Cost–Volume Profit Analysis (CVP)

Helps managers understand the interrelationships among cost, volume, and profit by focusing their
attention on the interrelations among the prices of products, volume of activity, per unit variable
costs, total fixed costs, and mix of product sold.

→ Steps in Applying CVP Analysis

1- Identify the problem & uncertainties
Two factors affect the analysis:
a) Selling price.
b) Number of units sold.
2- Obtaining information, through management judgment & experience.
3- Make predictions about the future.
4- To make decisions by choosing among decisions.
5- Implementing the decision, perform evaluation &learn.

→ Cost–Volume–Profit assumptions:
1- Change in the level of revenues and costs arise from changes in the number of product units
sold only.
2- Total costs include two components:
- Variable costs.
- Fixed costs.
3- Behavior in total revenues and total costs are linear in relation to unit sold within a relevant
range and time period.
Example:
Sold 1 unit → revenue $150
Linear
Sold 2 units → revenue $300
4- Selling price, V.C / unit and total F.C are known and constant within relevant range of time.
→ Three methods to express CVP:
1- Equation Method.
2- Contribution Margin Method.
3- Graph Method.

Example:
10 units 50 units
Sales Revenue ($150 / unit) $1,500 $7,500
Variable cost ($60 / unit) 600 3,000
Fixed cost 1,000 1,000
Operating income (100) 3,500

1- Equation Method:
Sales revenue (–) Variable cost (–) Fixed cost = Operating income
Sp./u × units sold (–) Vc./u × units produced (–) Fixed cost = Operating income

$150 × 10 units (–) $60 × 10 units (–) $1,000 = ($100)

Cost Volume profit analysis 1

2- Contribution Margin Method:

(Sp./u (–) Vc./u) × units (–) Fixed costs = operating income

($150 (–) $60) × 10 units (–) $1,000 = ($100)

OR (CM/unit × units) (–) Fixed cost = operating income
$90 × 10 units (–) $1,000 = ($100)

3- Graph Method:

Cost Volume profit analysis 2

RULES (IMPORTANT)

1- Income statement: FC
8- BEP in $ (sales revenue to achieve BEP)=
CM%

TSR (PQ) Target profit after tax

9-Target profit before tax = 1−Tax Rate
(−) TVC (VQ)
CM (P – V) 10- units to achieve a target profit before tax =
FC+Target profit before tax
CM
(−) FC .
NI 11- Sales $ or sales revenue to achieve a target
FC+Target profit
profit before tax =
2- Profit = TSR – TC CM%

Or ( CM per unit × Q) – fixed expenses 12- Sales rev. to achieve a profit %

FC
= CM%− profit%
3- TC = VQ + FC
13- Sales units to achieve a target profit %:
4- Profit %= % TSR (% PQ)
Profit = TSR – TC
5- CM per unit = P – V

P−V
%TSR= TSR – TC
6- CM ratio = P
%PQ = PQ – VQ – FC
Sales−Variable expenses
Or = Sales
14-Margin of safety = Expected sales in $ or units
− BEP in units or $
Or = 1– Variable expense ratio

FC FC 15 CM% = Means additional profit

7- BEP in units = CM or
P−V

Cost Volume profit analysis 3

 EXERCISES ON CHAPTER TWO
Exercise one:
Given the following information of a certain company for December:
Sales $180,000
Fixed Manufacturing Costs 22,000 Total fixed cost
Fixed Marketing and Administrative Costs 14,000 $36000
Total Variable Cost 120,000
Price/Unit $9
Variable Manufacturing Cost/Unit 5
VC/units = $6
Variable Marketing Cost/Unit 1
REQUIRED:
a) Operating profit when sales are $180000
b) Breakeven quantity.
c) Quantity that would produce operative profit of $30,000
d) Quantity that would produce operating profit of 20% of sales dollars.
e) Breakeven sales quantity, if unit variable costs are reduced by 10%/product units, assuming no
changes in total fixed costs.
f) Sales dollars (Revenues) required to generate an operating profit of $20,000
g) Number of units sold in Dec.
ANSWER
(a) Operating profit (Target profit) = TR – TC
= 180,000 – (36,000 + 120,000)
=180,000 – 156,000
=$24,000
FC 36000
(b) BEPQ = P−V = = 12,000 units
9−6
(c) If the desired profit = $30,000
𝐹𝐶+𝑇𝑎𝑟𝑔𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 36000+30000
Units to achieve a target profit = = = 22,000 units
𝑃 –𝑉 9−6
(d) If the desired profit = 20% of sales dollars.
Target profit = TR – TC
20% PQ = PQ – F – VQ
0.2 (9Q) = 9Q – 36000 – 6Q
1.8 Q = 9Q – 6Q – 36000
1.8 Q = 3Q – 36000
36000 = 3Q – 1.8Q
36000 = 1.2Q So Q = 30,000 units
FC
Or Sales revenue to achieve target profit in $ = CM%− target profit % = $270,000 ÷ $9 (price) = 30,000
units
(e) If Vc/unit is reduced by 10%
So Vc/unit = 6 – 6(10%)
= 6 – 0.6 = $5.4/unit
Breakeven sales quantity =?
FC
BEP = P−V = 36000/ (9 – 5.4) = 10,000 units (as VC decreased, BE quantity decreased)
(f) If desired profit = $20,000 Sales dollars =? PQ
FC+target profit FC+ target profit 36000+20000
Sales revenue in ($) = = = = $ 168,000
(P−V)/P CM% (9−6)/9
(g) No of units sold in December = Sales ÷ SP/unit = 180,000 ÷ 9 = 20,000 units

