1. Define break-even point.
2. List down two limitations of CVP analysis.
3. Highlight the objectives of CVP analysis
4. Write down the equation used to calculate break-even point (units).
ANSWERS
1. Break-even point is the volume of sales where there is neither profit nor loss. At this
point revenues and total costs are equal
2.
a. It is assumed that the production facilities anticipated for the purpose of cost-volume- profit analysis do not undergo any change. Such analysis gives misleading results if expansion or reduction of capacity takes place, which in most cases does.
b. In case a variety of products with varying margins of profit are manufactured, it is difficult to forecast with reasonable accuracy the volume of sales mix which would optimize the profit.
c. It assumes that input price and selling price remain fairly constant which in reality is not the case. Thus, if cost or selling price changes, the relationship between cost and profit will not be accurately depicted.
d. It assumes that variable costs are perfectly and completely variable at all levels of activity and fixed cost remains constant throughout the relevant range. However, this situation is not a practical one.
e. It is assumed that inventories do not change significantly from period to period. However, in reality, opening inventory and closing inventory are never the same and in most cases they vary significantly
3.
a. In order to forecast profits accurately, it is essential to ascertain the relationship between cost and profit on one hand and volume on the other.
b. Cost-volume-profit analysis is helpful in setting up flexible budget which indicates cost at various levels of activities.
c. Cost-volume-profit analysis assists in evaluating performance for the purpose of control thus enabling management to take corrective actions where necessary and in good time.
d. Such analysis may assist management in formulating pricing policies by projecting the effect of different price structures on cost and profit.
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