MAS-02: COST-VOLUME-PROFIT (CVP) ANALYSIS

CVP analysis- is useful tor profit planning by way of a systematic analysis of the profit's relationship with
various costs and volume of sales.

FACTORS AFFECTING PROFTT

If there is an increase in … Then profit tends to …

1. Selling Price Increase
2. Unit Variable Cost Decrease
3. Fixed Cost Decrease
4. Volume (Unit Sales) Increase

In multi-product companies, a change in sales mix may also affect company profit.

LIMITATIONS and ASSUMPTIONS of CVP analysis

✔ Relevant range, time and linearity assumptions in MAS 01 are also assumed in CVP analysis.
✔ Unless indicated otherwise, unit selling price is constant even if sales volume changes.
✔ Inventories do not change significantly from period to period.
✔ In case of a multi-product company, sales iik 1s constant.
✔ Labor productivity, production technology and market conditions remain stable.

TERMINOLOGIES USED IN CVP ANALYSIS

Contribution Margin (CM) - is the difference between sales and variable cost. It is otherwise known as
marginal income, profit contribution, contribution to fixed cost or incremental
contribution.
● CM Ratio = CM ÷ Sales Unit CM+ Unit Selling Price
● CM Ratio= CM ÷ Sales
NOTE: The sign ‘ ‘ is used to mean change or difference

Break-Even Point (BEP) - a level of activity, in units (break-even volume) or in pesos (break even
sales), at which total revenues equal total costs At the break-even point,
there IS neither a profit nor a loss.
● BEP units = Fixed Costs ÷ CM per unit
● BEP peso sales = Fixed Costs ÷ CM Ratio
● Unit Sales with Target Profit - (Fixed Costs + Profit*) ÷ CM per unit
● Peso Sales with Target Return on sales = Fixed Costs
CM Ratio – Return on Sales
*Profit must be expressed before tax: Profit after tax (100%% - tax rate)

Margin of Safety - the difference between actual sales and break-even sales. It indicates the
maximum amount by which sales could decline without incurring a loss.
● Margin of Safety = Sales Breakeven Sales
● Margin of Safety Ratio= Margin of Safety Sales
●
Indifference Point - the level of volume at which two alternatives being analyzed would yield equal
amount of total costs or profits.
Alternative A Alternative B
● (Unit CM x Q) - Fixed Cost = (Unit CM x Q) -Fixed Cost
● Fixed Cost + (Unit VC x Q) = Fixed Cost + (Unit VC x Q)
NOTE: Q number of units (indifference point)

Sales Mix - the relative combination of quantities of sales of various products that make
up the total sales of a company
● Over-all BEP units Fixed Costs Weighted Average CM per unit
● Over-all BEP peso sales= Fixed Costs+ Weighted Average CM Ratio

Degree of Operating Leverage (DOL) - measures how a percentage change in sales will affect
company profits. It indicates how sensitive the company 1s to sales volume
increases and decreases. Tt 1s also known as operating leverage factor.
● DOL= Contribution Margin Profit before tax
● A % sales x DOL A% profit before tax
 EXERCISES COST-VOLUME-PROFIL ANALYSIS
1. Thor Company manufactures and sells a single product. The company's sales and experience month
follows
Sales (1,500 units) P 37,000
Less Variable Costs 15,000
Contribution Margin P 22,500
Less Fixed Costs 15,000
Profit 7,500
REQUIRED:
1.Determine the following
A) Unit selling price
B) Unit variable cost
C) Contribution margin ratio (CMR)
2. For profit planning purposes, compute the following.
A) Break-even point in units liO00
B) Break-even peso sales 23 000
3. What unit sales are required to earn P 12,000 profit for the month
4. What peso sales are required to earn an after tax profit of P 9,000 (assuming tax rate is 25%)
5. Assume that Thor Co. is currently selling 800 units per month and that the company president
believes that sales would increase if advertising were increased by P 6,000. How many units should
sales increase to give Thor Co. the same profit or l0ss that it is currently earning?
(NOTE although you know that 800 units are being sold at present you do not need this information
to solve the problem)
6. What is the margin of safety of Thor Co. at its present sales of P 37, 500?
7. Thor Co currently pays its salespeople a monthly salary of P 4,000 per month without any
commission However, the company considers a plan whereby the salespeople would receive a
109% commission, but the monthly salary would fall to P 2,500 What sales level will the company be
indifferent between the two compensation plans?
(Adapted and edited: Managerial Accounting by Louderback)
SOLUTION.GUIDE
(2) 1,000 units (3) 1,800 units (5) 800 units
Sales
Less: Variable Costs
Contribution Margin
Less: Fixed Costs
Profit (Loss)

