management Back Forwards
Accounting: Fixed costs, Variable costs & Contribution
 

Assumptions of C-V-P analysis

By dividing a company's cost structure into two categories according to the costs behaviour as a function of output volume this model drastically simplifies reality. This simplification can be useful in clarifying the key decision variables in a situation, and allowing approximate calculations to be made quickly and easily. However, in its simplest form care must be taken to ensure that the models assumptions are not violated when applied to real situations. The model's key assumptions are:

1. All other variables remain constant - volume is assumed to be the only factor that causes costs and revenues to vary in relation to short-term product decisions. This allows a simple two-dimensional analysis. While it is true that sales revenue and the costs of many direct inputs to production will be closely correlated to production

 

volume and many factory overhead costs will remain unaffected by volume (accruing instead on a time basis), the costs some important product supporting activities (production scheduling, material movement, machine set-ups etc.) will be significantly affected by the range or complexity of products rather than the volume of output. Clearly, if we wish to include more than one 'cost driving' variable we could do it, but we would complicate the mathematics and lose the clear graphical presentation. The model therefore assumes that complexity-related overhead costs are not significant.

2. Single product or constant sales mix. This assumption ensures that the ratio of contribution to sales remains constant. Unless this ratio was the same for all products sold the contribution earned would be a function of both volume and the sales mix and simple two-dimensional analyses would not be possible.