Question

breakeven analysis assumes that all costs are fixed or variable. In reality, this is an inaccurate assumption. Some costs are semi-variable and mixed. In the book discusses 3 different ways to separate mixed and variable costs into fixed and variable parts, but these are estimates as well. Considering the inaccuracies and estimates in the assumptions, what is the point of doing break even analysis at all?

Answer 1

There are certain costs which are fixed till sertain point, and than convert to variable once it crosses some point. Such costs are called semi-variable cost. For example, Electricity cost can be fixed till certain points, and become variable once it crosses that point.

Following are the methods to convert such cost into fixed and variable:-

1) Scattergraph

2) High-low method

3) Regression Analysis

1) Scattergraph - Scattergraph means plotting of points on the graph. The benefit of the scattergraph is that it allows you to see if some of the plotted points are simply out of line. Let's assume that a company uses only one type of equipment and it wants to know how much of the monthly electricity bill is a constant amount and how much the electricity bill will increase when its equipment runs for an additional hour. The scattergraph's vertical or y-axis will indicate the dollars of total monthly electricity cost. Its horizontal or x-axis will indicate the number of equipment hours. For each monthly electricity bill, a point will be entered on the graph at the intersection of the dollar amount of the total electricity bill and the equipment hours occurring between the meter reading dates shown on the electricity bill. If you draw a line through the plotted points and extend the line through the y-axis, the amount where the line crosses the y-axis is the approximate amount of fixed costs for each month. The slope of the line indicates the variable cost per equipment hour. The slope or variable rate is the increase in the total monthly electricity cost divided by the change in the total number of equipment hours.

2) High low method - The high-low method involves taking the highestlevel of activity and the lowest level of activity and comparing the total costs at each level. The high-low method uses two sets of numbers: 1) the total dollars of the mixed costs occurring at the highest volume of activity, and 2) the total dollars of the mixed costs occurring at the lowest volume of activity. Calculation of variable cost using the method:-

Variable cost = (Total cost of high activity – Total cost low activity) / (Highest activity unit – Lowest activity unit)

Now fixed cost = Total Cost - Variable Cost

3) Regression Analysis - Regression analysis is used to study the relationship between two or more variables. Moreover, the regression technique is used to observe changes in the dependent variable with changes in the independent variables. The parameters in the regression equation are obtained by using least square method.
Independent variable:
In regression analysis, the independent variable represents the value which never changes.
Dependent variable:
The dependent variable represents the output based on the values of the independent variable.

So, here Fixed cost is the independent variable which remains fixed and variable cost is the dependent variable.

Break even anaylsis is to be done to know the number of units to be sold to break even or number of sales in dollars to be done to break even. Break even analysis can be done once the costs are distributed within fixed and variable cost.