MAS 2303

Cost-Volume-Profit Analysis
John Carlos S. Wee, CPA MBA and Ralph Jorline M. Chua, CPA RCA

CONCEPT NOTES

Nature of CVP Analysis

Definition of CVP Analysis

Cost-Volume-Profit (CVP) Analysis – a systematic examination of the relationships among costs, cost
driver/activity level /volume, and profit. It is a powerful tool used by the management in order to help them
understand the interrelationship among cost, volume and profit in an organization by focusing on
interactions between five CVP elements.

The Elements of CVP Analysis

1. Sales price of a product
2. Volume or level of activity (within a relevant range)
3. Variable cost per unit
4. Total fixed cost
5. Sales mix

Application of CVP Analysis

CVP Analysis may be applied to the planning and decision-making function of the management, which may
involve choosing the
1. type of product to produce and sell;
2. pricing policy to follow;
3. marketing strategy to use; and
4. type of productive facilities to acquire.

Simplifying Assumptions of CVP Analysis

1. All costs are classifiable as either variable or fixed (components of mixed costs are already
segregated).
2. Cost and revenue relationships are predictable and linear over a relevant range of activity and a
specified period of time.
3. Variable costs per unit and total fixed costs remain constant over the relevant range.
4. Unit sales price and market conditions remain unchanged.
5. Changes in costs in revenue are brought about by changes in volume alone.
6. There is no significant change in the level of inventory (Production = Sales).
7. Sales mix remains constant (for a company that sells multiple products).
8. Technology, as well as productive efficiency, is constant.
9. Time value of money concept is ignored.

Break-Even Analysis and Target Profit Analysis in a Single-Product Company

Definition of Break-Even Point
Break-Even Point – the sales volume (in pesos or in units) where total revenues equal total costs (TR = TC).
Thus, at this point, the entity experiences neither profit nor loss (TR – TC = 0).
Methods of Computing Break-Even Point
Break-even sales can be computed using any of the following methods:
1. Graphic Approach
2. Equation Method or Algebraic Approach
3. Formula or Contribution Margin Approach
Graphic Approach
CVP Graph – also called break-even chart, it depicts the relationship of cost, volume, and profit in a
graphical form. In this graph, the point where the total cost line intersects with the total
revenue/sales line represents the break-even point.

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Steps in preparing the break-even chart:
1. Draw a line parallel to the volume axis to represent total fixed expense.
2. Choose some volume of unit sales and plot the point representing total expense (fixed and variable)
at the sales volume you have selected. After the point has been plotted, draw a line through it back to
the point where the fixed expense line intersects the dollars axis.
3. Again choose some sales volume and plot the point representing total sales dollars at the activity
level you have selected. Draw a line through this point back to the origin.
Pesos

Equation Method or Algebraic Approach

This method uses the profit equation and applies algebraic techniques in computing the break-even point.
Profit Equation:
NI = TR – TC where: NI = profit/net income
TR = total revenue (sales)
TC = total cost
TR = SP/u X Salesu where: SP/u = sales price per unit
Salesu = units sold
TC = TVC + TFxC where: TVC = total variable costs
TFxC = total fixed costs
TVC = VC/u X Salesu where: VC/u = variable cost per unit
Salesu = units sold
Thus, expanding the Profit Equation:
NI = (SP/u X Salesu) – [(VC/u X Salesu) + TFxC]
NI = [(SP/u X Salesu) – (VC/u X Salesu)] – TFxC
NI = [(SP/u – VC/u) X Salesu] – TFxC
NI = (Unit CM X Sales) – TFxC

Contribution Margin Method or Formula Approach

This method uses directly the formula in finding Break-even point (in units or in pesos).
Break-Even Point in Pesos (BEPP)

When the BEP in units is already known, the BEPP can be computed as
BEPP = BEPu X Sales Price per Unit (SP/u)
Break-Even Point in Units (BEPu)

