Question

Back to cost behavior and how we can use it to perform Cost-Volume-Profit analysis. What are...

Back to cost behavior and how we can use it to perform Cost-Volume-Profit analysis. What are the primary underlying assumptions in C-V-P?

Homework Answers

Answer #1

Cost-volume-profit analysis (CVP analysis) helps a business in planning and decision-making.

It provides information regarding changes in profits and costs brought about by changes in volume or level of activity.

The CVP analysis is subject to the following limiting assumptions.

Costs are classified into variable or fixed

All costs are presumed to be classified as either variable or fixed. In the real business environment however, costs behave differently. Users of CVP analysis need to be able to identify variable costs from fixed costs, and vice versa. Also, different methods are used to segregate mixed costs into purely variable and purely fixed.

Variable costs per unit are constant. Total variable cost changes directly with the volume of activity. On the other hand, total fixed costs remain constant regardless of the level of activity.

Linear relationship within a relevant range

Cost and revenue relationships are linear within a relevant range of activity and over a specified period of time.

Say for example, the fixed costs from 1 to 100,000 units might be different from the fixed costs at 100,001 and above. Variable costs may also be different. Hence, we assume that we are working within one relevant range for which the behavior of fixed and variable costs are applicable.

Inventory level does not change from period to period

It is assumed that all units produced are sold during the period; hence, there is no change in beginning and ending inventory levels.

Volume is the only factor affecting variable costs

As volume (or level of activity) increases, the total variable cost increases directly with the change in volume. If the variable cost per unit is, say $5 per unit, the total variable costs would be equal to $5 multiplied by the number of units produced. It is important to take note that volume is the only factor affecting total variable costs. The variable cost per unit is assumed to be constant. Productivity and efficiency concerns are likewise ignored (assumed constant).

Selling price is constant

The selling price and market conditions are constant. Also, if the business produces and sells multiple products, the sales mix is assumed constant.

Know the answer?
Your Answer:

Post as a guest

Your Name:

What's your source?

Earn Coins

Coins can be redeemed for fabulous gifts.

Not the answer you're looking for?
Ask your own homework help question
Similar Questions
What is the underlying assumption for cost-volume-profit analysis?         A.   Revenues and costs behave in a...
What is the underlying assumption for cost-volume-profit analysis?         A.   Revenues and costs behave in a linear manner         B. Costs can be categorized as variable, fixed, or semi-variable         C.   Worker efficiency and productivity remain constant         D.   All of these are assumptions that underlie cost-volume-profit analysis
Cost-Volume-Profit Analysis: Analyze cost behavior in relation to changes in volume. Define contribution margin and its...
Cost-Volume-Profit Analysis: Analyze cost behavior in relation to changes in volume. Define contribution margin and its use in computing operating income. Discuss cost-volume-profit (CVP) analysis and how it is used as a decision tool.
What assumptions are inherent in cost-volume-profit analysis? Since these assumptions are usually not wholly valid, why...
What assumptions are inherent in cost-volume-profit analysis? Since these assumptions are usually not wholly valid, why do managers still use the analysis in decision making?
Cost-volume-profit (CVP) analysis is a planning tool that examines the relationship among costs and how they...
Cost-volume-profit (CVP) analysis is a planning tool that examines the relationship among costs and how they affect profits or losses. Cost-volume-profit analysis is also referred to as cost-volume-price analysis because changes in sales prices also affect profits or losses. The CVP assumptions are: The price per unit does not change as volume changes. Managers can classify costs as variable, fixed, or mixed. The only factor that affects total costs is change in volume, which increases or decreases variable and mixed...
How would you describe the cost-volume-profit analysis and its use in managerial planning?
How would you describe the cost-volume-profit analysis and its use in managerial planning?
Why is it necessary for companies to use Cost Volume Profit Analysis?
Why is it necessary for companies to use Cost Volume Profit Analysis?
Briefly explain the key assumptions underlie cost-volume-profit analysis.
Briefly explain the key assumptions underlie cost-volume-profit analysis.
What are several applications of cost-volume-profit analysis?
What are several applications of cost-volume-profit analysis?
Why do we do variance analysis? What can we do with the variance analysis we perform?
Why do we do variance analysis? What can we do with the variance analysis we perform?
In a cost-volume-profit (C-V-P model) analysis the graph is frequently used in business meetings because it...
In a cost-volume-profit (C-V-P model) analysis the graph is frequently used in business meetings because it presents a picture of cost relationships within a company. Required: 1. Briefly describe the type of information and data that you would need in order to prepare a CVP graph (construct a CVP graph for illustration).    2. How to interpret the breakeven point using graph analysis.