MAS_1.2.

2 INTEGRATED REVIEW & REFRESHER IN ACCOUNTANCY

R.D.BALOCATING
UNIVERSITY OF LUZON
COLLEGE OF ACCOUNTANCY
CPA REVIEW CENTER

MANAGEMENT ADVISORY SERVICES

Cost-Volume-Profit ANALYSIS
 COST-VOLUME-PROFIT ANALYSIS
a. analysis of the relations between cost and profits under conditions of changing volumes.
b. used for measuring the functional relationships among the major factors affecting profits, and for determining the
profit structure of the firm.
 Factors that affect CVP relationships:
a. Selling price
b. Variable costs
c. Fixed costs
d. Sales mix
e. Level of activity (volume)
 Break-even point
a. the level of activity or volume of operation where total revenues and total expenses are equal.
b. the point of zero profit.
c. at break-even point, fixed costs equals contribution margin.
d. once the break-even point has been reached, net income will increase by the unit contribution margin for each
additional unit sold.
 Margin of safety
a. the excess of budgeted or actual sales over the break-even sales.
b. indicates how much sales may decrease before the company will suffer a loss.
c. the greater the margin of safety, the better it is for the company.
 Operating leverage
a. a measure of the extent to which fixed costs are being used in an organization.
b. is high in companies that have high proportion of fixed costs in relation to variable costs.
c. is low in companies that have a low proportion of fixed costs in relation to variable costs.
d. the degree of operating leverage is a measure, at a given level of sales, of how a percentage change in sales
volume will affect profits.
 Assumptions (limitations) in CVP analysis:
a. Relevant range—CVP analysis is limited to the company’s relevant range of activity.
b. Cost behavior identification—fixed and variable cost can be identified.
c. Linearity—the unit selling price and the unit variable costs are constant over all sales volume within the relevant range
of activity.
d. Equality of production and sales or inventories are constant.
e. Activity measure—the primary cost driver is the volume of units.
f. Constant sales mix
 Sensitivity Analysis (what-if technique)
a. shows how the financial model responds to changes in any or all of its variables.
b. typically, analysts focus on how changes will affect operating profits.
 Cost Structure
a. refers to the proportion of fixed and variable costs to total costs.
b. an organization’s cost structure has a significant effect on the sensitivity of its profit to changes in volume.
 FORMULA/EQUATION:
Contribution margin (CM) = Sales – Variable costs
Contribution margin per unit = Selling price per unit – Variable cost per unit
Contribution margin % = Contribution Margin OR 100% - Variable Cost %
Sales
Variable Cost % = Variable Cost OR 100% - Contribution Margin %
Sales
Break-even point in units = Fixed Cost
CM per unit
Break-even point in pesos = Fixed Cost
CM %
TARGET PROFIT ANALYSIS:
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MAS_1.2.2 INTEGRATED REVIEW & REFRESHER IN ACCOUNTANCY
R.D.BALOCATING
After-tax profit:
Sales = Fixed Costs + AP / (1 – Tax Rate)
CM %
AP = After Tax Profit
The divisor is CM per unit in computing sales units
Before-tax profit:
Sales = Fixed Costs + Profit
CM %
The divisor is CM per unit in computing sales units.
Margin of safety = Actual (Expected/Budgeted sales) – Break-even Sales
Margin of safety % = ________Margin of Safety______
Actual (Expected/Budgeted) Sales
Degree of operating leverage (DOL) = Contribution Margin
Operating Income
Profit ratio= CM % x MS %
DOL and MS% are reciprocal.
Hence; 1 / MS% = DOL and 1 / DOL = MS%
 GRAPHICAL REPRESENTATION OF CVP RELATIONSHIPS
The cost-volume-profit graph depicts the relationships among cost, volume, and profits.

Pesos Total Revenue

Profit

Total Cost

Break-Even Point

Loss

Units Sold

THEORY:
1. Which of the following is NOT an assumption underlying CVP analysis?
a. the behavior of total revenue is linear
b. unit variable expenses remain unchanged as activity varies
c. inventory levels at the beginning and end of the period are the same
d. fixed costs remain constant as activity changes
e. the number of units produced exceeds the number of units sold

2. Which of the following statements describes variable costs?

a. costs that vary on a per-unit basis as the level of activity changes
b. costs that vary in total in direct proportion to changes in the level of activity
c. costs that remain the same in total peso amount as the level of activity changes
d. costs that vary on per-unit basis but remain the same in total as the level of activity changes

3. Cost-volume profit analysis allows management to determine the relative profitability of a product by:
a. Highlighting potential bottleneck in the production process.
b. Keeping fixed cost to an absolute minimum.
c. Determining the contribution margin per unit and the projected profits at various levels of production.
d. Assigning cost to a product in a manner that maximizes the contribution margin.

