CPP Costing and Profitability Analysis 3 — Questions and Answers
Question 1: Which of the following BEST describes the concept of 'economic profit' in pricing decisions?
- Net income after taxes
- Revenue minus total accounting costs
- Revenue minus all explicit and implicit (opportunity) costs (Correct answer)
- Operating income before depreciation
Correct answer: Revenue minus all explicit and implicit (opportunity) costs
Economic profit subtracts both explicit costs and the opportunity cost of capital employed, providing a true measure of value creation.
Question 2: A pricing analyst wants to determine the point at which a new product recovers its development costs over time. This analysis is BEST described as:
- Sensitivity analysis
- Break-even analysis
- Payback period analysis (Correct answer)
- Net present value analysis
Correct answer: Payback period analysis
Payback period analysis calculates how long it takes for cumulative cash inflows to recover the initial investment or development cost.
Question 3: Under the lifecycle costing concept, which phase typically incurs the HIGHEST cumulative costs over the entire product lifecycle?
- Introduction
- Growth
- Maturity
- Use and maintenance by the customer (Correct answer)
Correct answer: Use and maintenance by the customer
Lifecycle costing shows that customer use and maintenance costs often dwarf production and purchase costs over the total ownership period.
Question 4: A company allocates overhead using a plantwide rate based on direct labor hours. An ABC analysis reveals Product X consumes far more machine setups than Product Y. Switching to ABC will MOST likely:
- Decrease Product X's cost and increase Product Y's cost
- Increase Product X's cost and decrease Product Y's cost (Correct answer)
- Leave both products' costs unchanged
- Increase both products' costs proportionally
Correct answer: Increase Product X's cost and decrease Product Y's cost
ABC reveals that high-overhead-consuming products like Product X are undercosted under plantwide rates, while simpler products like Product Y are overcosted.
Question 5: Which of the following is a key limitation of using fully allocated cost as the basis for pricing decisions?
- It ignores variable costs entirely
- It can trigger a death spiral when volume declines raise unit costs (Correct answer)
- It always overstates profitability
- It is not accepted under GAAP
Correct answer: It can trigger a death spiral when volume declines raise unit costs
The cost-plus death spiral occurs when declining volume raises fixed cost per unit, forcing price increases that further reduce volume.
Question 6: A software firm has a 70% gross margin on licenses but only a 15% gross margin on professional services. Which profitability measure would BEST guide the sales force on deal mix?
- Return on equity
- Gross margin by product line (Correct answer)
- EBITDA margin
- Operating leverage ratio
Correct answer: Gross margin by product line
Gross margin by product line directly shows relative profitability of each component, guiding reps to prioritize high-margin license revenue.
Question 7: A manufacturer's fixed costs are $600,000, variable cost per unit is $30, and selling price is $50. How many units must be sold to break even?
- 12,000 units
- 15,000 units
- 20,000 units
- 30,000 units (Correct answer)
Correct answer: 30,000 units
Break-even units = Fixed Costs ÷ Contribution Margin per unit = $600,000 ÷ ($50 − $30) = 30,000 units.
CPP Costing and Profitability Analysis 3
Which of the following BEST describes the concept of 'economic profit' in pricing decisions?