The paper 'Whether Cost-Volume-Profit Is Applicable in Real Life" is a great example of finance and accounting coursework. CVP analysis is a method of cost accounting used in managerial economics that is based on the determination of the breakeven point of cost and volume of goods. The method is useful to managers in making short-term economic decisions. For it to be relevant, CVP makes some assumptions. For instance, CVP assumes that the sale price, variable cost and fixed cost per unit are constant. However, these assumptions are very simplistic and they fail to hold water in real life (Parvathy, 2014).
As such, owing to these assumptions that underlie cost-volume-profit analysis, it becomes difficult to apply CVP in the real world. However, this does not mean it has zero application in real life. Some managers still find the method applicable in making managerial decisions. This paper discusses the applicability of cost-volume-profit analysis in real-world settings with regard to the assumptions it makes. Assumptions of CVP analysis Some of the assumptions underlying CVP analysis place limitations on the application and use of CVP analysis.
As such, knowledge of the assumptions of CVP is important in a bid for one to make informed decisions on utilizing CVP in making managerial decisions. The key assumptions of CVP analysis include; a)It is possible to classify all costs as fixed and variable-CVP analysis assumes that all costs can be classified into being either fixed or variable costs. However, in real life, it is difficult to identify each and every cost element as being fixed or variable. In addition, the flexible policies of firms make it more difficult to identify costs as being fixed or variable.
In case one is unable to identify their cost fixture as such, then the applicability of cost – volume- profit analysis is rendered almost impossible (Hemed, 2010). b)That costs will be linear within the relevant range-CVP analysis assumes that total fixed costs remain constant in the short run within the relevant range. In this regard, it is assumed that total variable costs will be exactly proportionate within the relevant range. c)That selling price and variable costs per unit will not change with volume d)That sales volume approximates production volume and that there are no significant inventories balance fluctuations e)That a company produces either a single product or a product mix that is constant f)That productivity is constant in the short-run (Lewis, 2013). It is assumed that by applying CVP, firms derive a number of benefits.
CVP is useful to managers in terms of providing them with information that is useful in making decision making. Using CVP, managers are able to answer pragmatic questions that are needed in business analysis. Such questions include what the company’ s break-even point is and hence assist managers to project how the firms future spending and production will lead to the firm’ s success.
For instance, it is assumed that when managers know their break-even points, they will be able to tweak spending and increase production efforts and hence increase their profitability. Given that CVP is based on statistical models, it is possible to break down decisions into probabilities which help the managers in their decision-making processes. CVP also provides a detailed snapshot of the company’ s activities (Jared, 2011). This range from the costs necessary for the production of a product to how much product is produced.
This is helpful in helping the managers in deciding what the future holds with specificity if the variables are varied. As such, CVP is a useful tool for management in decision making. However, as stated above, some of the assumptions underlying CVP bring into doubt the applicability of CVP in modern-day business. Thus, the applicability of CVP in real life is examined below in detail.
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