Question

The linearity assumption is:

a) the assumption that total cost depends on activity level.

b)realistic in all costing situations.

c) the assumption that the relationship between fixed costs and variable costs can be approximated by a curved line.

d) the assumption that the relationship between fixed costs and variable costs can be approximated by a straight line.

Answer 1

Answer: Option a) the assumption that total cost depends on activity level.

Linearity indicates that the relationship between two variables is linear or can be approximated with a straight-line. A linear relationship is characterised by a change in one variable causing a specific amount of change in the other.

The linearity assumption is not very realistic in all costing situations and hence option b. is incorrect.

Linearity refers to a straight-line and hence approximating by a curved line is not a linearity assumption due to which option c. is incorrect.

There is no relationship between fixed costs and variable costs that can be approximated by a straight line and hence option d. is incorrect.

Total cost which comprises of the fixed cost and variable cost and is denoted by the cost equation y = a + bx denotes a linear relationship between the total cost ‘y’ and the activity level ‘x’. A change in the activity level would cause a specific change in the total cost. Thus, option a. is the correct answer.