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In CVP analysis, the usual assumption is that the total sales line and variable cost line will have linear relationship, that is, these lines will be straight lines. However, in actual practice it is unlikely to have a linear relationship for two reasons, namely:
• after the saturation point of existing demand, the sales value may show a downward trend.
• the average unit variable cost declines initially, reflecting the fact that, as output increase the firm will be able to obtain bulk discounts on the purchase of raw materials and can also benefit from division of labour. When the plant is operated at further higher levels of output, due to bottlenecks and breakdowns the variable cost per unit will tend to increase. Thus the law of increasing costs may operate and the variable cost per unit may increase after reaching a particular level of output.
• the average unit variable cost declines initially, reflecting the fact that, as output increase the firm will be able to obtain bulk discounts on the purchase of raw materials and can also benefit from division of labour. When the plant is operated at further higher levels of output, due to bottlenecks and breakdowns the variable cost per unit will tend to increase. Thus the law of increasing costs may operate and the variable cost per unit may increase after reaching a particular level of output.
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| Curvilinear CVP analysis |
In such cases, the contribution will not increase in linear proportion i.e. based on the phenomenon of diminishing marginal productivity; the total cost lie will not be straight, as assumed but will be of curvilinear shape. This situation will give rise to two break even points. The optimum profit is earned at the point where the distance between sales and total cost is the greatest.
