Assumptions of Cost-Volume-Profit (CVP) Analysis

Assumptions of Cost-Volume-Profit (CVP) Analysis:

Learning Objectives:

  1. 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:

  1. Selling price is constant. The price of a product or service will not change as volume changes.
  2. 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.
  3. In multi-product companies, the sales mix is constant.
  4. 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 manager might contemplate increasing the level of sales far beyond what the company has ever experienced before. However, even in these situations a manager can 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.

You may also be interested in other articles from “cost volume profit relationship” chapter

  1. Contribution Margin and Basics of CVP Analysis
  2. Difference Between Gross Margin and Contribution Margin
  3. Cost Volume Profit (CVP) Relationship in Graphic Form
  4. Contribution Margin Ratio (CM Ratio)
  5. Importance of Contribution Margin
  6. Change in fixed cost and sales volume
  7. Change in variable cost and sales volume
  8. Change in fixed cost, sales price and sales volume
  9. Change in variable cost, fixed cost, and sales volume
  10. Change in regular sales price
  11. Break even point analysis (calculation of break-even point by contribution margin and equation method)
  12. Target profit analysis
  13. Margin of safety
  14. Sales Mix and Break Even with Multiple Products
  15. Cost Volume Profit (CVP) Consideration in Choosing a Cost Structure
  16. Operating Leverage and degree of operating leverage
  17. Assumptions of Cost Volume Profit (CVP) Analysis
  18. Limitations of Cost Volume Profit Analysis

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