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Target Profit Analysis
At certain instances, entities need to determine the volume of sales (in pesos or in units) that they need in
order to achieve a specified amount of desired/targeted profit. In determining the targeted sales for a desired
profit, the formula in finding for the BEP will still be used, substituting the zero-value for profit with the
amount of the desired profit. Thus,
In Pesos In Units

where: TS = Targeted sales

DP = Desired profit before tax
After-tax Desired Profit
When the amount of the desired is expressed in an after-tax amount, said amount would have to be grossed-
up/converted into its before-tax equivalent before added to the amount of the total fixed cost. To compute
for the before-tax profit, the formula is:

Desired Profit as a Percentage of Sales

When the desired profit is expressed not as an amount, but as a percentage of sales, the formula to compute
for the required sales can be derived based on the formula above, substituting the DP with the expression
Profit Ratio (PR) multiplied by TS; thus,

*P/u = SP/u X PR

Break-Even Analysis and Target Profit Analysis in a Multiple Product Company

Multi-Product BEP – the total volume of sales (in pesos or in units) that a company that produces and/or
sells multiple products generates where the company experiences neither loss nor profit.
Product BEP – the share of an individual product in the total BEP of a multiple product company based on
the predetermined sales mix of the company’s products.
Sales Mix – the relative proportion in which a company’s products are sold.
Break-Even Analysis for a Multiple Product Company
In a multiple product company, determining the break-even point may involve additional computations due
to the following considerations:
1. Fixed costs incurred by a company cannot be usually identified with the specific products that the
company produces and/or sell.
2. Each product may differ in terms of its contribution to the profit of the company due to the difference
in selling price, variable costs, and sales volume of each product, thus differently contributes to the
recovery of the total fixed costs incurred by the entity.
In order to compute for the BEP for multiple product company, instead of using a single CMR or CM/u, it is
required that the same shall be expressed in terms of their weighted average values (WaCMR and WaUCM)
using the sales mix of each product as basis for weight assignment.

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The WaCMR and WAUCM can be computed using the following formulae:

Sales mix ratios (SM) in pesos and in units for each product may be computed as follows:

The BEP shall then be distributed to the different products using the following formule:

Target Profit Analysis

Target sales determination in a multiple product company is basically similar to that of a single product
company.

Margin of Safety
Margin of Safety – the excess of budgeted (or actual) sales over the creak-even volume. It is the amount or
units of sales by which actual or budgeted sales may be dropped/decreased without resulting into a
loss.

Operating Leverage
Operating Leverage – a measure of how sensitive net operating income is to a given percentage change in
sales. It is also considered as the extent to which a company uses fixed costs in its cost structure.
Degree of Operating Leverage (DOL) – also called the Operating Leverage Factor (OLF), this serves as
multiplier in measuring the extent of the change in profit before tax resulting from the change in sales.

To compute for the percentage change in profit:

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PROBLEM SOLVING
1. Jose’s cabinets sells a product for P360/unit. The company’s variable cost per unit is P60 for direct material, P40 per
unit for direct labor, P34 per unit for overhead, and P10 per unit for selling and administrative expenses. Annual fixed
production overhead is P74,800, and fixed selling and administrative cost is P50,480.
a. What is the contribution margin per unit?
b. What is the contribution margin ratio?
c. What is the break-even point in units?
d. Using the contribution margin ratio, what is the break-even point in sales pesos?
e. If Jose’s cabinets wants to earn a pre-tax profit of P51,840, how many units must the company sell?
f. Assume a tax rate for the company of 30%. If Jose’s cabinets wants to earn an after-tax profit of P135,800, how
many units must the company sell?

2. David wants to cash in on the increased demand for ethanol. Accordingly he purchased a corn farm in Mindanao.
David believes his corn crop can be sold to an ethanol plant for P4.80 per kilo. Variable cost associated with growing
and selling a kilo of corn is P4.00. David’s annual fixed cost is P132,000.
Required:
a. What is the break-even point in sales pesos and kilos of corn?
b. If David actually produces 200,000 kilos, what is the margin of safety in kilos, in pesos, and as a percentage?

