Question

1- The CVP analysis and incremental analysis affect the behavior of people. Behavioral consequences can be either positive or negative.

2- What kind of effects do the CVP and incremental analysis have on employee behavior? (HINTS: CVP is simple but concentrates on contribution margin while treating some costs as fixed in the short-run).

Answer 1

CVP analysis

Definition of CVP Analysis:

Cost-Volume-Profit (CVP) analysis is an important tool that provides management with useful information for managerial planning and decision-making. Profits of a business firm are the result of interaction of many factors.

Basic Assumptions of CVP Analysis

1. The selling price is constant. The price of a product or service will not change as volume changes.
2. Costs are linear and can be accurately divided into variable and fixed elements. The variable element is constant per unit, and the fixed element is constant in total over the entire relevant range.
3. In multiproduct companies, the sales mix is constant.
4. In manufacturing companies, inventories do not change. The number of units produced equals the number of units

Objectives of CVP analysis

• Profit planning;
• Help in preparation of flexible budgets;
• Ascertainment of no profit and no loss level;
• Ascertainment of optimum product mix;
• Taking pricing decisions;
• Production planning;
• Taking other managerial decisions;
• Help in controlling cost;
• Achieving efficiency

Limitations of CVP

Despite being considered as an important tool for decision making and planning the cost-volume-profit analysis, the technique has the following limitations:

• Problems in identifying fixed and variable costs.
• Fixed costs not always fixed.
• Proportionate relation between variable cost and volume of output not always effective.
• Unit selling price not always constant.
• Not suitable for a multiproduct firm.
• Ignoring the influence of other factors on cost and profit.
• Presence of inventory.
• Not effective in the long run.
• More emphasis on sales.
• A statistic tool.

Incremental analysis

What Is Incremental Analysis?

Incremental analysis is a decision-making technique used in business to determine the true cost difference between alternatives. Also called the relevant cost approach, marginal analysis, or differential analysis, incremental analysis disregards any sunk cost or past cost. Incremental analysis is useful for business strategy including the decision to self-produce or outsource a function.

TYPES OF INCREMENTAL ANALYSIS A number of different types of decisions involve incremental analysis. The more common types of decisions are whether to:

1. Accept an order at a special price.

2. Make or buy component parts or finished products.

3. Sell products or process them further.

4. Retain or replace equipment.

5. Eliminate an unprofitable business segment.

Disadvantages

Despite its simplicity and consistency, incremental budgeting is frequently criticized for a number of underlying flaws. The primary potential disadvantages of such a budgeting method are as follows:

1. Promotes unnecessary spending

Incremental budgeting can result in unnecessary spending for a company. The reason behind this is that the departments within a company generally tend to spend all the money that they’ve been allocated in a budget one year in order to obtain a greater amount of money in the next budgeting period. Incremental budgeting takes the position of increasing each part of the budget by a certain amount each year. However, some departments may not, in fact, need more money each year – but they will be allotted an increase anyway, simply because that’s how the budgeting process works. In this way, the budgeting process may be wasteful and less than optimally efficient.

2. Discourages innovation

This type of budgeting may discourage the production of innovative ideas and growth. Since new budgets are based on figures from previous budgets, there is a little room for the financing of completely new ideas or activities. Thus, the budgeting process discourages the implementation of new ideas and fosters a conservative business environment.

3. Fails to account for changes and external factors

The key assumption behind incremental budgets is the constant stability of the company’s operations. Therefore, the budgets are typically not responsive to potential changes that can result from unforeseen circumstances or some unanticipated factors.

4. Lacks an incentive for a comprehensive review

The stability of incremental budgets does not provide any incentives to the company’s management for reviewing its budgets with a view to realizing savings in expenditures. The lack of a review process makes budgets vulnerable to waste, inadequate assumptions, and mistakes

These all factors indicates the behavioural problems affect due to cvp anayisis and incremental analysis. These two analysis will reduce the salary outcome of the employees so it will discourage the work efficiency. More earnings will create more efficiency.

Thank you I hope this is the answer for your question. Sorry for if my answer is wrong please inform any doubt regarding this answer