Assumptions Underlying the CVP Analysis
CVP analysis as discussed above is based on certain assumptions . if these assumptions are not recognized then serious error may result and incorrect conclusions may be drawn. Some of the assumption are :
1) All other variables remain constant. The means that the unit selling price until variable cost and the total fixed cost remain constant . in other words it is assumed that the volume is the only variable that will cause the costs and revenues to change . the economists may not agree with this assumption because variable cost is likely to be reduced at higher levels of activity due to economies of scale .
2) Costs can be accurately divided into fixed and variable components. Though this assumption is difficult to be applied in practice because separation of semi fixed costs into fixed and variable component is extremely complicated nevertheless an accurate analysis is necessary if CVP analysis is to be used for decision making .
3) The sales mix is constant : the CVP analysis assumes that either the firm is dealing in a single product or the product mix remains constant . when a predetermines product mix is used the CVP analysis assumes average revenue and average cost for that mix .
4) Profits are calculated on a variable costing basis . the CVP analysis assumes that the fixed costs incurred during the period are treated as period costs and hence changed to the sales of that period only . however if absorption costing procedure is used then it is assumed that the production and sales are equal and there is no change in inventory level during the period .
5) Efficiency remains constant and there is no productivity gains or losses the period.
6) Total fixed costs remain same over the entire range of activity being considered .