3. Morgy Tire Co. manufactures tires for all-terrain bicycles. The tires sell for P60 and variable cost per tire is P45;
monthly fixed cost is P450,000.
Required:
a. Calculate the firm’s break-even point in sales pesos.
b. If the company is currently selling 40,000 tires monthly, what is the degree of operating leverage?

4. The Gloss Menagerie makes small pressed resin ducks and ducklings For every duck sold, the company sells foru
ducklings. The following information is available about the company’s seling prices and cost:
Ducks Ducklings
Seling price P24 P12
Variable cost 12 7.20
Annual fixed cost 62,400
a. Calculate the monthly break-even point in units and in pesos if fixed costs are incurred evenly throughout the
year.
b. If the company wants to earn P37,440 pre-tax profit monthly, how many units of each product must it sell?

5. ANGEL Corporation has the following income statement for the year 2015:
Sales (@P28 per unit) 588,000
Cost of goods sold 507,500
Gross Profit 80,500
Other expenses 17,500
Profit before tax 63,000

Cost of goods sold is considered a mixed cost. At10,000 units (the lowest activity level), Cost of Goods Sold is at
P282,000. At 25,000 units (the highest activity level), it would cost P589,500.
Other expenses compose of 60% variable and 40% fixed.
a. What is the variable cost per unit of ANGEL Corporation?
b. What should be the sales to obtain a profit of 35,000?
c. If the management can look for ways on how to decrease the direct labor, what would be the decrease in the
variable cost per unit if the target breakeven sales would be Php 210,000?

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5. Bazooka Company is a small but growing manufacturer of telecommunications equipment. The company has no sales
force of its own; rather, it relies completely on independent sales agents to market its products. These agents are paid
a commission of 15% of selling price for all items sold.

Barbara Cruz, Bazooka's controller, has just prepared the company's budgeted income statement for next year. The
statement shows the following:

As Barbara handed the statement to Karl Vega, Bazooka's president, she commented, "I went ahead and used the agents
15% commission rate in completing these statements, but we've just learned that they refuse to handle our products
next year unless we increase the commission rate to 20%."

"That's the last straw," Karl replied angrily. "Those agents have been demanding more and more, and this time they've
gone too far. How can they possibly defend a 20% commission rate?"

"They claim that after paying for advertising, travel, and the other costs of promotion, there's nothing left over for
profit," replied Barbara.

"I say it's just plain robbery," retorted Karl." And I also say it's time we dumped those guys and got our own sales force.
Can you get your people to work up some cost figures for us to look at?"

"We've already worked them up," said Karl. “Several companies we know about pay a 7.5% commission to their own
salespeople, along with a small salary. Of course, we would have to handle all promotion costs, too. We figure our fixed
costs would increase by P2,400,000 per year, but that would be more than offset by the P3,200,000 (20% x
P16,000,000) that we would avoid on agents' commissions." The breakdown of the P2,400,000 cost follows:
Salaries:
Sales Manager P 100,000
Salesperson 600,000
Travel and entertainment 400,000
Advertising 1,300,000
Total P 2,400,000

"Super," replied Karl. "And I noticed that the P2,400,000 is just what we're paying the agents under the old 15%
commission rate."

It's even better than that," explained Barbara, "We can actually save P75,000 a year because that's what we're having
to pay the auditing firm now to check out the agent's reports. So our overall administrative costs would be less."

“Pull all of these numbers together and we'll show them to the executive committee tomorrow," said Karl. "With the
approval of the committee, we can move on the matter immediately."

a. What is the BEP in pesos for next year assuming that the agents’ commission rate remains unchanged at 15%?
b. What is the breakeven point in pesos for next year assuming that the agents’ commission rate is increased to 20%?
c. What is the breakeven point in pesos for next year if the company employs its own sales force?
d. Assume that Bazooka Company decides to continue selling through agents and pays the 20% commission rate. The
volume of sales that would be required to generate the same net income as contained in the budgeted income statement
for next year would be
e. The volume of sales at which net income would be equal regardless of whether Bazooka Company sells through agents
(at a 20% commission rate) or employs its own sales force is?

