Cost Accounting

Assumptions and Limitations of CVP Analysis

As with all methods of analysis, CVP analysis relies on certain assumptions and these assumptions might limit the applicability of the results for decision making. It is important to understand, however, that the limitations are due to the assumptions that the cost analyst makes; that is, they are not inherent limitations to the method of CVP analysis itself.

For example, many people point to the assumptions of constant unit variable cost and constant unit prices for all levels of volume as important limitations of CVP analysis. However, these assumptions are simplifying assumptions that are made by the analyst. If we know that unit prices are lower for higher volumes, we can incorporate that relation into the CVP analysis. The result will be a more complicated relation among costs, volumes, and profits than we have worked with here and the breakeven and target volume formulas will not be as simple as those we have derived. But with
analysis tools such as Microsoft Excel we can model the more complicated relations and fi nd the break-even point (or points) if they exist.

The lesson from this is that CVP analysis is a tool that the manager can use to help with decisions. The more important the decision, the more the manager will want to ensure that the assumptions made are applicable. In addition, if the decisions are sensitive to the assumptions made (for example, those prices do not depend on volume), the manager should be cautious about depending on CVP analysis without considering alternative assumptions.

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