Sensitivity Analysis or What If Analysis and Uncertainty
Sensitivity analysis is relatively a new term in management accounting. It is a “what if” technique that managers use to examine how a result will change if the original predicted data are not achieved or if an underlying assumption changes.
In the context of CVP analysis, sensitivity analysis answers the following questions:
a. What will be the operating income if units sold decrease by 15% from original prediction?
b. What will be the operating income if variable cost per unit increases by 20%?
The sensitivity of operating income to various possible outcomes broadens the perspective of management regarding what might actually occur before making cost commitments.
A spreadsheet can be used to conduct CVPbased sensitivity analysis in a systematic and efficient way. With the help of a spreadsheet, this analysis can be easily conducted to examine the effect and interaction of changes in selling prices, variable cost per unit, fixed costs and target operating incomes.
Example
Following is the spreadsheet of ABC Ltd.,
Statement showing CVP Analysis for Dolphy Software Ltd.
Revenue required at $. 200 Selling Price per unit to earn Operating Income of
Fixed cost Variable cost
per unit 0 1,000 1,500 2,000
2,000 100 4,000 6,000 7,000 8,000
120 5,000 7,500 8,750 10,000
140 6,667 10,000 11,667 13,333
2,500 100 5,000 7,000 8,000 9,000
120 6,250 8,750 10,000 11,250
140 8,333 11,667 13,333 15,000
3,000 100 6,000 8,000 9,000 10,000
120 7,500 10,000 11,250 12,500
140 10,000 13,333 15,000 16,667
From the above example, one can immediately see the revenue that needs to be generated to reach a particular operating income level, given alternative levels of fixed costs and variable costs per unit. For example, revenue of $. 6,000 (30 units @ $. 200 each) is required to earn an operating income of $. 1,000 if fixed cost is $. 2,000 and variable cost per unit is $. 100. You can also use exhibit 34 to assess what revenue the company needs to breakeven (earn operating income of Re. 0) if, for example, one of the following changes takes place:
• The booth rental at the ABC convention raises to $. 3,000 (thus increasing fixed cost to $. 3,000)
• The software suppliers raise their price to $. 140 per unit (thus increasing variable costs to $. 140)
An aspect of sensitivity analysis is the margin of safety which is the amount of budgeted revenue over and above breakeven revenue. The margin of safety is sales quantity minus breakeven quantity. It is expressed in units. The margin of safety answers the “what if” questions, e.g., if budgeted revenue are above breakeven and start dropping, how far can they fall below budget before the breakeven point is reached? Such a fall could be due to competitor’s better product, poorly executed marketing programs and so on.
Assume you have fixed cost of $. 2,000, selling price of $. 200 and variable cost per unit of $. 120. For 40 units sold, the budgeted point from this set of assumptions is 25 units ($. 2,000 ÷ $. 80) or $. 5,000 ($. 200 x 25). Hence, the margin of safety is $. 3,000 ($. 8,000 – 5,000) or 15 (40 –25) units.
Sensitivity analysis is an approach to recognizing uncertainty, i.e. the possibility that an actual amount will deviate from an expected amount.
Blog Archive

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2010
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February
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 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

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