Cvp Analysis
QUESTION
a). Name five assumptions that underline the use of break – even analysis.
It is essential that anyone preparing or interpreting CVP information is aware of the underlying assumptions on which the information has been prepared. If these assumptions are not recognized, serious errors may result and incorrect conclusions may be drawn from the analysis.(Drury, 2004).
Breakeven analysis (cost-volume-profit analysis) is an approach to profit planning that requires derivation of various relationships among revenue, fixed costs, and variable costs in order to determine units of production or volume of sales at which firm “breaks even” (where total revenues equal total of fixed and variable costs). The analysis is built on various assumptions.
Below is a brief explanation of five assumptions underlying the use of break-even analysis or the CVP analysis.
1. All other variables remain constant.
It is assumed that all variables other than the particular one under consideration remain constant throughout the analysis. In other words, it is assumed that volume is the only factor that will cause costs and revenues to change. However, changes in other variables such as production efficiency, sales mix, price levels and production methods can have an important influence on sales revenue and costs. If significant changes in these other variables occur the CVP analysis presentation is incorrect.(Drury, 2004). Changes in the levels of revenues and costs arise only because of changes in the number of product (or service) units sold. The number of units sold is the only revenue driver and the only cost driver. Just as a cost driver is any factor that affects costs, a revenue driver is a variable, such as volume, that casually affects revenues.(Horngren & etal, 2009).
2. Single product or constant sales mix.
CVP analysis assumes that either a single product is sold or, if a range of products is sold, that sales will be in accordance with a predetermined sales mix.
a). Name five assumptions that underline the use of break – even analysis.
It is essential that anyone preparing or interpreting CVP information is aware of the underlying assumptions on which the information has been prepared. If these assumptions are not recognized, serious errors may result and incorrect conclusions may be drawn from the analysis.(Drury, 2004).
Breakeven analysis (cost-volume-profit analysis) is an approach to profit planning that requires derivation of various relationships among revenue, fixed costs, and variable costs in order to determine units of production or volume of sales at which firm “breaks even” (where total revenues equal total of fixed and variable costs). The analysis is built on various assumptions.
Below is a brief explanation of five assumptions underlying the use of break-even analysis or the CVP analysis.
1. All other variables remain constant.
It is assumed that all variables other than the particular one under consideration remain constant throughout the analysis. In other words, it is assumed that volume is the only factor that will cause costs and revenues to change. However, changes in other variables such as production efficiency, sales mix, price levels and production methods can have an important influence on sales revenue and costs. If significant changes in these other variables occur the CVP analysis presentation is incorrect.(Drury, 2004). Changes in the levels of revenues and costs arise only because of changes in the number of product (or service) units sold. The number of units sold is the only revenue driver and the only cost driver. Just as a cost driver is any factor that affects costs, a revenue driver is a variable, such as volume, that casually affects revenues.(Horngren & etal, 2009).
2. Single product or constant sales mix.
CVP analysis assumes that either a single product is sold or, if a range of products is sold, that sales will be in accordance with a predetermined sales mix.
References: Drury, C. (2004). Management and Cost accounting (6th ed.). High Holborn House, 50-51 Bedford Row,London WC1R4LR: Thomson Learning. Horngren, C., T., & etal. (2009). Cost Accounting: A Managerial Emphasis (13th ed.). Upper Saddle River,New Jersey: Pearson Education, Inc.