Question

How does assuming that operating activity occurs within a relevant range affect cost-volume-profit analysis?

Answer 1

The relationships among costs, volumes and profits are well presented by the cost-volume-profit (CVP) analysis. Costs are classified as variable cost and fixed costs. Variable costs are costs varies with the level of activity. Per unit variable cost is constant. On other hand total fixed costs within the relevant rage is constant. It does not change with the level of activity. The cost-volume-profit (CVP) analysis is based on few assumptions like no change in beginning and ending inventory levels, classification of costs in to variable and fixed costs, constant selling price, impact of activity level on variable costs and existence of Linear relationship within a relevant range. According to CVP analysis cost and revenue are expected to have linear relationships within the relevant range. If the activity is above or below the relevant change, there will be change in the fixed cost. This factor will distort the results of the CPV analysis. The CPV analysis ill offer useful information for decision making and determining break-even point, sales targets, etc. considering any change in activity level within relevant range.