96 Graph 1 Cost Accounting THE COST VOLUME PROFIT GRAPH USING Illustrative Problem I on page 93 — Nicolas Company Revenue and cost 180,000 160,000 140,000 120,000 4 100,060 80,000 60,000 40,000 20,000 100 180 Units ~ Revenue (sales) 200 | Quantity Sales _ Tot.Cost_Profit(Loss) | ("50 x 800 ‘ i 60,000 __( 20,000) | 100 x 800 _= 80,000 90,000 (10,000) 150 x 800 ~_ 30,000 | 120,000 0 | 200 x 800 130,000 30,000 | 150,000 [250 x 800 150,000 30,000 | 180,000 20, ‘ 180,000 | 30,000 [210,000 30,000 00 0,000 [270,000 40,000 | Fixed cost (30,000) 250,000Chapter 4 Cost Volume Profit Analysis 97 Graph 2 Cost Volume Graph — Nicolas Company 40,000t 30,000 20,000 PROFIT 10,000 BEP 150 UNITS 0° J Ss 150 200 250 «200 10,000 20,000 LOSS 30,000 40,000 MARGIN OF SAFETY Margin of safety is the units sold or revenue earned above the BEP volume: In simple words, it represents the number of units or amount of sales revenue that the company can absorb before incurring a loss. Using our ilustrative problem 1, if the current sales is 500 units and the BEP is 130units, the margin of safety is = current salea + BEP sales = 500 units - 150 units = 350 units Margin of safety98 Cost Accounting Margin of safety in pesos = 350 units x P 800 Ten of eaten Im pesos 780,000 i i 000 OR Margin of safety in pesos = P400,000— P 120, = P 280,000 Margin of safety ratio = Margin of safety Total sales =P280,000/P400,000 = 70% Alll of these formulas (computations) mean that sales may decrease by 350 units, or decrease by P280,000 or may decrease by 70% before the company will break even. In the event that sales take a downward tum, the risk of suffering a loss is less if the margin of safety is large than if the margin of safety is small. If the margin of safety is small, managers must take actions to increase sales or decrease cost. If two companies have the same amount of sales, it will not be safe to conclude that the BEP, the margin of safety, and the net income will be the same. If one company has a lower variable cost per unit and/or a lower total fixed cost , then its operating income will be higher. The differences in variable cost per unit and total fixed cost would result to different break even revenues. It would be safe to conclude that the company with the lower break- even sales would have a higher margin of safety. CVP ANALYSIS IN A MULTIPRODUCT The CVP analysis is simple and easy to use if selling a single product only. However, few companies are producing a single Product only, most companies are producing 2, 3, of more products, Even though CVP analysis becomes more complex. with multiple produce, ire operation is reasonably straightforward 7 simply convert the multiple product problem to 4 single luct problem. The key to this conversi identi mix, in units ot the products being produced and mace cently the expected sales cd and marketed. ix is the combination of progucts being marketed bythe company. The ne! Pane the company is producing andi Chapter 4 Cost Volume Profit Analysis 99 measured in terms of units sold. By defining the products as a package the -multiple product problem is converted into a single product problem. To use. the BEP in units, the package selling price and variable cost per package must be determined, Illustrative Problem 2 Selina Company produces three products A, B, and C with the following characteristics J PRODUCT A | PRODUCT B | PRODUCT C Sales price/unit P 10.00 P 16.00 P 18.00 Variable cost/uniy 6.00 10.00 14.00 Expected sales (units) 20,000 20,000 40,000 Total fixed costs are P 1,800,000. Assume that sales mix will be the same at all sales levels, Required 1.Compute for the break-even point in total units 2.Compute for the units A, B, and C must sell at break-even point 3.Compute for the total contribution margin if the company expects profit of P350,000. Solution PRODUCTA | PRODUCT B PRODUCT C Sales price/unit P 10.00 P16.00 P18.00 Variable cost/unit 6.00 10.00 14.00 Contribution margin " P.4,00 P.600 ° 24.00 1.Break- even in total units = = Total fixed cost Weighted average contribution margin = 1,800,000 4.50 = 400,000 units100 Cost Accounting : ee in = Total contribution margin Weighted average contribution margin bom expected sales = (20,000x4)+(20,000x6)+(40,000x4) 80,000 = 4,50/unit 2.Sales in units of A, B, and C at break-even 165 006 A = 400,000 x 25% (200,000/800,000) = 10 0 B 400,000 x 25% (200,000/800,000) = breed C = 400,000 x 50% (400,000/800,000) Check Sales (100,000 x 10) + (100,000 x 16) + (200,000 x 18) 6,200,000 Variable cost (100,000 x6)+(100,000x10)+(200,000x14) 4,400,000 Contribution margin - 1,800,000 Fixed cost 1,800,000 Net income ——2 P 350,000 3. Expected net income Total fixed cost 1,800,000 Total contribution margin BEP may be computed using this alternative solution BEP (units) = Total fixed cost Weighted CM per unit = 1,800,000 1,00+ 1.50 +2.00 = 400,000 units Weighted CM per unit, Contribution margin/unit P 4.00 P 6.00 P4.00 Multiply by sales mix ratio 25% 5A 50% Weighted contribution margin per unit P 1.00 P 1.50 P 2.00Chapter 4 Cost Volume Profit Analysis 101 SALES AND UNITS WITH DESIRED PROFIT Most companies would not want to break even only, the main objective is to eam profit. The break even point gives useful information to managers, but companies would want to eam income greater than PO. CVP gives us a way to determine how many units must be sold, or how much sales revenue must be eamed to earn a particular net income The formula for computing BEP will not change much, we simply add the desired profit to the fixed cost and then divide by the contribution margin per unit. The formula will be Sales = Total fixed cost + desired profit Contribution margin/unit Illustrative Problem 3 The Gilas Company is trying to do CVP analysis with the followig information for the month of August. Sales P $50,000 Total fixed cost 140,000 Selling Price 20 Variable cost per unit 12 Required 1. Sales (units and amount) to break even 2. Sales if the company desires a profit of P 120,000 Solution L.BEP (units) = Total fixed cost/contribution margin per unit = P140,000/(P20-12) = 17,500 units BEP(amount) = 17,500 x P20 = P350,000 Or BEP (amount) = Total fixed cost divided by contribution ratio = P140,000/40% = P350,000 Contribution margin ratio= 8/20 = 40%102 Cost Accounting 2. Sales with profit = Fixed cost + Desired Profi Contribution margin ratio = 140,000 + 120,000 40% . = 2650,000 Check Sales P 650,000 Variable cost ( 650,000 x 60%) . 