Require No. 7
✔ Monthly fixed cost will decrease by P 1, 500 under the proposal (P 4,000 P2,500).
✔ Unit variable cost increases by P 2.50 (10% of P 25)
Based on cost function “Y = a + bX”
Costs (old) = Costs (new) 1,500- 2.5 X
15,000 10 X = 13,500 + 12.5 X X = 600 units

2. PROVING:
Contribution margin ratio x margin of safety ratio = net profit ratio
Where: Contribution margin ratio Contribution margin ÷ sales
Margin of safety ratio Margin of safety Sale
Net profit ratio= Profit Sales
3. Hulk’s break even sales are P 528,000. The variable cost ratio Is 60% while the profit ratio is 8%

REQUIRED: Determine the following

1. Fixed Costs
2. Sales
3. Profit
4 Margin of Safety
5. Margin of Safety Ratio
4. Mahjong Company produces and sells two products, tables and chairs Following 15 next month budget:

Chairs Tables Total

Unit sales: 60 u 15 u 75 u

Sales P 1,200.00 P 187.50 P 1,387.50

Variable Costs 1,050.00 112.50 1,162.50
Contribution Margin P 150.00 P 75.00 P 135.00

REQUIRED:
1) How many units of chairs should be sold next month to break-even
2.) How many units of tables should be sold to earn a profit of P 150?
(Adapted: Managerial Accounting by Garrison, et.al.)
SOLUTION GUIDE
Chairs Tables
Contribution Margin (CM) per unit P 2.50 P 5.00
Sales Mix (4:1 → 80%:20%) 80% 20%
Weighted Average CM per unit:

3. Ms Rita has recently opened the UBE Fitness Gym being offered exclusively for malnourished
millennials. The income statement for its first year of operations follows.
Sales P 250,000
Variable Costs (100,000)
Contribution Margin P150,000
Fixed Costs (120,000)
Profit P 30,000

Ms Rita is unhappy about the results of his gyms first year of operations She observed that despite the
high contribution margin, profit was still low because of the high fixed costs. She concludes that an
increase in sales would not yield a satisfactory increase in profit.

REQUIRED:
1. Explain to Ms. Rita that his conclusion Is not right by computing the operating leverage factor 4
2. If sales increase by 10%, then how many percent would profit increase, ceteris paribus?
(NOTE: determine the percentage A in profit by using the operating leverage factor.)
(Adapted: Managerial Accounting by Garrison, et al.)

WRAP-UP EXERCISES (TRUE OR FALSE, MULTIPLE-CHOICE)

1. At the break-even point, total contribution margin is
a. Zero c. Equal to total costs
b. Equal to total fixed costs d. Equal to total variable costs
2. Which of the following does NOT affect a company s break-even point?
a. Total fixed costs c. Unit selling price
b. Unit variable cost d. Number of units sold
3. An increase in the income tax rate
a. Raises the break-even point
b. Lowers the break-even point
c. Increases sales required to earn a particular after-tax profit
d. Decreases sales required to earn a particular after-tax profit
4. A company with a negative margin of 5afety also has a (an)
a. Operating loss c. Sales above its break-even point
b. Operating profit d. Sales equal to its break-even point
5 Under CVP analysis, which of the following is NOT assumed to be constant?
a. Unit variable cost c. Sales mix
b. Unit selling price d. Unit fixed cost
6. A % change in pre-tax profit can be quickly computed by multiplying a o change in peso sales by the
a. Sales mix c. Indifference point
b. Margin of safety d. Degree of operating leverage
7. The operating leverage factor is equal to
a. Gross margin profit after tax c. Contribution margin profit after tax
b. Gross margin profit before tax d Contribution margin profit before tax
8. If inventories are expected to change, the type of costing that provides the best information from
breakeven analysis is
a. Job-order costing c. Joint costing
b. Variable costing d. Absorption costing