Cost-Volume-Profit Analysis (Cambridge (CIE) AS Accounting): Revision Note

Uses & limitations of cost-volume-profit analysis

What is cost-volume-profit analysis?

• The analysis of how the profit is affected by changes in:

  • costs

  • sales volume

  • and prices

What are the uses of cost-volume-profit analysis?

• Helps management estimate sales required to achieve target profit, so plans can be implemented to achieve this 

• Can analyse impacts of price changes on profit

• Clearly identifies break-even level of sales 

• Separates variable and fixed costs, helping managers focus on controllable costs 

• Easy to understand and analyse 

• Aids short-term decision-making 

  • Pricing 

  • Make or buy 

  • Accepting special orders 

  • Product mix selection

What are the limitations of cost-volume-profit analysis?

• Some unrealistic assumptions are made 

• Difficult to classify costs as fixed and variables sometimes 

• Ignores non-financial factors 

• Limited use in multi-product firms because CVP becomes complex when multiple products with different contribution margins exist 

• Assumes constant efficiency which is unrealistic

How can costing concepts be applied to make business decisions and recommendations?

• Marginal costing data provides useful information for short-term decision-making in businesses 

  • Pricing decisions 

    • When setting prices for products, especially for special orders, to ensure selling price covers variable costs and generates profit  

  • Product mix and prioritisation 

    • When resources (labour, machine hours, materials) are limited

    • Calculate the contribution of each product type per unit of limited resource 

    • Prioritise the products that give the highest contribution per unit of limited resource

  • Make or buy decisions 

    • Compare the variable costs of producing internally with the cost of purchasing from external supplier 

What is the usefulness of cost-volume-profit data as a support for management decision-making?

• Determining the break-even point 

  • Helps management know the minimum sales required to cover total costs 

  • Supports pricing and production planning 

• Profit planning 

  • Assists forecasting of profit based on expected sales 

  • Enables evaluation of impact of changes in price, cost or output 

• Pricing decisions 

  • Assists decision-making on prices for special orders 

  • Ensures price covers variable costs and contributes to covering fixed costs