Page 78 - DCOM206_COST_ACCOUNTING_II

Unit 4: Cost Volume Profit Analysis

(viii) The profit potentialities can be best judged from a study of the position of the break-even Notes
point and the angle of incidence in the break-even chart.

Limitations of Break-Even Chart

The main limitations of break-even chart arise from the number of assumptions which are made
in drawing break-even charts. These limitations are as under:
(i) The effect of various product mixes on profits cannot be studied from a single break-even
chart,

(ii) A break-even chart is based on a number of assumptions which may not hold good. In the
break-even chart, we have seen that the total cost line and the sales line look straight lines.
This is possible only with a number of assumptions. But, in practice, the total cost line and
the sales line are not straight lines because the assumptions do not hold good,
(iii) A break-even chart does not take into consideration capital employed which is a very
important factor in taking managerial decisions. Therefore, managerial decisions on the
basis of break-even chart may not be reliable,

(iv) A limited amount of information can be shown, in a break-even chart. A number of charts
will have to be drawn up to study the effects of changes in fixed costs, variable costs and
selling prices,
(v) No importance is given to opening and closing stocks, and
(vi) Constant selling price is not true.

Construction of Break-Even Chart

The common methods, followed in the construction of simple break-even chart, are stated here
under:
(i) A break-even chart is drawn on a graph paper,
(ii) There are two sides on a graph which are known as ‘axis’. The horizontal side at the
bottom of the graph is ‘x-axis’ and the vertical side is the ‘y-axis’,
(iii) On the graph, the x-axis shows the volume of production and the y-axis shows the cost and
sales price,

(iv) Draw both axes on the suitable graph paper on the basis of appropriate scale,
(v) Fixed cost line is drawn on the graph. Fixed cost line is drawn parallel to the x-axis because
fixed cost remain the same,

(vi) Total cost line is drawn above the fixed cost line. For this purpose, the variable cost is
added to the fixed cost to arrive at the total cost and drawn at each and every scale of
production,
(vii) Sales revenue line is drawn commencing at zero and finishing at the last point,
(viii) Then the sales line cuts the total cost line, i.e., sales equals the total cost. This is known as
a break-even point. When a line is drawn from BEP to x-axis, it indicates break-even point
in units and when a line is drawn from BEP to y-axis, it indicates break-even point in
rupees,
(ix) The difference between the sales line and total cost line to the right of BEP indicates the
profit. The position to the left of the BEP on the graph indicates the loss, and

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