Cost-Volume-Profit Analysis

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Definition: Cost-Volume-Profit Analysis




Full Definition of Cost-Volume-Profit Analysis


In management accountingCost-Volume-Profit Analysis (CVP) is a form of cost accounting. It is a simplified model, useful for elementary instruction and for short-run decisions.

COST-VOLUME-PROFIT ANALYSIS Cost-volume-profit (CVP) analysis expands the use of information provided by breakeven analysis. A critical part of CVP analysis is the point where total revenues equal total costs (both fixed and variable costs). At this breakeven point (BEP), a company will experience no income or loss. This BEP can be an initial examination that precedes more detailed CVP analyses.

The cost-volume-profit analysis employs the same basic assumptions as in breakeven analysis.

The assumptions underlying CVP analysis are:

  • The behaviour of both costs and revenues in linear throughout the relevant range of activity. (This assumption precludes the concept of volume discounts on either purchased materials or sales.)
  • Costs can be classified accurately as either fixed or variable.
  • Changes in activity are the only factors that affect costs.
  • All units produced are sold (there is no ending finished goods inventory).
  • When a company sells more than one type of product, the sales mix (the ratio of each product to total sales) will remain constant.

Assumptions

CVP assumes the following:

  • Constant sales price;
  • Constant variable cost per unit;
  • Constant total fixed cost;
  • Constant sales mix;
  • Units sold equal units produced.

These are simplifying, largely linearizing assumptions, which are often implicitly assumed in elementary discussions of costs and profits. In more advanced treatments and practice, costs and revenue are nonlinear and the analysis is more complicated, but the intuition afforded by linear CVP remains basic and useful.

Applications

CVP simplifies the computation of breakeven in break-even analysis, and more generally allows simple computation of Target Income Sales. It simplifies analysis of short-run trade-offs in operational decisions.

Limitations

CVP is a short runmarginal analysis: it assumes that unit variable costs and unit revenues are constant, which is appropriate for small deviations from current production and sales, and assumes a neat division between fixed costs and variable costs, though, in the long run, all costs are variable. For a longer-term analysis that considers the entire life-cycle of a product, one therefore often prefers activity-based costing or throughput accounting.


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Definition Sources


Definitions for Cost-Volume-Profit Analysis are sourced/syndicated and enhanced from:

  • A Dictionary of Economics (Oxford Quick Reference)
  • Oxford Dictionary Of Accounting
  • Oxford Dictionary Of Business & Management

This glossary post was last updated: 19th April, 2020 | 0 Views.