Page 100 - DMGT202_COST_AND_MANAGEMENT_ACCOUNTING

Unit 6: Marginal Costing and Absorption Costing

6. What are the revenue and cost implications of changing the process of production? Notes

7. Should one make, buy or lease capital equipment?
6.6.2 Assumptions of Break-even Analysis

The break even analysis is based on certain assumptions, namely:

1. All costs are either perfectly variable or absolutely fixed over the entire period of production
but this assumption does not hold good in practice.
2. The volume of production and the volume of sales are equal; but in reality they differ.
3. All revenue is perfectly variable with the physical volume of production and this assumption
is not valid.
4. The assumption of stable product mix is unrealistic.

6.6.3 Advantages of Break-even Analysis

The main advantages of using break even analysis in managerial decision making can be the
following:
1. It helps in determining the optimum level of output below which it would not be profi table
for a firm to produce.

2. It helps in determining the target capacity for a firm to get the benefit of minimum unit cost
of production.

3. With the help of the break even analysis, the firm can determine minimum cost for a given
level of output.

4. It helps the firms in deciding which products are to be produced and which are to be
bought by the fi rm.
5. Plant expansion or contraction decisions are often based on the break even analysis of the
perceived situation.

6. Impact of changes in prices and costs on profits of the firm can also be analysed with the
help of break even technique.
7. Sometimes a management has to take decisions regarding dropping or adding a product to
the product line. The break even analysis comes very handy in such situations.
8. It evaluates the percentage financial yield from a project and thereby helps in the choice

between various alternative projects.

9. The break even analysis can be used in finding the selling price which would prove most

profitable for the fi rm.
10. By finding out the break even point, the break even analysis helps in establishing the point

wherefrom the firm can start payment of dividend to its shareholders.
6.6.4 Drawbacks of Break-even Analysis (BEA)

This analysis will be useful only in situations relatively stable and slow moving rather than
volatile and erratic ones. In conditions when proper managerial accounting techniques and
procedures are maintained, the BEA will be useful. In a particular period costs are affected not
by the output of that period but due to past output or a preparation for future output. As such
the BEA cannot pin down that cost is the result of output of a particular period. It is diffi cult
to deal with selling costs under the framework of BEA because changes in selling costs are a
cause to bring out changes in output and not the result of output sales. In the real world, perfect

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