4. At the break-even point, the contribution margin equals total:

a. Variable cost. c. Selling and administrative costs
b. Sales revenues. d. Fixed costs.

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R.D.BALOCATING
5. Cost-volume-profit analysis is a key factor in many decisions, including choice of product lines, pricing of products,
marketing strategy, and use of productive facilities. A calculations used in a CVP analysis is the breakeven point. Once
the BEP has been reached, operating income will increase by the:
a. Gross margin per unit for each additional unit sold.
b. Contribution margin per unit for each additional unit sold
c. Variable costs per unit for each additional unit sold
d. Sales price per unit for each additional unit sold

6. When an organization is operating above the breakeven point, the degree or amount that revenues may decline before
losses are incurred is the:
a. Residual income rate. c. Margin of safety
b. Marginal rate of return d. Target (hurdle) rate of return.

7. Cost-volume-profit relationships that are curvilinear may be analyzed linearly by considering only:
a. Fixed and semi-variable costs’ c. Relevant variable cost
b. Relevant fixed cost d. A relevant range of volume

8. The breakeven point in units increases when unit costs:

a. Increases and sales price remains unchanged c. Remain unchanged and sales price increase
b. Decreases and sales price remains unchanged d. Increases and sales price increases

9. A company’s breakeven point in pesos of revenue may be affected by equal percentage increases in both selling and
variable cost per unit (assume all factors are constant within the relevant range). The equal percentage changes in selling
price and variable cost per unit will cause the breakeven point in pesos of revenue to:
a. Decrease by less than the percentage increase in selling price
b. Decrease by more than the percentage increase in a selling price
c. Increase by the percentage change in variable cost per unit
d. Remain unchanged

10. Given the following notations, what is the breakeven sales levels in units?
SP = selling price per unit
FC = total fixed cost
VC = variable cost per unit
a. SP / (FC / VC) b. SP / [1 – (VC / SP)] c. VC / (SP – FC) d. FC / (SP – VC)

11. The percentage change in earnings before interest and taxes associated with the percentage change in revenues is the
degree of:
a. Operating leverage c. Breakeven leverage
b. Financial leverage d. Combined leverage

12. A cost-volume profit model developed in a dynamic environment determined that the estimated parameters used may
vary between limits. Subsequent testing of the model with respect to all possible values of the estimated parameters is
termed:
a. A sensitivity analysis c. Statistical hypothesis testing
b. Statistical estimation d. A time series study

13. The contribution margin per unit is the difference between the selling price and the variable cost per unit, and the
contribution margin ratio is the ratio of unit contribution margin to the selling price per unit. If the selling price and the
variable cost per unit both increase 10% and fixed costs do not change, what is the effect on the contribution per unit and
the contribution margin ratio?
a. Both remain unchanged.
b. Both increase.
c. Contribution margin per unit increases, and the contribution margin ratio remains unchanged.
d. Contribution margin per unit increases and the contribution margin ratio decreases.

14. In profit-volume graph, the cost/volume/profit relationships are represented. The vertical axis is the profit in pesos and the
horizontal axis is the volume in units. The diagonal line is the contribution margin line. The point at which the contribution
margin line intersects the zero profit line is the point:
a. At which volume level is zero. b. At which total cost equals the total sales.

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R.D.BALOCATING
c. At which sales increases. d. At which total variable cost equals total sales.

15. The indifference point is the level of volume at which a company:

a. earns the same profit under different operating c. earns its target profit
schemes d. any of the above
b. earns no profit

16. Cost-volume-profit analysis includes some inherent simplifying assumptions. Which of the following is not one of these
assumptions?
a. Cost and revenues are predictable and are linear over the relevant range
b. Variable costs fluctuate proportionally with volume
c. The inventories do not change
d. Sales mix will change as fixed costs increase beyond the relevant range

17. If the fixed costs attendant to a product increase, while variable costs and sales price remain constant, what will happen
to (1) contribution margin and (2) break-even point?
Contribution Margin Break-even Point
a. unchange increase
b. unchange unchange
c. increase decrease
d. decrease increase

18. What does sensitivity analysis refers to?

a. control.
b. what-if situations.
c. variable costs only.
d. fixed costs only.