Cost Volume profit analysis 4

 Exercise two:
Menlo Company distributes a single product. The company’s sales and expenses for last
month follow:
Total Per Unit
Sales $450,000 $30
Variable expenses 180,000 12
Contribution margin 270,000 $18
Fixed expenses 216,000
Net operating income $ 54,000
Required:
1. What is the monthly break-even point in unit sales and in dollar sales?
2. Without resorting to computations, what is the total contribution margin at the break-
even point?
3. How many units would have to be sold each month to earn a target profit of $90,000?
Use the formula method. Verify your answer by preparing a contribution format income
statement at the target sales level.
4. Refer to the original data. Compute the company’s margin of safety in both dollar and
percentage terms.
5. What is the company’s CM ratio? If sales increase by $50,000 per month and there is
no change in fixed expenses, by how much would you expect monthly net operating
income to increase?
ANSWER

1. Profit = Unit CM × Q − Fixed expenses

$0 = ($30 − $12) × Q − $216,000
$0 = ($18) × Q − $216,000
$18Q = $216,000
Q = $216,000 ÷ $18
Q = 12,000 units, or at $30 per unit, $360,000
Alternative solution:
Unit sales = Fixed expenses
to break even Unit contribution margin

$216,000
= = 12,000 units
$18
or at $30 per unit, $360,000
2. The contribution margin is $216,000 because the contribution margin is equal to the
fixed expenses at the break-even point.

3. Units sold to attain = Target profit + Fixed expenses

target profit Unit contribution margin
$90,000 + $216,000
=
$18
= 17,000 units

Cost Volume profit analysis 5

 Total Unit
Sales (17,000 units × $30 per unit) $510,000 $30
Variable expenses
(17,000 units × $12 per unit) 204,000 12
Contribution margin 306,000 $18
Fixed expenses 216,000
Net operating income $ 90,000

4. Margin of safety in dollar terms:

Margin of safety = Total sales - Break-even sales
in dollars
= $450,000 - $360,000 = $90,000
Margin of safety in percentage terms:
Margin of safety = Margin of safety in dollars
percentage Total sales
$90,000
= = 20%
$450,000

5. The CM ratio is 60%.

Expected total contribution margin: ($500,000 × 60%) $300,000
Present total contribution margin: ($450,000 × 60%) 270,000
Increased contribution margin $ 30,000
Exercise three:
Furniture, Inc., sells lamps for $30. The unit variable cost per lamp is $22. Fixed costs total
$9,600.

REQUIRED:
a. What is the contribution margin per lamp?
b. What is the breakeven point in lamps?
c. How many lamps must be sold to earn a pretax income of $8,000?
d. What is the margin of safety, assuming 1,500 lamps are sold?

ANSWER

Cost Volume profit analysis 6

Exercise four:
Alex Miller, Inc., sells car batteries to service stations for an average of $30 each. The variable
cost of each battery is $20 and monthly fixed manufacturing costs total $10,000. Other monthly
fixed costs of the company total $8,000.

REQUIRED:
a. What is the breakeven point in batteries?
b. What is the margin of safety, assuming sales total $60,000?
c. What is the breakeven level in batteries, assuming variable costs increase by 20%?
d. What is the breakeven level in batteries, assuming the selling price goes up by 10%, fixed
manufacturing costs decline by 10%, and other fixed costs decline by $100?
ANSWER

Exercise five:
The management of a certain company has performed cost studies and projected the following
annual cost based on 40,000 units of production and sales.
Costs Variable
Direct material $400,000 100%
Direct Labor 360,000 75%
Manufacturing OH 300,000 40%
Selling and general administrative 200,000 25%
REQUIRED:
(a) Compute the selling price per unit that will yield a projected 10% profit if sales are 40,000 units.
(b) Assume that management selects a selling price of $30 per unit; compute the dollar sales that
will yield a projected 10% profit on sales.

