Question

Do you agree with the claims made by the critics of CVP analysis regarding its limited value in practice? Why or why not?

Critics of CVP analysis claim that the assumptions underlying the analysis are almost certain to be violated in practice, thus severely limiting the practical value of the various techniques covered in this chapter. Moreover, say the critics, in the highly competitive environment in which many companies operate, the assumptions necessary for CVP analysis are even more likely to be violated. Arguably, companies that face stiff competition and thus could benefit most from CVP analysis may be the least likely to be able to use the techniques because of the restrictive assumptions.

Answer 1

Yes, I do agree with the fact that CVP analysis has limited value in practice due to some of its underlying assumptions like constant selling price, variable costs per unit and fixed costs. It is also assumed that all units produced have been sold, which may not hold true in practical world quite often. Under CVP analysis, it is also assumed that all changes in expenses are the results of changes in the level of activity, but there may be some other factors in real life world. All these assumptions look theoretically sound and good but a big question mark still surrounds their practical relevance in the real world due to which they have limited value in practice as advocated by the critics of CVP analysis.

Cost-volume-profit (CVP) analysis refers to a technique which aims to consider and examine the effect of changing levels of volume and cost on the operating profit. It is useful for short-term decision making on the part of managers, as it computes the break-even point for various volume of sales and cost structures.