Page 82 - Microsoft Word - 00 Prelims.docx
P. 82
Chapter 3
Limitations of breakeven analysis
The following underlying assumptions will limit the precision and reliability of a given
cost-volume-profit analysis.
The behaviour of total cost and total revenue has been reliably determined and
is linear over the relevant range.
All costs can be divided into fixed and variable elements.
Total fixed costs remain constant over the relevant volume range of the CVP
analysis.
Total variable costs are directly proportional to volume over the relevant range.
Selling prices are to be unchanged.
Prices of the factors of production are to be unchanged (for example, material,
prices, wage rates).
Efficiency and productivity are to be unchanged.
The analysis either covers a single product or assumes that a given sales mix
will be maintained as total volume changes.
Revenue and costs are being compared on a single activity basis (for example,
units produced and sold or sales value of production).
Perhaps the most basic assumption of all is that volume is the only relevant
factor affecting cost. Of course, other factors also affect costs and sales.
Ordinary cost-volume-profit analysis is a crude oversimplification when these
factors are unjustifiably ignored.
The volume of production equals the volume of sales, or changes in beginning
and ending inventory levels are insignificant in amount.
76
