State and briefly explain three assumptions underlying the break-even theory.

Management Accounting Block Revision Mock Exams

Assumption of Break-even analysis

1) The behaviour of total costs and total revenues applies to relevant range only.

CVP analysis is appropriate only for decisions taken within the relevant production range. It is incorrect to project cost and revenue figures beyond the relevant range.

Relevant range refers to the output range at which the firm expects to be operating in the future and is equivalent to normal capacity. It represents the output levels which the firm has had experience of operating in the past and for which cost information is available.

2) All costs can be divided into fixed and variable elements.

CVP analysis assumes that costs can be accurately analyzed into their fixed and variable elements.

3) The analysis either covers a single product or assumes that a given sales mix will be maintained as total volume changes.

CVP analysis assumes that either a single product is sold, or if a range of products is sold that sales will be in accordance with a predetermined sales mix.

4) Volume is the only relevant factor affecting costs: all other variables remain constant.

It is assumed that all variables other than volume remain constant throughout the analysis.

i.e changes in other variables such as production efficiency, sales mix price levels and production methods do not have an influence on sales revenue and costs.

5) Single product or constant sales mix.

CVP analysis assumes that either a single product is sold or if a range of products are sold those sales will be in accordance with a predetermined sales mix.

6) Profits are calculated on variable costing basis i.e. the volume of sales or changes in beginning and ending inventory levels are insignificant in amount.

The analysis assumes that fixed costs incurred during the period are charged as an expense for that period. Therefore variable costing profit calculations are assumed. I f absorption costing profit calculations are used; it is necessary to assume production is equal to sales.

7) Total costs and total revenue are linear functions of output.

Thee analysis assumes that unit variable cost and selling price are constant.

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