Economists and accountants have diametrically opposite views of cost-volume profit (CVP) behaviour but only accountant's have a CVP model that is appropriate for assisting management with decision making
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[TYPE THE COMPANY NAME] BEA2003- Management Accounting Economists and accountants have diametrically opposite views of cost-volume profit (CVP) behaviour but only accountant's have a CVP model that is appropriate for assisting management with decision making Ryan Bebbington Word Count 1796 Economists and accountants have diametrically opposite views of cost-volume profit (CVP) behaviour but only accountant's have a CVP model that is appropriate for assisting management with decision making Cost volume profit analysis looks into the relationship between a firms fixed and variable costs and total revenues across a varying level of production. The model will give a predicted level of profit at a given level of production. There are many ways that CVP analysis can be useful for decision making, it is important to distinguish between the different applications of the Economists and Accountants interpretations, as well as other factors involved in decision making. CVP analysis is used in management decisions when forecasting production levels. To use this model effectively, Management will look at different scenarios of output, prices and costs, and see where the model predicts the firm's revenues will cover its total costs. This point is known as the breakeven point. Management can investigate the effects of price increases, changing costs from fixed to variable such as salaries to commission based pay. Managers can also investigate the outcomes from decisions such as making components in house or buying in, retaining or replacing equipment and marketing decisions.
The Accountant's interpretation of the fixed cost curve is different to the Economist's view because it meets the Y axis at a higher point, which indicates that the Accountants believe that firms are committed to a higher minimum level of fixed costs. This is because although a firm may reduce its fixed costs to a lower level, as in the Economist's interpretation, the firm can only do this by redundancies and shutting down plants. As the Accountants model only represents a relevant range, the fixed costs cannot be reduced to this level in the short run, when this interpretation is extended outside of the relevant range, a stepped fixed cost and total function will be seen, as in figure 3. The other difference is that the revenue function is linear. This is because in the short run, firms cannot change the price of their products easily; it may also be because of firms competing on non-price, rather than price competition. As Accountants make no attempt to extend the revenue function outside of the relevant range, there is no need to model the firm's decrease in product price to increase demand. The Accountant's interpretation of the Cost Volume Profit model is more appropriate for Management decisions, as management decisions are not concerned with long term information. This is because the Board of Directors will be making the firms long term decisions.
If management are not aware of the assumptions made in the data, then they will be unable to draw relevant conclusions from the information. The assumptions i are that all other variables remain constant; there is a constant sales mix, total costs and revenues are linear functions of output, profits are calculated using variable costing, the analysis only applies to the relevant range, costs can be divided into fixed and variable elements, it only applies to the short term, and fixed costs do not change. In conclusion, the Accountant's interpretation of the CVP analysis, as shown by the underlying assumptions, will allow managers to develop a more relevant understanding of the information, so that it can be used more effectively in decision making. If managers tried to use the economists CVP graph, the cost of gathering and interpreting the data would be high, as well as making the information more difficult to understand and less reliable. In the real world, the Accountant's model may be considered too simplistic, as it relies on many assumptions and conditions, which are often not met. This is why it important to understand that the Accountant's CVP model may not be applicable. For the CVP analysis to be effective, managers must be aware of the limitations of the model, otherwise they will be unprepared for any deviations from the outputs of the model. i Drury C. 2004. Management and Cost accounting 6th edition P263-286 ?? ?? ?? ?? Candidate Number: 018255 Management Accounting BEA2003 Ryan Bebbington
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