COST-VOLUME PROFIT ANALYSIS AS MANAGERIAL PLANING TOOL

COST-VOLUME PROFIT ANALYSIS – is a powerful tool that helps managers understands the relationships
among cost, volume, and profit.1

Elements of CVP analysis:

1. Sales
a. Selling price
b. Units or volume
2. Total fixed costs
3. Variable cost per unit
4. Sales mix

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; and
4. Type of productive facilities to acquire.

The Contribution Margin Income Statement

The costs and expenses in the Contribution Margin Income Statement are classified as to behavior
(variable and fixed). The amount of contribution margin, which is the difference between sales and
variable costs, is shown. The format is as follows:

Contribution Margin Income Statement

Sales (units x selling price) Pxxxx
Less variable costs (units x variable cost per unit) xxxx
Contribution margin Pxxxx
Less total fixed costs xxxx
Income before tax Pxxxx

The contribution margin income statement is prepared for management’s own use. The format
facilitates CVP analysis.

Inherent Simplifying Assumptions of CVP Analysis2

1. All costs are classified as either variable or fixed.
2. Cost and revenue relationships are predictable and linear over a relevant range of activity and a
specific period of time.
3. Total variable costs change directly with the cost driver, but variable cost per unit are constant
over the relevant range.
4. Total fixed cost are constant over the relevant range, but fixed costs per unit vary inversely with
the cost driver.

1
Managerial Accounting, Asia Global Edition, 2/e
2
Management advisory services (Roque 2016 Edition)
 5. Selling price unit and market conditions remain unchanged.
6. Productions equal sales, there is no change in inventory.
7. If the company sells multiple products, sales mix is constant.
8. Technology, as well as productive efficiency, is constant.
9. The time value of money is ignored.

BREAK-EVEN ANALYSIS3

Break-Even Point – the sales volume level (in pesos or in units) where total revenues equals total costs,
that is, there is neither profit nor loss

Method of Determining the Break-Even Point

A. Graphical Method

B. Contribution Margin Method (Formula Approach)

3
Management advisory services (Roque 2016 Edition)
4
https://syedmfahimbsnotes.blogspot.com/2016/03/break-even-point.html?m=1
 a. Single-Product Break-even Calculations
1 Break-even Point in Pesos

FxC
BEPp =
CMR

Where: BEPp = Break-even point in pesos

FxC = Total fixed costs
CMR = Contribution margin ratio

2 Break-even Point in Units

FxC
BEPu =
CM/u

Where: BEPu = Break-even point in units

FxC = Total fixed costs
CMR = Contribution margin per unit

b. Multiple-Product/Service Break-Even Calculations

FxC
BEPp =
WaCMR

BEPu = FxC
WaUCM

Where: WaCMR = Weighted average contribution margin ratio

WaUCM = Weighted average unit contribution margin

Target Profit Analysis5

One of the key uses of CVP analysis is called target profit analysis. In target profit analysis, we estimate
what sales volume needed to achieve a specific target profit.
1. The equation method

Target profit = Unit CM x Q – Fixed cost

Unit CM x Q = Target profit + fixed cost
Q = (Target profit + Fixed cost) / Unit CM

5
 2. The formula method

Target profit + Fixed cost

Unit sales to attain the target profit =
Unit CM

Margin of Safety6 – The amount of peso-sales or the number of units by which actual or budgeted sales
maybe decreased without resulting into a loss.

Margin of safety in Pesos = Total budgeted (or actual0 sales – Break-even sales

The margin of safety can also be expressed in percentage form by dividing the margin of safety in pesos
by total peso sales.

Operating Leverage7
A lever is a tool for multiplying force. Using a lever, a massive object can be moved with only a modest
amount of force. In business, operating leverage serves as similar purpose. Operating leverage is a
measure of how sensitive net operating income is to a given percentage change in peso sales. Operating
leverage acts a multiplier. If operating leverage is high, a small percentage increase in sales can produce
a much larger percentage increase in net operating income.

Degree of operating leverage = Contribution margin / Net operating income

Sample Quiz

Multiple Choice Questions:8

1. CVP analysis may be used by managers in planning and decision-making, which may involve the
following except
a. Choosing the type of product to produce and sell.
b. Choosing the pricing policy to follow
c. Choosing the type of productive facilities to acquire
d. Choosing the analytical technique to use.

2. The elements of CVP analysis include the following, except

a. Total fixed cost
b. Unit variable cost
c. Volume or number of units
d. Relevant cost

3. Which of the following statement is correct?

a. Gross margin and contribution margin are the same

6
Managerial Accounting, Asia Global Edition, 2/e
7
Managerial Accounting, Asia Global Edition, 2/e
8
Management advisory services (Roque 2016 Edition)
 b. Contribution margin is the excess of sales over variable costs, and this is the mount available for
the recovery of fixed assets and generation of profit.
c. One inherent, simplifying assumption in CVP analysis is that production equals sales
d. Unit variable costs change directly with the cost driver or activity level

4. In CVP analysis, it is assumed that

a. All costs are classified as either direct or indirect costs
b. Cost and revenue relationships are predictable and linear over any range of activity
c. Selling prices per unit and market conditions remain unchanged
d. Total fixed costs are constant over the relevant range, but fixed costs per unit vary with the cost
driver or volume

5. Cost-volume-profit relationships that are curvilinear may be analyzed linearly by considering only
a. A relevant range in activity
b. The variable costs
c. The fixed costs
d. The relevant costs

6. The alternative that would increase the contribution margin per unit the most is
a. 10% decrease in unit variable cost
b. 10% increase in selling price
c. 10% decrease in fixed costs
d. 10% decrease in selling price

7. Which of the following changes in CVP factors will reduce the break-even point?
a. A decrease in total fixed costs
b. A decrease in selling price
c. An increase in unit variable costs
d. An increase in total fixed costs

8. Which of the following is not correct?

At break-even point,
a. Profit equals zero
b. Gross profit equals zero
c. Sales equals total costs
d. Fixed cost equals contribution margin

Items 9 – 10 are based on the following information:

Basic Illustration Corp. produces and sells a single product. The selling price is P25 and the variable cost
costs is P15 per unit. The corporation’s fixed costs is P100,000 per month. Average monthly sales is
11,000 units.

9. The corporation’s contribution margin per unit and as a percentage of sales (CMR) is
a. P10per unit; 40%
b. P40 per unit; 160%
c. 10 units; 40%
d. P10 per unit; 60%
10. The corporation break-even point
a. P10,000
b. 250,000 units
c. 10,000 units or P250,000
d. 250,000 units or P10,000

Answer Key
1. D 6. B
2. D 7. A
3. C 8. A
4. C 9. A
5. A 10. C