MULTIPLE CHOICE QUESTIONS

1. CVP analysis requires costs to be categorized as
A. either fixed or variable. B. fixed, mixed, or variable.
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 C. product or period. D. standard or actual.

2. With respect to fixed costs, CVP analysis assumes total fixed costs
A. per unit remain constant as volume changes.
B. remain constant from one period to the next.
C. vary directly with volume.
D. remain constant across changes in volume.

3. CVP analysis relies on the assumptions that costs are either strictly fixed or strictly variable. Consistent with these
assumptions, as volume decreases total
A. fixed costs decrease. C. costs decrease.
B. variable costs remain constant. D. costs remain constant.

4. According to CVP analysis, a company could never incur a loss that exceeded its total
A. variable costs. C. costs.
B. fixed costs. D. contribution margin.

5. CVP analysis is based on concepts from

A. standard costing. C. job order costing.
B. variable costing. D. process costing.

6. Cost-volume-profit analysis is a technique available to management to understand better the interrelationships of

several factors that affect a firm's profit. As with many such techniques, the accountant oversimplifies the real
world by making assumptions. Which of the following is not a major assumption underlying CVP analysis?
A. All costs incurred by a firm can be separated into their fixed and variable components.
B. The product selling price per unit is constant at all volume levels.
C. Operating efficiency and employee productivity are constant at all volume levels.
D. For multi-product situations, the sales mix can vary at all volume levels.

7. In CVP analysis, linear functions are assumed for

A. contribution margin per unit. C. total costs per unit.
B. fixed cost per unit. D. all of the above.

8. Which of the following factors is involved in studying cost-volume-profit relationships?

A. product mix C. fixed costs
B. variable costs D. all of the above

9. Cost-volume-profit relationships that are curvilinear may be analyzed linearly by considering only
A. fixed and mixed costs. C. relevant variable costs.
B. relevant fixed costs. D. a relevant range of volume.

10. After the level of volume exceeds the break-even point

A. the contribution margin ratio increases.
B. the total contribution margin exceeds the total fixed costs.
C. total fixed costs per unit will remain constant.
D. the total contribution margin will turn from negative to positive.

11. Which of the following will decrease the break-even point?

Decrease in fixed cost Increase in direct labor cost Increase in selling price
A. yes yes yes
B. yes no yes
C. yes no no
D. no yes no

12. At the break-even point, fixed costs are always

A. less than the contribution margin. C. more than the contribution margin.
B. equal to the contribution margin. D. more than the variable cost.

13. The method of cost accounting that lends itself to break-even analysis is
A. variable. C. absolute.
B. standard. D. absorption.

14. Given the following notation, what is the break-even sales level in units?
SP = selling price per unit, FC = total fixed cost, VC = variable cost per unit
A. SP/(FC/VC) C. VC/(SP - FC)
B. FC/(VC/SP) D. FC/(SP - VC)

15. Consider the equation X = Sales - [(CM/Sales) x (Sales)]. What is X?

A. net income C. contribution margin
B. fixed costs D. variable costs
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16. If a firm's net income does not change as its volume changes, the firm('s)
A. must be in the service industry. C. sales price must equal P0.
B. must have no fixed costs. D. sales price must equal its variable costs.

17. Break-even analysis assumes over the relevant range that

A. total variable costs are linear. C. total variable costs are nonlinear.
B. fixed costs per unit are constant. D. total revenue is nonlinear.

