Chapter 6, Problem 1Q

Identify and briefly describe the assumptions of CVP.

To determine

Introduction:

Cost-volume profit analysis is a tool that helps in decision making by establishing a relationship between volume, price, variable cost, fixed cost and profit.

To identify and describe:

The assumptions of CVP.

Answer to Problem 1Q

The assumptions of CVP are:

1. Linear cost and revenue function
2. Cost can be categorized as either fixed or variable
3. Only volume affects total cost and total revenue.
4. Volume of production is equals to volume of sales
5. Product mix is constant

Explanation of Solution

The assumptions of CVP are:

Linear cost and revenue function:

A straight line is used to describe the relationship between total cost and sales volume and total revenue and sales volume.

Cost can be categorized as either fixed or variable:

To find mixed cost, we must determine total fixed cost and variable cost per unit.

Only volume affects total cost and total revenue:

Other factors such as employee learning curve, productivity gains etc. are ignored.

Volume of production is equals to volume of sales:

It is assumed that There will not be any change in beginning or ending inventory, it is assumed that all the units produced are sold during a period.

Product mix is constant:

The companies dealing in multiple products assumes that units sold, or sales revenue generated from each product or service line remains constant.