COST VOLUME PROFIT ANALYSIS Maria Cristina P.

Obeso, CPA, MBA

COST VOLUME PROFIT ANALYSIS

- Systematic examination of the relationships among costs, activity levels or volume

and profit

- A useful tool in decision making activities covering but not limited to the following
areas:

 Setting selling prices

 Selecting the mix of products to sell

 Choosing among marketing strategies

 Analysing the effects of changes in cost on profits

COST BEHAVIOR

-way cost change with change in activity level

Cost behavior patterns

Fixed costs

Variable cost

Mixed costs

Semi-variable costs

Semi-fixed costs

Fixed costs

Cost that do not change with changing levels of activity

Fixed cost per unit changes in an indirect or inverse pattern

Y= a example: rental expense, depreciation- straight line method

Variable costs

Costs that change directly and proportionately with the level of activity

Cost per unit is constant

Y= bx example: direct materials, direct labor

Mixed costs

it has the characteristics of both variable and fixed costs

ex. Basic salary + incentive or commission

Y= a+ bx
Semi variable costs

Costs which vary directly with change in activity level but the rate of change is not
constant

a. Cost that increase at an increasing rate ex. electricity

b. Cost that increase at a decreasing rate ex. Learning curve theory

Semi fixed costs/step function cost or step cost

Like variable cost, semi-fixed costs increase with the activity level, although not
proportionately, and like fixed costs, they remain constant for stretches of activity level,
although not for all levels of activity

COST BEHAVIOR ASSUMPTIONS

RELEVANT RANGE ASSUMPTION

Refers to the band of activity within which the identified cost behaviour patterns are
valid

TIME ASSUMPTION

Cost behaviour patterns identified are true only over a specific period of time

VARIABLE COSTING INCOME STATEMENT

Sales
Variable Cost
Contribution Margin
Fixed Cost
Profit

BREAK-EVEN ANALYSIS
Break even sales – that point of activity level where total revenues equal total cost, therefore
there is no profit or loss

Computation:
1. Equation method or algebraic approach
Sales = Variable cost + Fixed cost + Profit

2. Contribution margin method or formula approach

BES units = Fixed cost

Contribution margin per unit

BES pesos = Fixed cost

Contribution margin ratio

Variable cost ratio = Variable cost

Sales
Contribution margin ratio = Contribution margin
Sales

Contribution margin = Sales – Variable cost

TARGET ANALYSIS – is concerned with estimating the level of sales required to attain a
specified target profit

Sales in units = Fixed cost + Profit

Contribution margin per unit

Sales in pesos = Fixed cost + Profit

Contribution margin ratio

Sales in units = Fixed cost + Profit after tax

100% - tax rate
Contribution margin per unit

Sales in pesos = Fixed cost + Profit after tax

100% - tax rate
Contribution margin ratio

Desired profit as a certain %

Sales in pesos Fixed cost
CMR – PR

Sales in units Fixed cost

CM/u – P/u

3. Graphic Approach

Break Even Chart - highlights the CPV relationships over a wide range of activity and
gives managers a perspective that can be obtained in no other way. It also clearly shows
the break-even point on the graph

1. Plot the sales line

2. Plot the cost line

3. The intersection between the cost line and the sales line is the break even point

Ex.

Activity level Fixed cost Variable cost Total cost Sales

3000 units 12,000 12,000 24,000 30,000

5000 units 12,000 20,000 32,000 50,000

Profit Volume Graph - focuses on profitability. This highlights only the difference between total
sales revenues and total costs and enables the manager to more easily determine the operating
profit/loss for various levels of operation

1. Plot the profit line based on assumed activity level

Ex.

Activity level Total sales Total cost Profit

3000 units 30,000 24,000 6,000

5000 units 50,000 32,000 18,000

MARGIN OF SAFETY

Indicates the amount by which actual or planned sales may be reduced without
incurring a loss

Margin of safety = Actual or planned sales - Breakeven sales

Margin of safety ratio = Margin of safety

Actual or planned sales

MSR + BESR = 100%

MSR = 1 – BESR
BESR = 1 – MSR
PR = CMR x MSR

FACTORS AFFECTING PROFIT

1. Selling price per unit
2. Variable cost per unit
3. Volume or number of units
4. Fixed cost
5. Sales mix

UNDERLYING ASSUMPTIONS IN BREAK EVEN ANALYSIS

1. Costs are classified as variable or fixed
2. Variable costs change at a linear rate
3. Fixed costs remain unchanged over relevant range
4. Selling prices do not change as sales volume changes
5. For multi-products, the sales mix remains constant
6. Productive efficiency does not change
7. Inventory levels remain constant, (production = sales)
8. Volume is the only relevant factor affecting revenues and costs
9. Relevant range for which all the other underlying assumptions and concepts are valid

OPERATING LEVERAGE
is a principle by which management in a high fixed industry with a relatively high
contribution margin can increase profits substantially with a small increase in sales volume

 Measure of how sensitive net income is to a given percentage change in sales

The degree of operating leverage (DOL) is the change in the operating income (EBIT) resulting
from a percentage change in sales. Here, the unchanging fixed costs are used as a lever to
increase profits

The greater the DOL, the greater the risk of loss when the sales decline and the greater the
reward when sales increase

FORMULAS:

DOL = Contribution margin

Net income

DOL = Percentage change in operating income

Percentage change in sales

DOL = 1/ MSR

DOL x Percentage change in sales = Percentage change in net income