Cost Volume Profit Analysis
COST-VOLUME PROFIT (CVP) ANALYSIS
This is a technique used for planning short-term run profits by finding the relationship between profits and factors that influence profits. The following factors are taken to be influencing profits:- • Selling price • Variable cost of production • Fixed costs • Activity level (production and sales units)
Profit planning is based on break-even analysis and can be worked out using either; a) Algebraic method b) Contribution method c) Break-even chart.
Accountants Model: Assumptions of Break-even Analysis: a) The selling price will remain constant at all levels of sales units (using marginal costing) b) The fixed costs will not change at whatever level of activity c) The variable costs of production will remain constant for each unit. d) Costs and revenues will follow a linear trend. e) Organizations produce only one type of product or various products at a constant mix. f) The only factor that affects costs and revenue is the production-volume. g) Technology and efficiency methods do not change. h) Production level is equal to sales level i.e. all that is produced is sold hence no changes in stock levels.
Single product is assumed to be produced.
Limitations of Break-Even Analysis (Criticisms)
The limitations arise from the shortcoming of the assumptions given above. a) It is not true that the selling price will always remain constant at all levels of sales because to induce … sales is customary to lower the price. b) The costs of production per unit does not remain constant as at a certain stage, the costs fall per unit due to the learning curve effect and the economies of scale and may raise again later at diseconomies of scale. c) The economies today are dynamic leading to changes in technology of production and yet it has been assumed constant. d) There are fluctuations in production and did leading to changes in stock levels that are assumed to
This is a technique used for planning short-term run profits by finding the relationship between profits and factors that influence profits. The following factors are taken to be influencing profits:- • Selling price • Variable cost of production • Fixed costs • Activity level (production and sales units)
Profit planning is based on break-even analysis and can be worked out using either; a) Algebraic method b) Contribution method c) Break-even chart.
Accountants Model: Assumptions of Break-even Analysis: a) The selling price will remain constant at all levels of sales units (using marginal costing) b) The fixed costs will not change at whatever level of activity c) The variable costs of production will remain constant for each unit. d) Costs and revenues will follow a linear trend. e) Organizations produce only one type of product or various products at a constant mix. f) The only factor that affects costs and revenue is the production-volume. g) Technology and efficiency methods do not change. h) Production level is equal to sales level i.e. all that is produced is sold hence no changes in stock levels.
Single product is assumed to be produced.
Limitations of Break-Even Analysis (Criticisms)
The limitations arise from the shortcoming of the assumptions given above. a) It is not true that the selling price will always remain constant at all levels of sales because to induce … sales is customary to lower the price. b) The costs of production per unit does not remain constant as at a certain stage, the costs fall per unit due to the learning curve effect and the economies of scale and may raise again later at diseconomies of scale. c) The economies today are dynamic leading to changes in technology of production and yet it has been assumed constant. d) There are fluctuations in production and did leading to changes in stock levels that are assumed to
References: proposed reading list ACCA F2 Management Accounting Atkinson et. Al (1997) Management Accounting Collin Drury (1996, 2000, & 2004), Management and Cost Accounting, up to 4th Edition Hongren . T. Charles (1991-2002), Cost Accounting, Dp Publications. M. Arora (1996, 2001), Costing Principles M. W. E. Glautier & B. Underdown (2001), Accounting theory and practice, Financial Times Prentice Hall. N. a Saleemi, (2007) Cost accounting simplified (Revised 2007/08 Edition) T. Lucey (1996), Cost Accounting. DP Publications, Wilson & Chua, (1993), Managerial Accounting, Managerial Accounting, Method and meaning, Hpman Hall