19. The cost structure of an organization refers to which of the following?

a. proportion of fixed and variable costs to total costs.
b. proportion of total revenue to total costs.
c. proportion of profits to total costs.
d. None of the answers is correct.

20. Operating leverage is high in firms with:

Fixed Costs Variable Costs Contribution Margin Per Unit
a. small proportion high proportion high
b. high proportion small proportion high
c. small proportion high proportion low
d. high proportion small proportion low

PROBLEMS:
1. Tech Mouse Inc. makes a special mouse for computers. Each mouse sells for P25 and annual production and sales
are 120,000 units. Costs for each mouse are as follows:
Direct materials P 6.00
Direct labor 3.00
Variable overhead 0.80
Variable selling expenses 2.20
P12.00
Total fixed expenses P589,550
a. Calculate the unit contribution margin in peso and the contribution margin ratio for the product.
b. Determine the break-even point in number of mice.
c. Determine the break-even point in peso sales.
d. Determine the margin of safety in units, in pesos, and in percentage.
e. Calculate the degree of operating leverage. If sales increase by 25%, by what percentage would pre-tax income
increase.
f. How many number of units must the company sell in order to have pre-tax profit of P996,450.
g. If the company is subject to 20% tax rate, how many units must be sold in order to have after-tax profit of P657,800.

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MAS_1.2.2 INTEGRATED REVIEW & REFRESHER IN ACCOUNTANCY
R.D.BALOCATING
2. Brugger Corp. reports the following information concerning the firm’s three products:
X Y Z
Price P150 P25 P80
Variable cost 100 10 60
If fixed costs are P255,000 and the product mix is 3 X, 6 Y and 5 Z, compute:
a. weighted average contribution margin ratio
b. weighted average contribution margin per unit
c. breakeven point in pesos and in units.

3. A company with a break-even point at P900,000 in sales revenue and had fixed costs of P225,000. When actual sales
were P1,000,000 variable costs were P750,000. Determine
a. the margin of safety expressed in pesos
b. the margin of safety expressed as a percentage of sales
c. the contribution margin ratio, and
d. the operating income.

4. EMC sells one of its products, a piece of soft-sided luggage, for P60. Variable cost per unit is P34, and monthly fixed
costs are P60,000. A combination of changes in the EMC produces and sells this product could reduce per unit
variable cost to P28 but increase monthly fixed costs to P104,000.
a. Determine the monthly breakeven points under the two available alternatives.
b. Determine the indifference point.

5. The break-even units are 600. At break-even, variable costs are P600 and the fixed costs are P450. The 601st unit sold
will contribute net profit of:
a. P0.75 c. P0.25
b. P1.00 d. P0.50

6. The break-even point is 35,000 units. Each unit is sold for P6.25. The variable cost per unit is P3.80. What are the fixed
costs within this relevant range of operations?
a. P 85,750 b. P133,000 c. P 9,210 d. P 92,100

7. Sylbe Company sells its product for P6 per unit. Fixed costs are expected to be P200,000 and variable costs are expected
to be P4 per unit. How many units must be sold to provide a target profit of P40,000?
a. 50,000 b. 60,000 c. 100,000 d. 120,000

8. The fixed costs are P24,000 and the CM Ratio is 30%. The margin of safety is P45,000. The current level of sales must
be:
a. P125,000 b. P 80,000 c. P 69,000 d. P 89,700

9. A firm's degree of operating leverage is 5. Should the sales volume of the firm increase by 30%, the net income will:
a. increase by 30% b. increase by 15% c. increase by 150% d. increase by 6%

10. A firm's current contribution margin is P30,000 and its degree of operating leverage is 6. Sales are to increase by 50%.
The firm's degree of operating leverage following the increase in sales volume will be:
a. 6.0 b. 3.0 c. 2.25 d. 18.0

11. MIDA Manufacturing reported the following:

Product A B C
Sales pesos P20,000 P40,000 P80,000
Contribution margin ratio 20% 25% 40%
The overall contribution margin ratio for the sales mix is:
a. 28.33% b. 32.86% c. 30.00% d. 32.50%

