Break-even 

is the point where total sales equal to total costs.                                                 

The Keynotes in computing the break-even point:                                                   

1. The net operating income (disregarding tax) is ZERO and would mean Total Sales = Total Cost.

2. Total cost would include both variable cost (constant per unit) and fixed cost (constant in total
amount) which is linear.

3. Since NOI is zero, then FC = CM

4. CM per unit is therefore also constant

5. Any other variables such as sales price are constant

6. If multiple products, the sales mix is constant.

7. Units sold = Units produced.

Let us apply the concept by solving the illustrative problem.

Mimi Company data:

Selling price per unit P50

Units produced 1,000

Units sold 1,500

Variable costs per unit:

Direct materials P12

Direct labor 20

Variable manufacturing overhead 1

Variable selling and admin 2

Fixed costs:

Fixed manufacturing overhead P3,000

Fixed selling and administrative 3,000

Given the above data, let us construct the Income statement under Variable costing:
In the above data, Mimi sold 1,500 units and the corresponding net operating income is P16,500.

Interpretation: To break-even, Mimi Company should sell 400 units.                                            

 The break-even point is 4,000 units and the break-even sales amount is P20,000.                                    

Things to remember:

1. Since NOI is zero, then, FC should be equal to CM.

2. As we all know, total fixed cost is constant regardless of the activity level. Hence, CM is also
P6,000.

3. VC is constant and the selling price in CVP analysis is also constant, therefore CM per unit should
also be constant.

4. The only thing that can change is the units sold and the total sales amount, total variable cost,
and total CM.

5. Formula: BE in units = FC / CM per unit

Note: To earn a net operating income of P906,000, Mimi should sell 60,800 units and sales revenue of
P3,040,000.

60,800 target sales units are computed by adding the P906,000 target NOI and P6,000 fixed cost to
arrive at the P912,000 contribution margin. The CM is then divided into CM per unit if P15.
Note: For Mimi to earn a P840,000 net income, the company should sell 80,400 units and have a
P4,020,000 sales revenue.

The target sales in units of 80,400 are computed by dividing by P840,000 target NI to 70%, to arrive at
P1,200,00 NOI. The NOI is then added to FC to arrive at CM of P1,206,000. The P1,206,000 is then
divided into P15 CM margin ratio.

Since corporate tax expense is generally 30% in the Philippines, the target NI is deducted by a 30%
income tax expense. This would mean that the target net income is 70% of the Net operating income.

Key considerations:

1. If CM per unit is not available, we use the CM ratio to compute for the break-even amount.

2. The CM ratio is computed using vertical analysis percentage. The total contribution margin
divided by total sales equals to CM ratio.

3. If we use the CM ratio, we can only compute for the break-even amount.

4. If we use CM per unit, the first thing we can compute is the break-even sales in units.

5. TFC is still constant and is equals to TCM, so we will be using it as the starting point.

Let us apply the key considerations by solving the illustrative problem.

Note: P100,000 break-even sales are computed by dividing the P40,000 fixed cost to the 40% CM ratio.

The 40% CM ration is computed by dividing the P80,000 CM to 200,000 sales.

The margin of safety (MOS) is the excess of the actual sales to break-even sales.

The margin of safety indicates the amount by which a company's sales could decrease before the
company will have no profit.

Formula: Actual sales - BE sales = MOS                                            

Degree of operating leverage (DOL) is the degree at any level of sales, how the percentage change in
sales volume affects profit.

Formula: CM / NOI = DOL

Using the data of Mimi Company, we compute for the MOS and DOL:

Interpretation: The change in sales volume will have 1.36 times the effect on profit.

Key concepts:

1. Since it is multiple products, the assumption is that the sales mix is constant.

2. We use the total CM ratio as a basis to compute the company's break-even sales and not the
individual product's CM ratio.

3. To distribute the break-even sales per product, we prorate the total break-even sales based on
the actual sales amount.

4. We use the actual CM ratio per product to distribute the CM per product line.

5. Formula: TFC / TCM ratio = BE sales amount

Let us apply the key concepts by solving the illustrative problem:

Note: The P120,000 break-even sales are computed by dividing 40% company's CM ratio by the
P120,000 total fixed cost.

The computation of the P180,000 break-even sales is: (360,000/600,000)*300,000.