volume).
95. The consequences of decision alternatives are sometimes categorized as qualitative and quantitative. Quantitative
factors are decision outcomes that can be measured in numerical terms. Quantitative factors are further
differentiated as financial and nonfinancial measures. Nonfinancial measures can be expressed numerically (e.g., a
12% increase) but not in financial terms.