12. A firm pays income taxes at the rate of 45% and plans for an after-tax target profit of P88,000. Estimated fixed expenses
and CM ratio are P200,000 and 40%, respectively. The required peso sales volume to achieve the target net profit is:
a. P720,000 b. P988,889 c. P900,000 d. P621,000

13. A firm pays income taxes at the rate of 40% and plans for an after-tax target profit of P60,000. Estimated fixed expenses
are P200,000. The required total contribution margin to achieve the target profit is:

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R.D.BALOCATING
a. P300,000 b. P365,000 c. P226,400 d. P239,600

Information for next two questions:

A company that sells its single product for P40 per unit uses cost-volume-profit analysis in its planning. The company’s after-
tax net income for the past year was P1,188,000 after applying an effective tax rate of 40%. The projected cost for
manufacturing and selling its single product in the coming year are as follows:
Variable cost
Direct material P5.00
Direct labor 4.00
Manufacturing overhead 6.00
Selling and administrative costs 3.00
Total cost per unit P18.00
Annual fixed operating costs:
Manufacturing overhead P6,200,000
Selling and administrative costs 3,700,000
Total annual fixed costs P9,900,000

14. The sales volume required in the coming year to earn the same after-tax net income as the past year is
a. P20,160,000 b. P21,600,000 c. P23,400,000 d. P26,400,000

15. The company has learned that a new direct material is available the will increase the quality of its product. The new
material will increase the direct material costs P3 per unit. The company will increase the selling price of the product to
P50 per unit and increase its marketing costs by P1,575,000 to advertise the higher-quality product. The number of units
the company has to sell in order to earn a 10% before-tax return on sales would be
a. 337,500 units b. 346,875 units c. 425,000 units d. 478,125 units

16. A company has just completed the final development of its only product, general recombinant bacteria, which can be
programmed to kill most insects before dying themselves. The product has taken 3 years and P6,000,000 to develop.
The following cost are expected to be incurred on a monthly basis for the normal production level of 1,000,000 pounds of
the new product:
1,000,000 pounds
Direct materials P300,000
Direct labor 1,250,000
Variable factory overhead 450,000
Fixed factory overhead 2,000,000
Variable selling, general, and administrative expenses 900,000
Fixed selling, general, and administrative expenses 1,500,000
Total P6,400,000
At a sales price of P5.90 per pound, the sales in pounds necessary to ensure a P3,000,000 profit the first year would
be ( to the nearest thousand pounds)
a. 13,017,000 b. 14,000,000 c. 15,000,000 d. 25,600,000
pounds pounds pounds pounds

17. A company with P280,000 of fixed costs has the following data:

Product A Product B
Sales price per unit P5 P6
Variable cost per unit P3 P5
Assume three units of A are sold for each unit of B. Revenues for product B at the breakeven point will equal:
a. P200,000 b. P240,000 c. P600,000 d. P840,000

18. Acids, Inc. produces and sells three major acids: A, B, and C. it sells to industrial users who use and buy these acids, in
the following ratio:
Three (3) measures of A for one (1) measure of C, two (2) of B per one (1) measure of A.
The company makes the following per measure contribution margin:
A - P30 B - P45 C - P90
Fixed costs amounted to P1.8 million. At breakeven point, the volume of A to be sold would be:
a. 12,000 b. 36,000 c. 24,000 d. 4,000

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R.D.BALOCATING
19. Carl Company currently sells 400,000 bottles of perfume each year. Each bottle costs P.84 to produce and sells for P1.00.
Fixed costs are P28,000 per year. The firm has annual interest expense of P6,000, preferred stock dividends of P2,000
per year, and 40% tax rate. The degree of operating leverage for Carl is:
a. 2.4 b. 1.78 c. 2.13 d. 1.2

20. Two companies are expected to have annual sales of P1 million decks of playing cards next year. Estimates for next year
are presented below

Company A Company B
Selling price per deck P3.00 P3.00
Cost of paper per deck .62 .65
Printing ink per deck .13 .15
Labor per deck .75 1,25
Variable overhead per deck .30 .35
Fixed costs P960,000 P252,000

Given these date, which of the following responses is correct?

Volume in
Units at which
Breakeven Point Breakeven Point Profits of Co. A &
In units for Co. A in units for Co. B Co. B are equal
a. 800,000 420,000 1,180,000
b. 800,000 420,000 1,000,000
c. 533,334 105,000 1,000,000
d. 533,334 105,000 1,180,000