CHAPTER 3:

COST VOLUME & COST

VOLUME PROFIT ANALYSIS

Prepared by:

Ruby Ann Camagay

Bhea Frias
Aira Jane Perez
COST BEHAVIOR
COST BEHAVIOR
refers to the relationship between total
costs and activity level.
Based on behavior, costs are categorized
as either fixed, variable or mixed.
◦ Fixed costs are constant regardless of activity
level, variable costs change proportionately
with output and mixed costs are a combination
of both.
Fixed Costs

Fixed costs are those which do not change

with the level of activity within the
relevant range. These costs will be
incurred even if no units are produced.
For example rent expense, straight-line
depreciation expense, etc.
Fixed cost per unit decreases with
increase in production.
Total Fixed Cost P 30,000 P 30,000 P 30,000

÷ Units
5,000 10,000 15,000
Produced

Fixed Cost per

P 6.00 P 3.00 P 2.00
Unit
Variable Costs

• Variable costs change in direct proportion

to the level of production. This means that
total variable cost increase when more
units are produced and decreases when
less units are produced. 
• Variable cost per unit is constant .
Total Variable
P 10,000 P 20,000 P 30,000
Cost
÷ Units
5,000 10,000 15,000
Produced
Variable Cost
P 2.00 P 2.00 P 2.00
per Unit
Mixed Costs
Mixed costs or semi-variable costs have
properties of both fixed and variable costs
due to the presence of both variable and
fixed components in them. An example of
mixed cost is delivery cost which has a
fixed component of depreciation cost of
trucks and a variable component of fuel
expense.
Since mixed cost figures are not useful in
their raw form, therefore they are split
into their fixed and variable components
by using cost behavior analysis techniques
such as High-Low Method, 
Scatter Graph Method and 
Regression Analysis.
The following table shows a comparison of different costs classifications based on behavior:

Category Fixed Costs Variable Costs Mixed Costs

Changes
Change with output but
Total cost Constant proportionately
not proportionately
with output

Decreases with
Cost per Decreases with increase increase in output but
Constant
unit in output less than the decrease
in fixed cost per unit

Telecommunication
Fuel expense,
costs, senior
Examples Plant depreciation wages, raw
management salaries,
materials
transportation cost
COST BEHAVIOR ANALYSIS
TECHNIQUES
High-Low Method
usedin managerial accounting to split a 
mixed cost into its fixed and variable
components.

Given a set of data pairs of activity levels

(i.e. units, labor hours, machine hours,
etc.) and the corresponding total cost
figures, high-low method only takes two
extreme data pairs (i.e. the highest and the
lowest) as inputs.
These are then used to calculate the
average variable cost per unit (b) and total
fixed cost (a) to obtain a linear 
cost volume function:
y = a + bx
Where,
y is total cost; and
x is activity level.
Variable Cost per Unit
◦ Variable cost per unit (b) is calculated using
the following formula:
y2 − y1
Variable Cost per Unit =
x2 − x1

Where,
y2 is the total cost at highest activity level;
y1 is the total cost at lowest activity level;
x2 are the number of units/labor hours etc. at highest
activity level; and
x1 are the number of units/labor hours etc. at lowest
activity level.
Total Fixed Cost
◦ Total fixed cost (a) is calculated by
subtracting total variable cost from total cost
at either highest or lowest activity level, thus:

Total Fixed Cost = y2 − bx2 = y1 − bx1

Example

ABC Company wants to determine the cost-

volume relation between its factory overhead
cost and number of units produced. Use high-
low method to split its factory overhead (FOH)
costs into fixed and variable components and
create a cost volume relation. The volume and
the corresponding total cost information of the
factory for past eight months are given below:
Month Units FOH
1 1,520 P 36,375
2 1,250 38,000
3 1,750 41,750
4 1,600 42,360
5 2,350 55,080
6 2,100 48,100
7 3,000 59,000
8 2,750 56,800
Solution:

We have,
at highest activity: x2 = 3,000; y2 = $59,000
at lowest activity: x1 = 1,250; y1 = $38,000
Variable Cost per Unit
= ($59,000 − $38,000) ÷ (3,000 − 1,250)
= $12 per unit
Total Fixed Cost
= $59,000 − ($12 × 3,000)
= $38,000 − ($12 × 1,250)
= $23,000
Cost Volume Formula:
y = $23,000 + 12x