18. To compute the break-even point in units, which of the following formulas is used?
A. FC/CM per unit C. CM/CM ratio
B. FC/CM ratio D. (FC+VC)/CM ratio

19. A firm's break-even point in dollars can be found in one calculation using which of the following formulas?
A. FC/CM per unit C. FC/CM ratio
B. VC/CM D. VC/CM ratio

20. The contribution margin ratio always increases when the

A. variable costs as a percentage of net sales increase.
B. variable costs as a percentage of net sales decrease.
C. break-even point increases.
D. break-even point decreases.

21. In a multiple-product firm, the product that has the highest contribution margin per unit will
A. generate more profit for each P1 of sales than the other products.
B. have the highest contribution margin ratio.
C. generate the most profit for each unit sold.
D. have the lowest variable costs per unit.

22. _____________ focuses only on factors that change from one course of action to another.
A. Incremental analysis C. Operating leverage
B. Margin of safety D. A break-even chart

23. The margin of safety would be negative if a company('s)

A. was presently operating at a volume that is below the break-even point.
B. present fixed costs were less than its contribution margin.
C. variable costs exceeded its fixed costs.
D. degree of operating leverage is greater than 100.

24. The margin of safety is a key concept of CVP analysis. The margin of safety is the
A. contribution margin rate.
B. difference between budgeted contribution margin and actual contribution margin.
C. difference between budgeted contribution margin and break-even contribution margin.
D. difference between budgeted sales and break-even sales.

25. Management is considering replacing an existing sales commission compensation plan with a fixed salary plan. If
the change is adopted, the company's
A. break-even point must increase. C. operating leverage must increase.
B. margin of safety must decrease. D. profit must increase.

26. As projected net income increases the

A. degree of operating leverage declines. C. break-even point goes down.
B. margin of safety stays constant. D. contribution margin ratio goes up.

27. A managerial preference for a very low degree of operating leverage might indicate that
A. an increase in sales volume is expected. C. the firm is very unprofitable.
B. a decrease in sales volume is expected. D. the firm has very high fixed costs.

Below is an income statement for Thompson Company:

Sales P400,000
Variable costs (125,000)
Contribution margin P275,000
Fixed costs (200,000)
Profit before taxes P 75,000

28. Refer to Thompson Company. What is Thompson’s degree of operating leverage?

A. 3.67 B. 5.33 C. 1.45 D. 2.67

29. Refer to Thompson Company. Based on no. 28, what would be the profit before taxes if the sales increased by
10%?
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 A. P302,500 B. P275,000 C. P202,500 D. P102,500

30. Refer to Thompson Company. Based on the cost and revenue structure on the income statement, what was
Thompson’s break-even point in dollars?
A. P200,000 B. P325,000 C. P300,000 D. P290,909
31. Refer to Thompson Company. What was Thompson’s margin of safety?
A. P200,000 B. P75,000 C. P100,000 D. P109,091

32. Refer to Thompson Company. Assuming that the fixed costs are expected to remain at P200,000 for the coming
year and the sales price per unit and variable costs per unit are also expected to remain constant, how much profit
before taxes will be produced if the company anticipates sales for the coming year rising to 130 percent of the
current year’s level?
A. P97,500
B. P195,000
C. P157,500
D. A prediction cannot be made from the information given.

Value Pro produces and sells a single product. Information on its costs follow:
Variable costs:
SG&A P2 per unit
Production P4 per unit
Fixed costs:
SG&A P12,000 per year
Production P15,000 per year

33. Refer to Value Pro. Assume Value Pro produced and sold 5,000 units. At this level of activity, it produced a profit
of P18,000. What was Value Pro's sales price per unit?
A. P15.00 B. P11.40 C. P9.60 D. P10.00

34. Refer to Value Pro. In the upcoming year, Value Pro estimates that it will produce and sell 4,000 units. The
variable costs per unit and the total fixed costs are expected to be the same as in the current year. However, it
anticipates a sales price of P16 per unit. What is Value Pro's projected margin of safety for the coming year?
A. P7,000 B. P20,800 C. P18,400 D. P13,000

