Evaluate the reliability of break-even analysis in estimating budgeted activity levels for selected organisation

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Asid Ashraf

Unit 7 Management Accounting D1:

Evaluate the reliability of break-even analysis in estimating budgeted activity

levels for selected organisation

 As I have already summarised the breakeven point is the point at which cost or expenses and revenue are equal: there is no net loss or gain, and one has broken even. [Selling price-variable costs=contribution] [Fixed costs/contribution=breakeven point]So in your businesses scenario it is, the selling price £15 minus your variable costs £12 which equals £3. This then leaves you with your fixed costs which are 11,500 divided by the contribution which £3 is leaving you with a total breakeven point of, 3833.33.

First of all, production managers like Mr Jones and management accountants need to have a clear understanding of break-even analysis. This analysis is used as a general guideline for business decision making and is important for a number of reasons, including the ability to forecast the future cost and revenues and determine whether the business is making profit or loss, and also be able to develop a pricing strategy. The break-even analysis is based on marginal costing. The break-even analysis is based on forecasting and has a certain limitations which should be considered. It is not always possible to predict what will happen on the market. The linear relationship is based on the presumption that costs remain constant. However this is not the case in practical market situations. The business may get some discount from its suppliers. Also the business can often reduce its selling price in order to increase its sales volume and this is an efficient strategy known as a non-linear relationship. The break-even analysis is internal and it is not used to consider the things like competition or market demand which means that the business should use other analysis to watch what is happening on the market and what strategies are used by competitors.

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Limitations/assumptions of break even analysis:

All costs are classified as either fixed or variable. If not impossible or impractical, dividing costs into the variable and fixed cost elements as an extremely difficult job. This is attributable to the inherent nature or characteristics of the cost per selling-product.  Fixed costs remain constant within the relevant range. Fixed costs remain unchanged at any level of activity within the relevant range, even at the zero level. The behaviour of total revenues and total costs will be linear over the relevant range, i.e. will appear as a straight line on the Break-even ...

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