Question

In: Accounting

How does CVP analysis contribute to increasing the quality of decisions? What is your interpretation of...

How does CVP analysis contribute to increasing the quality of decisions?

What is your interpretation of operating leverage? Is it relevant? Can you estimate it from a traditional GAAP accounting income statement?

Solutions

Expert Solution

  • CVP analysis is a modern technique to analyse the projects and make decisions. Unlike traditional approches to calculate sales and deduct cost from it, this technique analyse the affect of sales volume on the profit. It is assumed here that some costs are fixed and they would not change even if less or more volume is produced and sold. Thus this technique looks at the sales figure on cumulative basis by drawing comparison between different level of sales. This helps in having quality decision as maangement can decide what would be the optimal production and sales level for the maximum production
  • Operating leverage means what is the advantage to the profit of company with the change in the sales quantity of the company provided fixed cost remain the same. It is relevant since company with more proportion of fixed cost will be in the more advantageous position to record more profit per unit when their sales quantitiy increases.
  • In a traditional GAAP stateemnts, gross profit and net profit are shown. There is no contribution or segregation of fixed and variable costs in that. Thus it will not be possitble to estimate operating leverage from it.
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