Assumptions of Cost-Volume-Profit (CVP) Analysis:
- What are underlying assumptions of
cost volume profit (CVP) analysis?
A number of assumptions underlie cost-volume-profit (CVP) analysis: These
cost volume profit analysis assumptions are as follows:
Selling price is constant. The price of a
product or service will not change as volume changes.
Costs are linear and can be accurately divided
into variable and fixed elements. The variable element is constant per unit,
and the fixed element is constant in total over the relevant range.
In multi-product companies, the
sales mix is
In manufacturing companies, inventories do not
change. The number of units produced equals the number of units sold.
While some of these assumptions may be violated
in practice, the violations are usually not serious enough to call into
question the basic validity of CVP analysis. For example, in most
multi-product companies, the
sales mix is constant enough so that the result
of CVP analysis are reasonably valid.
Perhaps the greatest danger lies in relying on
simple CVP analysis when a manager is contemplating a large change in volume
that lies outside of the relevant range. For example, a
contemplate increasing the level of sales far beyond what the company has
ever experienced before. However, even in these situations a
adjust the model as we have done in this chapter to take into account
anticipated changes in selling price,
fixed costs, and the
sales mix that
would otherwise violate the cost volume profit assumptions.