Question

Question 1 – Breakeven Chart with Increases in Fixed Costs

(a)     Identify and discuss briefly five assumptions underlying cost-volume-profit analysis.

                                                                                                                                      

(b)     A local authority, whose area include a holiday resort situated on the east coast, operates, for 30 weeks each year, a holiday home which is let to visiting parties of children in care from other authorities. The children are accompanied by their own house mothers who supervise them throughout their holiday. From six to fifteen guests are accepted on terms of £100 per person per week. No differential charges exist for adults and children.

Weekly costs incurred by the host authority are:

	£ per guest
Food	25
Electricity for heating and cooking	3
Domestic (laundry, cleaning, etc.) expenses	5
Use of minibus	10

Seasonal staff supervise and carry out the necessary duties at the home at a cost of £11,000 for the 30-week period. This provides staffing sufficient for six to ten guests per week but if eleven or more guests are to be accommodated, additional staff at a total cost of £200 per week are engaged for the whole of the 30-week period.

Rent, including rates for the property, is £4,000 per annum and the garden of the home is maintained by the council’s recreation department which charges a nominal fee of £1,000 per annum.

Required:

(i)      Tabulate the appropriate figures in such a way as to show the break-even point(s) and to comment on your figures.                                                                                           

(ii)        Draw, on the graph paper provided, a chart to illustrate your answer to (b)(i) above.

Answer 1

Part A

Cost volume profit analysis is prepared basis on few underlying assumptions and one should be mindful of those assumptions to avoid serious errors and incorrect conclusions that may be drawn from the analysis if assumptions are not followed. Some of the key assumptions underlying CVP analysis is as follows:

1. CVP analysis assumes that total fixed costs do not change in the short-run within the relevant range. Total variable costs are exactly proportionate to sales volume. But in reality, cost behaviour may not remain constant.
2. Variable costs remain constant.
3. Selling prices remain constant for any volume
4. Unit sold should equal units produced - There are no significant change in size of inventory and this goes by assumption that either the company should follow variable costing for the inventories product cost or all the production volume should be sold within the same period
5. CVP analysis is a short term planning tool as nothing remains constant in the long run and most of the underlying assumptions of this analysis remains constant

Part B (i)