390,000 Contribution margin 260,000 Fixed cost 140,000 Net income P.120,000 The break-even point is affected by the three factors: selling price, variable cost, and volume of sales. Any change in any of these will definitely change the break- even point. There will be a decrease in BEP if total fixed cost decrease or unit contribution increase. BEP will increase if there an increase in fixed cost or a decrease in unit (or percentage) contribution margin. EFFECT OF CHANGE IN SALES PRICE Illustrative Problem 4 Nicolas Company produces a product that sells for P800.00. The variable cost is P600 per unit. The units sold for the month is 500 units. Assuming variable cost is still P600 and fixed cost remain at P30,000. The selling price this time increased to P850 Required 1.Compute for BEP 2.Compare with Illustrative Problem 1 Solution 1. BEP (units )= Total fixed cost . CM per unit = P30,000 P850-P600 = 120 unitsChapter 4 Cost Volume Profit Analysis 103 2.BEP in Problem i is 150 units and with the new selling price the BEP decreased to 120 units because of the increase in the contribution margin/unit EFFECT 0F CHANFE IN FIXED COST Illustrative Problem SSame data as in Problem 1 for NicolasCompany. The change is the amount of fixed cost that increased to P150,000 Selling price is still P800. Variable P600 Required 1.Compute for BEP 2.Compare with Illustrative Problem 1 Solution 1.BEP (units) = Total fixed cost CM per unit = P50,000/200 = 250 units 2.With the increase in fixed cost to P50,000 the new BEP increased to 250 units. As we increase the fixed cost BEP increased also. EFFECT OF CHANGE IN VARIABLE COST PER UNIT Mlustrative Problem 6 Same data as in Problem 1 Nicolas Companybut the change now is on the variable cost per unit The selling price is still P800 per unit. Fixed cost is P30,000 but variable cost is P650 per unit Required 1.Compute for BEP 2.Comparith Illustrative Problem 1 Solution 1.BEP (units) = Total fixed cost CM per unit = P30,000 P800-P650 = 200 unitst+ Accountin: 104 Cos' ig EP in Problem | because 2.The BEP increased to 200 units as compared to 150 BEP it Heh) of the decrease in contribution margin (due to increase in V So we can conclude that BEP will increase if total fixed cost increas® and BEP will decrease if total fixed cost decrease. If selling price increase Dee ied because each unit will be able to contribute more to the recovery Of the * veh st - An increase in selling price will result to increase in contribution margin an decrease in BEP. Operating Leverage is the use of fixed cost to get higher percentage changes in profit as sales changes. The operating leverage is concerned with the relative mix of fixed cost and variable cost in an organization, Sometimes fixed cost can be traded off for variable costs. As variable cost is decreased , the contribution margin increases, making the contribution of each unit to the recovery of the fixed cost increase. Companies with lower variable costs by increasing the proportion to fixed cost will benefit with greater .increases in profit as sales increase. On the other hand it is also true that companies with a higher operating leverage will experience greater reduction in profit as sales decrease The formula to compute for the degree of operating leverage is Depree of operating leverage = Contribution margin Operating income Using data from Illustrative Problem 3 on page 100, the operating leverage is Degree of operating leverage = Contribution margin Net income = P260,000 P120,000 =2.17 The greater the degree of operating leverage, the more that ¢ i, . affect operating income. hanges in sales willChapter 4 Cost Volume Profit Analysis 105 PROBLEMS Problem 1 Candace Company’s projected Profit for the coming year is as follows: TOTAL | PERUNIT Sales P.600,000__ | P 60.00 Variable cost 360.000 36.00 Contribution margin 240,000 | P2400 | Fixed cost 192,000 erating incomé P 48,000 Required 1.Compute the variable cost ratio 2.Compute the contribution ratio 3.Compute the break- even point in units 4.Compute the break - even sales in pesos Problem 2 Monet Company plans to. sell 10,000 motorcycle helmets at P1,000 each in the coming year. Variable cost is P 700 which includes direct materials, direct labor, variable factory overhead, variable selling, and variable administrative. Total fixed cost equals P148,500 which includes fixed factory overhead, and fixed administrative expenses. Required 1.Compute the break-even point in number of helmets 2.Compute for the break-even sales 3.Check your answer by preparing a contribution margin statement based on the break-even sales Problem 3 Reno sell a product for P1,050 with variable cost of P630. Total fixed cost amounted to P630,000. , 1.Compute for contribution margin per unit 2.Compute for contribution margin ratio | 3.Compute for the break-even point in units and in pesos 4.]f Reno wants to earn P94,500, how many units must the company sell?