7) . How should mixed costs be classified in CVP analysis? What approach is used to effect the appropriate classification?
Most of your costs are going to be semi-mixed/semi-variable. You will have to try to segregate the two types of costs, fixed and variable that's really the only way to do it. You have several options in how to separate them - either using your own judgment (i.e., work with management to determine what the cost would be if there would be no manufacturing activity?). The second method would be using statistics. Here, there are several options, like a scatter chart, regression analysis
In CVP (Cost-Volume-Profit) analysis, it is important to properly classify mixed costs, which are costs that contain both fixed and variable components. The appropriate classification helps in understanding the behavior of costs at different levels of production or sales volume.
To classify mixed costs in CVP analysis, two approaches are commonly used:
1. Judgmental Approach: This approach involves the company's management using their knowledge and expertise to determine the fixed and variable components of the mixed costs. They assess the cost behavior by considering factors such as the cost's nature, historical data, industry standards, and their own understanding of the cost components.
For example, if a mixed cost is related to manufacturing activity, the management can estimate the fixed cost component by determining what the cost would be if there was no manufacturing activity. They can use their judgment to assign the remaining cost as the variable component.
2. Statistical Approach: This approach involves using statistical techniques to segregate the fixed and variable components of mixed costs. There are several methods available, including scatter charts and regression analysis.
a. Scatter Charts: Scatter charts plot historical cost data on a graph, with the volume of production or sales on the x-axis and the corresponding cost on the y-axis. By visually analyzing the pattern of the data points, it may be possible to identify a linear relationship between the cost and the volume. The scatter chart can provide insights into the fixed and variable components of the mixed cost.
b. Regression Analysis: Regression analysis is a more sophisticated statistical approach to segregate mixed costs. It allows for a more precise mathematical determination of the fixed and variable components. By using historical data to fit a regression line, the analysis estimates the equation of the line, which identifies the fixed cost component (the intercept) and the variable cost component (the slope).
Both approaches can be used to classify mixed costs in CVP analysis. It's important to note that the accuracy of the classification relies on the quality of the data and the expertise of those involved. Regular review and adjustment of the classifications may be necessary as business circumstances change.