Cost Behavior and the Relationship to the Budgeting Process
Management is always faced with uncertainty about the future. Unless managers can forecast cost and revenue trends reasonably well, their decisions may yield unfavorable results. Forecasts concerning cost–volume–profit relationships are necessary to make accurate decisions about such matters as how many units should be manufactured, should price be changed, should advertising be increased, or should plant and equipment be expanded.
Cost–volume–profit relationships depend on accurate descriptions of cost behavior. 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.
To be analyzed, all costs must be broken down into their fixed and variable portions. This is essential in determining what a cost will be at a certain point (usually defined as production or sales volume). Otherwise, management will not be able to regulate the costs properly, which is vital for efficient budgeting or for making any plans or decisions. Various alternatives as to how costs will be allocated may be utilized, and accurate cost estimates should be prepared for each alternative in determining the best decisions.
Costs that remain ...