Assumptions and Limitations underlying CVP Analysis

The assumptions imposed by accountants in calculating the C VP ratios also serve as the possible limitations of the technique. Most CVP analyses are based on the concept of static cost.

    1. All costs can be classified into two categories: fixed costs and variable costs. This assumption is not always true because certain costs like depreciation cannot be determined exactly. Different depreciation methods may yield different results. There is a third category of costs known as ‘semi-variable’ costs. These costs are also called mixed costs, because part of the cost is fixed and part is variable (for example, Telephone expenses).
    2. Fixed costs will not change at all levels of sales within the assumed relevant range of activity.
    3. Selling price per unit remains constant.
    4. Variable costs vary in direct proportion to changes in activity i.e. as a percentage of sales revenue. They remain constant.
    5. The sales mix is assumed to remain constant if more than one product is sold.
    6. The projections are over a short period of time only.

The limitations and assumptions of CVP analysis mentioned above impair but do not destroy the usefulness of the technique for managers as a useful profit planning tool.

Leave a Comment