Due to its unreliability, high low method

should be carefully used, usually in cases
where the data is simple and not too
scattered. For complex scenarios, alternate
methods should be considered such as 
scatter-graph method and 
least-squares regression method.
Scatter Graph Method
Scatter graph method is a graphical
technique of separating fixed and variable
components of mixed cost by plotting
activity level along x-axis and
corresponding total cost (i.e. mixed cost)
along y-axis.
A regression line is then drawn on the
graph by visual inspection. The line thus
drawn is used to estimate the total fixed
cost and variable cost per unit. The point
where the line intercepts y-axis is the
estimated fixed cost and the slope of the
line is the average variable cost per unit.
Since the visual inspection does not
involve any mathematical testing
therefore this method should be applied
with great care.
Procedure

Step 1: Draw scatter graph

Plot the data on scatter graph. Plot activity level
(i.e. number of units, labor hours etc.) along x-
axis and total mixed cost along y-axis.
Step 2: Draw regression line
Draw a regression line over the scatter graph by
visual inspection and try to minimize the total
vertical distance between the line and all the
points. Extend the line towards y-axis.
Step 3: Find total fixed cost
Total fixed is given by the y-intercept of the
line. Y-intercept is the point at which the line
cuts y-axis.
Step 4: Find variable cost per unit
Variable cost per unit is equal to the slope of the
line. Take two points (x ,y ) and (x ,y ) on the line
1 1 2 2

and calculate variable cost using the following

formula:
Fixed Cost = y-intercept = $18,000

Variable Cost per Unit = Slope of Regression

Line

To calculate slop we will take two points on

line: (0,18000) and (3500,68000)

Variable Cost per Unit =

(68000 − 18000) ÷ (3500 − 0) = $14.286
Least-Squares Regression in Cost
Estimation
Least-squares regression is a statistical
technique that may be used to estimate a
linear total cost function for a mixed cost,
based on past cost data. The cost function
may then be used to predict the total cost
at a given level of activity such as number
of units produced or labor/machine hours
used.
Formulas

nΣxy − (Σx)(Σy)
Unit Variable
Cost (b) = nΣx2 − (Σx)2

Σy − bΣx
Total Fixed
Cost (a) = n
Where,
n is number of pairs of units–total-cost used
in the calculation;
Σy is the sum of total costs of all data pairs;
Σx is the sum of units of all data pairs;
Σxy is the sum of the products of cost and
units of all data pairs; and
Σx2 is the sum of squares of units of all data
pairs.
Example

Considering the example given earlier, estimate the total

cost of producing 4,000 units.

Solution:
Month x y x2 xy
1 1,520 $36,375 2,310,400 55,290,000
2 1,250 38,000 1,562,500 47,500,000
3 1,750 41,750 3,062,500 73,062,500
4 1,600 42,360 2,560,000 67,776,000
5 2,350 55,080 5,522,500 129,438,000
6 2,100 48,100 4,410,000 101,010,000
7 3,000 59,000 9,000,000 177,000,000
8 2,750 56,800 7,562,500 156,200,000
16,320 377,465 35,990,400 807,276,500
We have,
n = 8;
Σx = 16,320;
Σy = 377,465;
Σx2 = 35,990,400; and
Σxy = 807,276,500

Calculating the average variable cost per

unit:
8 × 807,276,500 − 16,320 ×
b= 377,465 ≈ 13.8
8 × 35,990,400 − 16,3202
Calculating the approximate total fixed
cost:
377,465 − 13.8078 × 16,320
a= ≈ 19,015
8
The cost-volume formula now becomes:
y = 19,015 + 13.8x

At 4,000 activity level, the estimated total

cost is $74,215 [= 19,015 + 13.8 × 4,000].
COST-VOLUME-PROFIT
(CVP) RELATIONSHIP
COST-VOLUME PROFIT (CVP)
RELATIONSHIP

an analysis which studies

the relationships between the following
factors and its impact on the amount of
profits.
a management accounting tool that
expresses relationship among total sales,
total cost and profit.
APPLICATION OF COST-VOLUME-
PROFIT (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.
CVP Model – Assumptions
• All costs are classifiable as either variable or fixed.
• Cost and revenue relationships are predictable and linear over a
relevant range of activity and a specified period of time.
• Total variable costs change directly with the cost driver, but
variable costs per unit are constant over the relevant range.
• Total fixed costs are constant over the relevant range, but fixed
costs per unit vary inversely with the cost driver.
• Selling prices per unit and market conditions remain unchanged.
• Production equals sales, i. e. there is no change in inventory.
• If the company sells multiple products, sales mix is constant.
• Technology, as well as productive efficiency, is constant.
• The time value of money is ignored.
One Product Cost-Volume-Profit Model
Total Revenue = Selling Price Per Unit (P) * Number of
Units Sold (X)

