IX. A. Assumptions of Cost-Volume-Profit Analysis.wmv

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“Accounting cost. Volume profit. Analysis assumptions. Now that we have learned what variable costs are are and how they behave as activity changes.

And what fixed are and how they as activity changes and also how to separate a mixed cost into its fixed and variable components. We can begin doing some analysis and projecting what profits will be under certain activity situations now in order to do that we have to make some stabilizing assumptions about certain elements of the income statement and the first assumption that s necessary for us to do and a valid caused by a profit analysis is that sales price will remain constant. Now if sales price changes then every aspect of the income statement is going to be effective effective. So in order for us to analyze or play what if with different activities.

We need to assume that the sales price is going to remain constant. So that other related items on the income statement will not be impacted by the change in sales price..

The second assumption is that costs are linear. Now as we saw when we looked at the high low method and the scatter graph and regression that if costs are not linear then it s very difficult to predict how they re going to respond to changes in activity. So a second assumption simplifying assumption of cost volume profit analysis is that costs do indeed behave in a linear fashion. The third assumption has to do with our definitions of fixed and variable cost.

And that is that the activity changes that we re going to play with in cost volume. Profit analysis are within the relevant range. So activities is within the relevant range for our definitions of fixed cost the total not changing as activity changes or variable costs that the kerr unit figure stays. The same over a certain range.

That those definitions will be true as we perform the cost profit volume analysis. Now the fourth assumption is that for businesses that sell more than one product that the mix the sales mix of those products will be constant..

Now just as with sales price. If we change the mix of our products. That have different prices and different contributions to profit. Then that s going to change the whole income statement.

So we assume that that sales mix whatever it may be is constant as we perform the analysis and then the final assumption for a merchandiser in particular. But also for a manufacturer. The final assumption is that inventory levels do not change now since some of our fixed costs may also be product cost those fixed product costs attached to the inventory. And we ll learn in a later chapter that if inventory levels change.

Then part of that fixed cost gets deferred in other words. Does not show up on the income statement..

As an expense. So if inventories levels change. Then again our profits will be impacted by something other than true changes. In activity.

True changes in sales volume. So these again are simplifying assumptions. Now if something does change for example if in doing cost volume profit analysis. We say well what if we increase the sales price.

How is that going to impact profits well if we make that change then we also have to modify other relationships for example. The if the sales price changes..

Then the sales mix may also change. And if the sales price changes. Then that may cause our activity level to change as well. So if there is a change in one of these assumptions.

Then we have to incorporate that change into our cost volume profit analysis and we ll see more about that as we take a look at ” ..

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