COST- VOLUME PROFIT ANALYSIS

► Examines the behaviour of total revenues, total costs, and operating income as changes occur in the
output level, selling price, variable cost per unit or fixed costs of a product.

ELEMENTS OF CVP ANALYSIS

1. Sales

1.1 Selling Price

1.2 Units or Volume

2. Total Fixed Costs

3. Variable Cost per unit

APPLICATIONS OF CVP ANALYSIS

Planning and Decision Making which may involve choosing the:

1. Type of product to produce and sell

2. Pricing policy to follow

3. Marketing strategy to use

4. Type of productive facilities to acquire

THE CONTRIBUTION MARGIN INCOME STATEMENT

Sales (units x selling price) xxx

Less: Variable Costs (units x variable cost per unit) xxx

Contribution Margin xxx

Less: Total Fixed Costs xxx

Income before Tax xxx

Note: The Contribution Margin Income Statement is prepared for management’s own use

INHERENT SIMPLIFYING ASSUMPTIONS OF CVP ANALYSIS

1. All costs are classifiable as either variable or fixed

2. Total variable costs change directly with the cost driver, but variable costs per unit are constant
over the relevant range.

3. Total fixed costs are constant over the relevant range, but fixed costs per unit vary inversely with
the cost driver or volume.
 4. Selling Prices per unit and market conditions remain unchanged

5. Changes in the level of revenues and costs arise only because of changes in the number of
product (or service) units produced and sold.

Cost Volume Profit Equations -- Single Product

Illustrative Example:

CHIQUI CHIKADORA sells products A and B. Data are as follows:

A B

Selling Price P 18 P 24

Variable Costs Per Unit P6 P9

Fixed Costs P 50,000 P 80,000

The following relationships may be established if the five elements are known.

a)   Contribution Margin per unit or marginal income per unit

This is the excess of unit selling price over unit variable costs and the amount each unit sold
contributes toward

1)            Covering fixed costs and

2)     Providing operating profits.

Formula:

CM per unit = Unit selling price - unit variable costs

Using the Illustrative Problem above:

A B

Selling Price P 18 P 24

Variable Costs Per Unit P6 P9

Contribution Margin Per Unit P 12 P 15

b)   Contribution Margin ratio/percentage

This is the percentage of contribution margin to total sales.   This ratio is computed as
follows:
 CM Ratio = Contribution Margin/ Unit

                  Selling Price

Using the Illustrative Problem above:

A B

Contribution Margin/ Sales P 12/ P 18 = 0.67 or 67% P 15/ P 24 = 0.625 or 62.5%

The CM ratio is very useful in that it shows how the contribution margin will be affected by a given peso
change in total sales. For instance, if a company's CM ratio is, 40%, it means that for each peso increase in
sales, total contribution margin will increase by P0.40. Net income likewise will increase by P0.40
assuming that there are no changes in fixed costs.

The CM ratio is particularly valuable in those situations where the manager must make trade-offs bet. Change
in selling price and change in variable cost.

c)  Break Even Point

     This is the level of sales volume where the total revenues and total expenses are equal, that is, there is
neither profit nor loss. This may be computed as follows.

1) Breakeven point (units) = total FC/CM per unit

A B

Total Fixed Costs/ CM per unit P 50,000/ 12 = 4,167 P 80,000/ 15 = 5, 333 units
units

2) Breakeven point (pesos) = total FC/ CM ratio/percentage

A B

Total Fixed Costs/ CM ratio P 50,000/ * 0.67 = P 80,000/ 0.625 = P 128,000

P75,000

To prove:

A B

Sales P 75,000 P 128,000

 Less: Variable Costs P 25,000 P 48,000
Product A= (50,000/12 x P 6)

Product B= (80,000/15 x P 9)

Contribution Margin P 50,000 P 80,000

Less :Fixed Costs P 50,000 P 80,000

Net Income P0 P0

d) Required Sales with desired profit

This is the amount of sales needed to earn a desired amount of profit. The equation that may be used to
compute for this follows:

Sales (unit) = total FC + desired profit/CM per unit

Assume the company desires a profit of P 130,000

A B

Total Fixed Costs + Desired P 50,000 + P 130,000/ 12 P 80,000 + P 130,000/ 15 =

Profit/ CM per unit = 15,000 units 14,000 units

Sales (peso) = total FC+ desired profit/CM ratio

A B

Total Fixed Costs + Desired P 50,000 + P 130,000/ P 80,000 + 130,000/ 0.625 =

Profit/ CM ratio *0.67 = P 270,000 P 336,000

To prove:

A B

Sales P 270,000 P 336,000

Less: Variable Costs P 90,000 P 126,000

Product A= (180,000/12 x P
6)

Product B= (210,000/15 x P
9)

Contribution Margin P 180,000 P 210,000

Less :Fixed Costs P 50,000 P 80,000

 Net Income P 130,000 P 130,000

e) Required sales with a desired profit after tax

This is the amount of sales needed to earn a desired amount of profit. The equation that may be used to
compute for this follows:

Sales (unit) = Total Fixed Cost + Desired profit after tax

1- Tax rate

Contribution Margin per unit

Assume the company desires a profit after tax of P 220,000. Tax rate is at 30%

A B

Desired Sales in Units after tax 30,357 units 26, 286 units

Sales (peso) = Total Fixed Cost + Desired profit after tax

1- Tax rate

Contribution Margin ratio

A B

Desired Sales in pesos after tax P 546,429 P 630, 857

To prove:

A B

Sales * P 546,429 *P 630,857

Less: Variable Costs * P 182,143 * P 236,572

Product A= (50,000 +
*314,286/12 x P 6)

Product B= (80,000 + * 314,

286/15 x P 9)

Contribution Margin P 364,286 P 394,285

Less :Fixed Costs P 50,000 P 80,000

Net Income before tax P 314,286 P 314,285

 Less: Income Tax (30%) P 94,286 P 94,286

Net Income after tax P 220,000 *P 220,000

f) Margin of Safety

This is the excess of actual budgeted sales over break-even sales and indicates the amount by which sales
could decrease before losses are incurred. Once the margin of safety is determine, the MS ratio may be
computed as follows

MS in Pesos = Actual sales in Pesos – Breakeven Sales in Pesos.

Assume the company generated actual sales of P 350,000

A B

MS in Pesos P 275,000 P 222,000

Product A = P 350,000- 75,000

Product B = P 350,000 – 128,000

MS in Units = Actual sales in Units – Breakeven Sales in Units

Assume the company generated actual sales in units of 10,000 units

A B

MS in Units 5, 833 units 4,667 units

Product A = 10,000 units- 4, 167

units

Product B = 10,000 units – 5,

333 units

MS ratio in units= margin of safety (P)/actual or budgeted sales

A B
MS Ratio 0.58 or 58% 0.47 or 47%

Product A = 5,833/ 10,000

Product B = 4,667/10,000