ANSWER
Variable cost Fixed cost

Direct material $400,000 --

Direct Labor 270,000 90,000
Manufacturing OH 120,000 180,000
Selling and general administrative 50,000 150,000
840,000 420,000

Cost Volume profit analysis 7

 840,000
Total fixed cost = 420,000 Variable cost/unit = = $21/unit n= 40,000 units
40,000
(a) If sales = 40,000 units Q= 40,000
P=? , if desired profit 10%
Profit (Target profit) = TR – TC
10% Sales Rev. = SR – F – VC
10% (40000 P) = 40000 P – 420000 – (40000 X 21)
4000 P = 40000 P – 420000 – 840000
4000 P = 40000 P – 1,260,000
1,260,000 = 40000 P – 4000 P
1,260,000 = 36000 P So P = $35

SR (40,000 x 35) 1 400 000

− TC:
Vc (40,000 x 21) 840,000
FC 420,000
(1,260,000)
Profit 140,000
(b) P = 30 , V = 21 , F = 420,000
F P−V 30−21
Sales Revenue = CM%− Target profit % where, CM % = = = 0.3
P 30

420,000
Sales Revenue = = $2,100,000 to achieve target
0.3−0.1
Exercise six:

Cost Volume profit analysis 8

 ANSWER
1- Q* = F ÷ (P – V) = 64000 ÷ (20 – 12) = 8000 units
2- Q Target profit = (64000 + 30000) ÷ (20 – 12) = 11750 units
3- CM% = (20 – 12) ÷ 20 = 40%
So additional sales of $25,000 will result in additional profit of $25,000 x 0.4=$10,000
4- Operating profit = TSR – VQ – FC
20%TSR = TSR – VQ – FC So, Q = 16000 units.
5- Margin safety = 10,000 units (sales) − 8000 units (BEP) = 2000 units or $40,000

Exercise seven
Wehr Corporation produces one product. Total fixed costs are $600,000.
The unit selling price is $60.00 and the unit variable cost is $45.00.
REQUIRED:
a. Compute the contribution margin per unit.
b. Compute the contribution-margin ratio.
c. Compute the break-even point in units.
d. Compute the break-even point in dollars.

ANSWER
A) $60.00 - $45.00 = $15.00
B) $15.00/$60.00 = 0.25
C) $600,000/$15.00 = 40,000 units
D) 40,000 × $60 = $2,400,000

Exercise eight
Stefanko Manufacturing has prepared the following income statement:

Sales $450,000
Cost of goods sold 200,000
Gross margin 250,000
Operating expenses 196,000
Operating income $54,000

According to company records, $100,000 of Cost of Goods Sold and $100,000 of Operating
Expenses are fixed.
REQUIRED:
A) Compute the contribution margin.
B) Compute the contribution margin ratio.
C) Compute the break-even point in sales dollars.
ANSWER
A) Fixed costs = $100,000 + $100,000 = $200,000
Variable costs = $100,000 + $96,000 = $196,000
Contribution Margin = $450,000 - $196,000 = $254,000
B) $254,000/$450,000 = 56.44%
C) $200,000/0.5644 = $354,359

Cost Volume profit analysis 9

Exercise nine
Bruder Company produces one type of product. Total fixed costs are $100,000. Unit variable costs
are $6.00. The break-even point is 25,000 units. Planned unit sales are 30,000.
REQUIRED:
A) Compute the selling price per unit.
B) Compute the contribution-margin ratio.
C) Compute the break-even point in dollars.

ANSWER
A) = 25,000
(X - 6)25,000 = 100,000
X = $10
B) ($10 - $6)/$10 = 0.40

C) 25,000 × $10 = $250,000

𝐹.𝐶 $100,000
Or = = $250,000
𝐶𝑀% 0.4

Exercise ten
Franklin Company produces only one product. The selling price is $100 per unit and the variable
cost is $60 per unit. Total fixed costs are $120,000.
REQUIRED:
A) Compute break-even point in units.
B) Compute break-even point in dollars.
ANSWER
A) $120,000/($100 - $60) = 3,000 units
B) 3,000 units × $100 = $300,000

Exercise eleven
The Eastman Family Restaurant is open 24 hours per day. Fixed costs are $24,000 per month.
Variable costs are estimated at $9.60 per meal. The average revenue is $12 per meal. The
restaurant wished to earn a profit before taxes of $6,000 per month.

REQUIRED:
B) Compute the number of meals that must be served to earn a profit before taxes of $6,000 per
month.
C) Assume that fixed costs increase to $30,000 per month. How many additional meals must be
served to earn a profit before taxes of $6,000 per month?
ANSWER

A) ($24,000 + $6,000)/($12.00 - $9.60) = 12,500 meals

B) ($30,000 + $6,000)/($12.00 - $9.60) = 15,000

15,000 – 12,500 = 2,500 meals

Cost Volume profit analysis 10

Exercise twelve
Sole Company manufactures running shoes. The selling price is $80 per pair (unit) and variable
costs are $60 per pair (unit). The sales volume of $776,000 generates $100,750 of net income
before taxes.
REQUIRED:
A) Compute total fixed costs.
B) Compute total variable costs.
C) Compute the break-even point in units.
D) Compute the quantity of units above the break-even point to reach targeted net income before
taxes.
ANSWER
A) $776,000/$80= 9,700 units
Variable costs= $60 × 9,700 = $582,000
Fixed costs= $776,000 - $582,000 - $100,750 = $93,250
B) 9,700 × $60 = $582,000
C) $93,250/ ($80 - $60) = 4,662.5 = 4,663 units
D) 9,700 - 4,663 = 5,038 units

Cost Volume profit analysis 11