35. Harris Manufacturing incurs annual fixed costs of P250,000 in producing and selling a single product. Estimated
unit sales are 125,000. An after-tax income of P75,000 is desired by management. The company projects its
income tax rate at 40 percent. What is the maximum amount that Harris can expend for variable costs per unit
and still meet its profit objective if the sales price per unit is estimated at P6?
A. P3.37 B. P3.59 C. P3.00 D. P3.70

The following information relates to financial projections of Folk Company:

Projected sales 60,000 units
Projected variable costs P2.00 per unit
Projected fixed costs P50,000 per year
Projected unit sales price P7.00

36. Refer to Folk Company. How many units would Folk Company need to sell to earn a profit before taxes of
P10,000?
A. 25,714 B. 10,000 C. 8,571 D. 12,000

37. Refer to Folk Company. If Folk Company achieves its projections, what will be its degree of operating leverage?
A. 6.00 B. 1.20 C. 1.68 D. 2.40

38. Unique Company manufactures a single product. In the prior year, the company had sales of P90,000, variable
costs of P50,000, and fixed costs of P30,000. Unique expects its cost structure and sales price per unit to remain
the same in the current year, however total sales are expected to increase by 20 percent. If the current year
projections are realized, net income should exceed the prior year’s net income by:
A. 100 percent. B. 80 percent. C. 20 percent. D. 50 percent.

Eclectic Corporation manufactures and sells two products: A and B. The operating results of the company are as follows:
Product A Product B
Sales in units 2,000 3,000
Sales price per unit P10 P5
Variable costs per unit P7 P3

In addition, the company incurred total fixed costs in the amount of P9,000.

39. Refer to Eclectic Corporation.. How many total units would the company have needed to sell to break even?
A. 3,750 B. 750 C. 3,600 D. 1,800

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40. Refer to Eclectic Corporation. If the company would have sold a total of 6,000 units, consistent with CVP
assumptions how many of those units would you expect to be Product B?
A. 3,000 B. 4,000 C. 3,600 D. 3,500

41. Refer to Eclectic Corporation. How many units would the company have needed to sell to produce a profit of
P12,000?
A. 8,750 B. 20,000 C. 10,000 D. 8,400

Below is an income statement for Brittany Company:

Sales P300,000
Variable costs (150,000)
Contribution margin P150,000
Fixed costs (100,000)
Profit before taxes P 50,000

42. Refer to Brittany Company. What was the company's margin of safety?
A. P50,000 B. P100,000 C. P150,000 D. P25,000

43. Refer to Brittany Company. If the unit sales price for Brittany’s sole product was P10, how many units would it
have needed to sell to produce a profit of P40,000?
A. 27,500
B. 29,000
C. 28,000
D. can't be determined from the information given

44. A firm estimates that it will sell 100,000 units of its sole product in the coming period. It projects the sales price at
P40 per unit, the CM ratio at 60 percent, and profit at P500,000. What is the firm budgeting for fixed costs in the
coming period?
A. P1,600,000 B. P2,400,000 C. P1,100,000 D. P1,900,000

45. Sombrero Company manufactures a western-style hat that sells for P10 per unit. This is its sole product and it has
projected the break-even point at 50,000 units in the coming period. If fixed costs are projected at P100,000, what
is the projected contribution margin ratio?
A. 80 percent B. 20 percent C. 40 percent D. 60 percent

Brandon Company manufactures a single product. Each unit sells for P15. The firm's projected costs are listed below:
Variable costs per unit: Fixed costs:
Production P5 Production P40,000
SG&A P1 SG&A P60,000
Estimated volume 20,000 units

46. Refer to Brandon Company. What is Brandon's projected margin of safety for the current year?
A. P133,333 B. P150,000 C. P80,000 D. P100,000

47. Refer to Brandon Company. What is Brandon's projected degree of operating leverage for the current year?
A. 2.25
B. 1.80
C. 3.75
D. 1.6

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