Total Cost = Total Variable Cost + Total Fixed Cost (F)

Total Variable Cost = Variable Cost Per Unit (V) * Number

of Units Sold (X)

Net Income (NI) = Total Revenue – Total Cost

NI = P X – V X – F
NI = X (P – V) – F
Contribution Margin Income Statement

CONTRIBUTION MARGIN INCOME STATEMENT

Sales (units x selling price) P xx

Less: Variable Costs (units x variable cost/unit) xx
Contribution Margin xx
Less: Fixed Costs xx
Income Before Tax P xx
Contribution Margin Income Statement
Contribution Margin Income Statement
Racing Bicycle Company

Sales (10 x P10,000) P 100,000

Less: Variable Costs (10 x P4,000) 40,000

Contribution Margin P 60,000

Less: Fixed Costs 30,000
Income Before Tax P 30,000
Contribution Margin

Itis the difference between sales revenue

and variable cost
incremental profit earned for each unit
sold
represents the total earnings available to
pay for fixed expenses and to generate a
profit.
Contribution Margin
It can be expressed in two ways:

• Sales Revenue – Variable Cost

• Fixed Cost + Profit

Contribution Margin = P60, 000

 Contribution Margin Ratio
In terms of pesos, the contribution margin ratio is:

CM
CM Ratio =
Total Sales
For Racing Bicycle Company the ratio is:

P60,000
= 60%
P100,000
 Contribution Margin Ratio
Or, in terms of units, the contribution margin ratio is:

Unit CM
CM Ratio =
Unit selling price
For Racing Bicycle Company the ratio is:

P6,000
= 60%
P10,000
 Break-Even Analysis
Break Even Point (BEP) is a volume of sales
where there is neither loss nor profit. That
means contribution is enough to cover the
fixed costs.
 Break-Even Analysis
Break-even analysis can be approached in
two ways:
1. Equation method
2. Contribution margin method
 Equation Method
Profits = (Sales – Variable expenses) – Fixed expenses
OR

Sales = Variable expenses + Fixed expenses + Profits

At the break-even point

profits equal zero
 Equation Method

We calculate the break-even point as follows:
Sales = Variable expenses + Fixed expenses + Profits

P10,000Q = P4,000Q + P30,000 + P0

Where:
Q = Number of bicycles sold
P10,000 = Unit selling price
P4,000 = Unit variable expense
P30,000 = Total fixed expense
 Equation Method

We calculate the break-even point as follows:
Sales = Variable expenses + Fixed expenses + Profits

P10,000Q = P4,000Q + P30,000 + P0

P6,000Q = P30,000
Q = P30,000 ÷ P6,000 per bike
Q = 5 bikes
 Equation Method

The equation can be modified to calculate the break-
even point in peso sales.

Sales = Variable expenses + Fixed expenses + Profits

X = 0.40X + P30,000 + P0

Where:
X = Total peso sales
0.40 = Variable expenses as a % of sales
P30,000 = Total fixed expenses
 Equation Method

The equation can be modified to calculate the
break-even point in peso sales.

Sales = Variable expenses + Fixed expenses + Profits

X = 0.40X + P30,000 + P0
0.60X = P30,000
X = P30,000 ÷ 0.60
X = P50,000
 Contribution Margin Method
The contribution margin method has two key
equations.

Break-even point Fixed expenses

=
in units sold Unit contribution margin

Break-even point in Fixed expenses

total peso sales =
CM ratio
 Contribution Margin Method
Let’s use the contribution margin method to calculate
the break-even point in unit sales at Racing.

Break-even point in Fixed expenses

units sold =
unit CM

P30,000
= 5 bikes break-even sales
P6,000
 Contribution Margin Method
Let’s use the contribution margin method to calculate
the break-even point in total peso sales at Racing.

Break-even point in Fixed expenses

total peso sales =
CM ratio

P30,000
= P50,000 break-even sales
60%
 Target Profit Analysis
The equation and contribution margin methods can be
used to determine the sales volume needed to achieve
a target profit.

