Question

Outline and briefly discuss the assumptions underlying the accountants’ typical PV or break-even analysis and assess whether they limit its usefulness.

Answer 1

PV analysis assumes that unit variable costs and unit revenues are constant, which is appropriate for small deviations from current production and sales and assumes a neat division between fixed costs and variable costs, though in long run all costs are variable.

There are few points required to be kept in mind as the limits have disadvantages rather then usefulness

1. Segregation of total costs into fixed and variable is always a daunting task in large organisation

2. Fixed costs are likely to unlikely to stay constant as output increases beyond a certain range of activity

3. The analysis is restricted to the relevant range specified and beyond that the results can become unreliable

4. It ignores the other factors such as Efficiency, capacity, inflation, technology etc.

5. Also in large organisation it is impractical to assume that sales mix remains constant.