CVP analysis is to enable management to select the most desirable operating plans for achieving the enterprise's profit objective - under the circumstances foreseeable at the time the decision is to be made. According to Scapens, the difficulties of applying CVP analysis arise from both the simplicity and complexity of technique and its data requirement. One significant limitation is its emphasis on fixed-variable split. A number of limitations are commonly mentioned with respect to CVP analysisIn spite of having so many limitations CVP is still very useful in making decisions. It assists in establishing prices of products.
It helps in analysing the impact that volume has a short term profits. It tells us that changes in costs (variable and fixed) have no profits. Assists in analysing how the mix of products affects profits. Activity based costing ABC systems provide more meaningful decision making information because they recognize that many of the so-called fixed overhead costs vary in proportion to changes other than production volume. By identifying the costs drivers that cause costs to change and assigning costs to products on the basis of cost driver usage, costs can be more accurately traced to products.
This cause and effect relationship provides a superior way of determining relevant costs. A sophisticated ABC system will clearly generate the most accurate product costs. Despite early criticism about the cost and complexities of implementing ABC, evidence is emerging about steady recognitions of benefits. The main benefit is cost reduction through better understanding of causes of costs. Ability to build in low cost production through new product design and process re-engineering.
More accurate product/ service pricing and more management focus on potentially unprofitable products/services/customers. More focussed product marketing takes place particularly in bid and tender pricing. The traditional accounting techniques have many limitations. It is no longer suitable for the companies having multiple products as compared to single product firms as they have few problems with costing accuracy. The main drawback of this technique is that it uses the same measurement throughout the factory no variation between the single product firm and multiple product firm.
Limitations of ABC Despite its nuances and subtleties, an Activity Based Costing system is still essentially an "historic cost" system. In certain circumstances its usefulness is doubtful, especially if future cost consideration are of greater importance (Smith, 1994). Far from eliminating arbitrary cost allocations of overhead costs, an ABC system actually may increase the number of such allocations. Thus, we must determine decision rules of the pooling of common overheads into separate cost pools and common cost drivers into separate activities.
Once these items have been identified, there is the danger of trying to employ a single cost driver that may not be entirely representative to explain the cost behaviour of the whole cost pool (Smith, 1994) The aim of ABC is to apply overhead costs on the basis of cause and effects, i. e. , production overhead costs are more closely traced to products. But there are some costs such as factory rent for which driver cannot be identified. The allocation of such costs to products remains arbitrary even under ABC (Kennedy, 1996).