Suppose Racing Bicycles Co. wants to know

how many bikes must be sold to earn a profit of
P60,000.
 The CVP Equation Method
Sales = Variable expenses + Fixed expenses + Profits

P10,000Q = P4,000Q + P30,000 + P60,000

P6,000Q = P90,000

Q = 15 bikes
 The Contribution Margin Approach
The contribution margin method can be used to determine
that 15 bikes must be sold to earn the target profit of
P60,000.

Unit sales to attain Fixed expenses + Target profit

=
the target profit Unit contribution margin

P30,000 + P60,000
= 15 bikes
P6,000/bike
 Multi-Product CVP Model
A company sells Products A, B, and C. Data
about the three products are as follows:
A B C Total
Selling Price ₱ 100.00 ₱ 120.00 ₱ 50.00
Variable Costs per unit 60.00 90.00 40.00
Contribution Margin (units) 40.00 30.00 10.00
Sales in Units 1000 2000 5000 8000
₱ 101,680.00
Total Fixed Costs
 Multi-Product CVP Model
a) A B C Total
Sales in Units ₱ 100,000.00 ₱ 240,000.00 ₱ 250,000.00 ₱ 590,000.00
Less: Variable Costs 60,000.00 180,000.00 200,000.00 440,000.00
Contribution Margin ₱ 40,000.00 ₱ 60,000.00 ₱ 50,000.00 ₱ 150,000.00

Total CM ₱ 150,000.00
WaCMR = = 25.42%
Total Sales ₱ 590,000.00

FxC ₱ 101,680.00
BEPp = = = 400,000.00
WaCMR 25.42%
b) Product A Product B Product C
CMR (CM/S) (40/100) 40.00% (60/240) 25.00% (50/250) 20.00%
x Sales Mix Ratio (100/590) 16.95% (240/590) 40.68% (250/590) 42.37%
WaCMR 6.78% 10.17% 8.47%

WaCMR: Product A 6.78%

Product B 10.17%
Product C 8.47%
Total 25.42%

Note: For purposes of computing the WaCMR, the sales mix ratio
(sales mix percentage) is determined using the sales volume in pesos.
Breakdown of Break-even Sales:

  Total Product A Product B Product C

    (16.95%) (40.68%) (42.37%)

*Break-even sales 400,000.00 67,800.00 162,720.00 169,480.00

*Total BE Sales x Sales Mix Ratio      

 • The company’s break-even point in units is:

Computation of Weighted-Average Unit Contribution Margin

(WaUCM)

b) Product A Product B Product C

CM per unit ₱ 40.00 ₱ 30.00 ₱ 10.00
x Sales Mix Ratio (1000/8000) 12.5% (2000/8000) 25% (5000/8000) 62.5%
WaCMR 5% 7.5% 6.25%

*Sales in units/Total sales in units

FxC ₱ 101,680.00
BEPu = = = 5,422.93 units
WaUCM 18.75
  
WaCMR:Product A 5.00%
Product B 7.50%
Product C 6.25%
18.75%
 
Note: for purposes of computing the WaUCM, the
sakes mix ratio is determined using the sales volume
in units.
 MARGIN OF SAFETY
The amount of peso-sales or the number of units by
which actual or budgeted sales may be decreased without
resulting into a loss.
Formulas:                  

             

MSp = Sp-
BEPp
  BEPp     where:      

              MSp = Margin of safety in pesos

  MSp   MSu = Margin of safety in units
MSu = Su-BEP =
  BEPu SP   MSR = Margin of safety ratio
              Sp = Sales in pesos
  MSp Msu   Su = Sales in units
MS
= or BEP Break-even point in
R
  Sp Su   p = pesos
BEP
              u = Break-even point in units
Example:
If a company’s present sales is 100,000 units (or
P500,000.00, because the selling price is P5), and the
break-even point is 60,000 units (or P300,000.00)
 
a. The MSp = P500,000.00 – P300,000.00 = P200,000.00
b. The Msu = 100,000 – 60,000 = 40,000 units;
or P200,000.00/P5 = 40,000 units
c. The MSR = P200,000.00 = 40,000 units = 40%
P500,000.00 100,000 units
 OPERATING LEVERAGE FACTOR (OLF) or DEGREE
OF OPERATING LEVERAGE (DOL)

 Used to measure the extent of the change in profit

before tax resulting from the change of sales.

Total CM %△in Profit before Tax

DOL or OLF = or
Profit before tax %△in Sales
%△in Profit = %△in Sales x DOL  

Where: %△= percentage change

THANK YOU