Explaining the principles of cost volume behavior and cost volume analysis

Cost Volume Behavior refers to how a specific cost reacts to changes in activity levels. Fixed
costs are those that stay the same in total regardless of the number of units produced or sold. Fixed
costs per unit vary depending on whether fewer or more units are produced, even though total fixed
costs remain constant. Straight‐line depreciation is an example of a fixed expense. It does not matter if
the machine is used to manufacture 1,000 units or 10,000,000 units in a month, the depreciation
expenditure is the same since it is dependent on the number of years the equipment would be in
operation. Variable costs are those that change in total each time a new unit is manufactured or sold.
With a variable cost, the per unit cost stays the same, but the more units produced or sold, the higher
the total cost. Direct materials is a variable expense. If one yard of fabric costs P5 per yard and it costs
one yard to make one dress, the total cost of the materials is P5. The total cost for 10 dresses is P50 (10
dresses × P5 per dress) and the total cost for 100 dresses is P500 (100 dresses × P5 per dress). Mixed
costs, on the other hand, contain both fixed and variable costs. For example, a corporation pays a price
of P1,000 for the first 800 local phone calls in a month and P0.10 every local call made over 800. A
business made 2,000 local calls in March. It will have a P1,120 phone bill (P1,000 + (1,200 $0.10)).

Cost Volume Profit or CVP analysis is an approach in determining how changes in variable and
fixed costs impact a company's profit. Companies can utilize CVP Analysis to determine how many units
they must sell to attain a specific minimum profit margin or break even. Breakeven point is the point
where an entity does not enjoy profit but does not incur a loss, which is when total contribution margin
equals total fixed costs. This is a determinant on how much sales or how much units to be sold to be
able to, at least, cover all operational costs. When employing CVP analysis, accountants often make the
following assumptions: fixed costs won't vary within the relevant range of activity; all costs can be
divided into fixed and variable costs; the selling price per unit won't change; and fixed costs won't
change. For example, if a company has P10,000 in fixed costs per month, and their product has an
average selling price of P100, and the variable cost is $20 for each product, that comes out to a
contribution margin per unit of $80 . Given and solution are stated below.

Fixed Costs per Month = P10,000

Average Selling Price (ASP) = P100.00

Variable Cost per Unit = P20.00

Contribution Margin = P80.00

Break-Even Point (BEP) in units = Fixed Costs ÷ Contribution margin per unit

= 10,000 ÷ 80

= 125 Units