Briefly explain three methods that can be used to analyze uncertainty in cost-volume-profit (C-V-P) analysis

CPA-Advanced-Management-Accounting-Section-5

(i) Sensitivity analysis
This is what if analysis that considers the effect of a marginal change on each of the relevant variables to the decision.

(ii) Point estimate of probability
This approach requires a number of different values for each of the uncertain variables to be selected. Usually three values are selected: these are the worst possible, most likely and best possible outcomes. For each of these values a probability of occurrence is estimated. The expected values and standard deviation can then be computed.

(iii) Continuous probability distribution
(e.g. normal distribution)
The uncertain variables can be estimated as a continuous probability distribution. Estimates are made of the mean and standard deviation, which can then be used to compute expected profit, standard deviation of profits and probability that the company will break even.

(iv) Simulation analysis
This is a method of analyzing a system by experimentally duplicating its behaviour. Simulation is used where analytical techniques are not available or would be very complex.

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