The article by Gean & Gean (2016) explores the three-way cost classification model for supply. According to the article cost analysis is enhanced by classifying according to the bases of function, behavior, and relevance to decision-making. The classification by the basis of function focuses on the context of indirect production costs (overhead). The classification enables the accountants to identify costs related to different units such as manufacturing, selling, administrative activities among others.
Cost classified by behavior gave rise to CVP analysis. Gean & Gean (2016) states that cost-volume-profit analysis is based on the assumptions that the parameters of fixed costs in total, price per unit, variable costs per unit, and contribution margin per unit will remain fixed over a relevant range of output (Glean & Glean, 2016). CVP analysis emphasizes cost, and it is based on historical data. There are three different approaches to CVP analysis: income statement approach, algebraic and graphical approach.
Delegate your assignment to our experts and they will do the rest.
CVP analysis is essential to the organization. Managers use CVP analysis to make short-term decisions such as “what-if” scenarios to anticipate the consequences of decisions such as changes in cost or the price structure (Glean & Glean, 2016). CVP analysis also enables the organization to determine the relationship between bottom line profits and top-line total revenue. According to Anderson & Leese (2016), CVP plays a more significant role in managerial accounting than in financial accounting. Managers have the responsibility to run the business by making smart and cost-effective moves. The three elements of CVP- cost, volume, and profit work together to help managers make decisions in the right direction for the business. The CVP is also used to calculate the break-even analysis as the break-even analysis involves the concepts of cost, volume, and price.
Managers make some assumptions when using CVP such as the costs can be accurately identified as fixed or variable. Another assumption is that all units produced are sold and that the selling price per unit is constant. Managers also rely on historical data to create a CVP analysis before making future decisions. The CVP assumptions are not realistic. Costs and prices cannot remain constant for an extended period; managers are often forced to adjust prices according to the changes in cost and economic conditions. Additionally, most businesses do not sell all the manufactured units because of the changes in demands. Customers, competitors, and other economic conditions often determine the units that the company will sell, thus using CVP analysis can be misleading. Given the many weaknesses of CVP, managers usually try to address these issues before using CVP to make decisions, and they are bound to make subjective decisions. CVP has a simplistic approach towards costs and price, and in reality, these concepts are complicated. Managers can use a certain price to conduct a CVP analysis, and when the product reaches the consumer, the managers are forced to adjust the price as per the volatile market prices.
According to Park et al. (2016), the weaknesses of CVP analysis can be solved by using both the product-process matrix and CVP analysis to analyze cash flows. Product-process matrix is used to illustrate the relationship between the two dimensions of product and process. The two aspects help the organization to make changes to the production approach to achieve production targets. Product-process matrix has similarities to the volume component of the CVP, and when the two are used together, it brings together the manufacturing department and financial managers so that they can make objective decisions.
The article by Gean & Gean (2016) presents a CVP analysis shortly and effectively. The article starts with a definition of the three concepts of CVP and how to calculate CVP using historical data. The article also explores the three ways of calculating CVP. Aside from the three methods, Gean & Gean (2016) also include a fourth integrated method of calculating CVP that combines all the three approaches. The assumption that total costs are fixed guide the integrated approach in calculating the price. The article covers the basics of CVP analysis, but the textbook has more detailed information on CVP analysis. The article does not have information on the assumptions that make up CVP, how CVP is used to calculate break-even analysis and limitations of CVP. The textbook gives a list of the assumptions and limitations of CVP analysis so that managers can be aware of the weaknesses of CVP and make the necessary adjustments.
The article does not exhaust all information about CVP analysis because it has to explore two other classifications of costs, that is cost classified by function and cost classified by relevance. However, since the authors examine the additional classification of costs, they provide other alternatives in the form of the three-way classification so that managers will not solely rely on CVP analysis only. In conclusion, the article is not as comprehensive as the text, but it has all the critical information used to do a CVP analysis and how managers utilize the CVP analysis in decision making.
References
Anderson, J. A., & Leese, W. R. (2016). A Formula for the Units to Satisfy an Operation's Desired Rate of Return in CVP Analysis--A Conceptual Approach. American Journal of Business Education , 9 (2), 87-100.
Gean, F., & Gean, V. (2016). A Three-Way Cost Classification Model for Understanding the Supply Side of the Firm. Journal of Business and Educational Leadership , 6 (1), 37.
Park, W., Lee, K., Doo, S., & Yoon, S. S. (2016). Investments for New Product Development: A Break-Even Time Analysis. Engineering Management Journal , 28 (3), 158-167.
