Following are the assumptions on which the theory of CVP is based:
1. The changes in the level of various revenue and costs arise only because of the changes in the number of product (or service) units produced and sold, e.g., the number of television sets produced and sold by Sigma Corporation. The number of output (units) to be sold is the only revenue and cost driver. Just as a cost driver is any factor that affects costs, a revenue driver is any factor that affects revenue.
2. Total costs can be divided into a fixed component and a component that is variable with respect to the level of output. Variable costs include the following:
o Direct materials
o Direct labor
o Direct chargeable expenses
Variable overheads include the following:
o Variable part of factory overheads
o Administration overheads
o Selling and distribution overheads
3. There is linear relationship between revenue and cost.
4. When put in a graph, the behavior of total revenue and cost is linear (straight line), i.e. Y = mx + C holds good which is the equation of a straight line.
5. The unit selling price, unit variable costs and fixed costs are constant.
6. The theory of CVP is based upon the production of a single product. However, of late, management accountants are functioning to give a theoretical and a practical approach to multiproduct CVP analysis.
7. The analysis either covers a single product or assumes that the sales mix sold in case of multiple products will remain constant as the level of total units sold changes.
8. All revenue and cost can be added and compared without taking into account the time value of money.
9. The theory of CVP is based on the technology that remains constant.
10. The theory of price elasticity is not taken into consideration.
Many companies, and divisions and subdivisions of companies in industries such as airlines, automobiles, chemicals, plastics and semiconductors have found the simple CVP relationships to be helpful in the following areas:
• Strategic and longrange planning decisions
• Decisions about product features and pricing
In real world, simple assumptions described above may not hold good. The theory of CVP can be tailored for individual industries depending upon the nature and peculiarities of the same.
For example, predicting total revenue and total cost may require multiple revenue drivers and multiple cost drivers. Some of the multiple revenue drivers are as follows:
• Number of output units
• Number of customer visits made for sales
• Number of advertisements placed
Some of the multiple cost drivers are as follows:
• Number of units produced
• Number of batches in which units are produced
Managers and management accountants, however, should always assess whether the simplified CVP relationships generate sufficiently accurate information for predictions of how total revenue and total cost would behave. However, one may come across different complex situations to which the theory of CVP would rightly be applicable in order to help managers to take appropriate decisions under different situations.
Blog Archive

▼
2010
(94)

▼
February
(38)
 VARIANCES ANALYSIS PRACTICE QUESTIONS
 Sales mix and quantity variances
 Sales mix and quantity variances
 Materials mix and yield variances
 The significance of variances
 Interdependence between variances
 Reasons for variances
 Selling price variance
 The fixed production overhead variances
 Fixed production overhead variances
 Variable production overhead total variances
 Variable cost variances
 Variance Analysis
 Variance Analysis
 Summery on Break Even Analysis
 Profit Graph
 Profit Graph
 Breakeven Point in Sales Revenue
 Multiple Product Situations
 Multiple Product Situations
 Limitations and Uses of Breakeven Charts
 Uses of Breakeven Chart
 Construction of a Breakeven Chart
 Breakeven Analysis Graphical Presentation
 Problems Related with Break Even Analysis
 Marginal Cost Equations and Breakeven Analysis
 Sensitivity Analysis or What If Analysis and Uncer...
 Chartered Certified Accountant (ACCA)  Profession...
 What is ACCA ?
 Sensitivity Analysis or What If Analysis and Uncer...
 Limitations of CostVolume Profit Analysis
 Limitations of CostVolume Profit Analysis
 Assumptions and Terminology of CVP
 Objectives of CostVolumeProfit Analysis
 CostVolumeProfit (CVP) Relationship
 MARGINAL COSTS, CONTRIBUTION AND PROFIT
 Chapter 3 – Breakeven Analysis

▼
February
(38)
Friday, February 12, 2010
Assumptions and Terminology of CVP
Labels:
ACCA,
accounting,
Assumptions and Terminology of CVP,
Breakeven Analysis,
CAAT,
Tips,
Tutorials
Reactions: 
Subscribe to:
Post Comments (Atom)
No comments:
Post a Comment