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.
- 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).
- Fixed costs will not change at all levels of sales within the assumed relevant range of activity.
- Selling price per unit remains constant.
- Variable costs vary in direct proportion to changes in activity i.e. as a percentage of sales revenue. They remain constant.
- The sales mix is assumed to remain constant if more than one product is sold.
- 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.