Cvp Analysis

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At the end of this chapter, you should be able to: * Describe the differences between the accountant’s and the economist’s model of cost volume profit analysis. * Apply the cost volume profit approaches in the calculation of breakeven point, margin of safety, target selling price and sales volume. * Construct breakeven, contribution and profit volume graph. * Apply cost volume profit analysis in a multi product setting * Identify and explain the assumptions and limitations of cost volume profit analysis.

CVP Analysis is a method of examining the relationship between changes in activity (i.e. output) and changes in total sales revenue, expenses and
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2. Relevant range

* Between the relevant range point (point X and Y), the shape of accountant’s total cost line is very similar to that of economist’s model. * This is because the total cost line is only intended to provide a good approximation within the relevant range. * Within this range, the accountant assumes variable cost per unit is the same and the total cost line is linear. * For the total revenue line, the accountant assumes the selling price is constant over the relevant range of output. Therefore, total revenue line is a straight line. * Reason for the assumption: 1) Firms operate in industries where selling price tend to be fixed in the short term. 2) Competition may take form of non-price rather than price competition. ASSUMPTIONS OF CVP ANALYSIS 1) All other variables remain constant. * Volume is the only factor that will cause costs and revenues to change. 2) Single product or constant sales mix. * CVP assumes either single product is sold, or multi products are sold. * For multi products, sales mix is calculated based on sales volume. 3) Total costs and total revenues are linear functions of output. * CVP assumes variable cost per unit and selling price per unit is constant. 4) Profits are calculated on a variable costing basis. * Fixed costs incurred are charged as an expense for that period. 5) Analysis

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