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CHAPTER 13
COST-VOLUME-PROFIT RELATIONSHIPS
I. Questions
1. The total “contribution margin” is the excess of total revenue over total
variable costs. The unit contribution margin is the excess of the unit
price over the unit variable costs.
2. Total contribution margin:
Selling price - manufacturing variable costs expensed -
nonmanufacturing variable costs expensed = Total contribution margin.
Gross margin:
Selling price - variable manufacturing costs expensed - fixed
manufacturing costs expensed = Gross margin.
3. A company operating at “break-even” is probably not covering costs
which are not recorded in the accounting records. An example of such a
cost is the opportunity cost of owner-invested capital. In some small
businesses, owner-managers may not take a salary as large as the
opportunity cost of forgone alternative employment. Hence, the
opportunity cost of owner labor may be excluded.
4. In the short-run, without considering asset replacement, net operating
cash flows would be expected to exceed net income, because the latter
includes depreciation expense, while the former does not. Thus, the
cash basis break-even would be lower than the accrual break-even if
asset replacement is ignored. However, if asset replacement costs are
taken into account, (i.e., on a “cradle to grave” basis), the long-run net
cash flows equal long-run accrual net income, and the long-run break-
even points are the same.
5. Both unit price and unit variable costs are expressed on a per product
basis, as:
= (P1 - V1) X1 + (P2 - V2) X2 + + (Pn - Vn) Xn - F,
for all products 1 to n where:
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Chapter 13 Cost-Volume-Profit Relationships
= operating profit,
P = average unit selling price,
V = average unit variable cost,
X = quantity of units,
F = total fixed costs for the period.
6. If the relative proportions of products (i.e., the product “mix”) is not
held constant, products may be substituted for each other. Thus, there
may be almost an infinite number of ways to achieve a target operating
profit. As shown from the multiple product profit equation, there are
several unknowns for one equation:
= (P1 - V1) X1 + (P2 - V2) X2 + + (Pn - Vn) Xn - F,
for all products 1 to n.
7. A constant product mix is assumed to simplify the analysis. Otherwise,
there may be no unique solution.
8. Operating leverage measures the impact on net operating income of a
given percentage change in sales. The degree of operating leverage at a
given level of sales is computed by dividing the contribution margin at
that level of sales by the net operating income.
9. Three approaches to break-even analysis are (a) the equation method, (b)
the contribution margin method, and (c) the graphical method. In the
equation method, the equation is: Sales = Variable expenses + Fixed
expenses + Profits, where profits are zero at the break-even point. The
equation is solved to determine the break-even point in units or peso
sales.
10. The margin of safety is the excess of budgeted (or actual) sales over the
break-even volume of sales. It states the amount by which sales can
drop before losses begin to be incurred.
11. The sales mix is the relative proportions in which a company’s products
are sold. The usual assumption in cost-volume-profit analysis is that the
sales mix will not change.
12. A higher break-even point and a lower net operating income could result
if the sales mix shifted from high contribution margin products to low
contribution margin products. Such a shift would cause the average
contribution margin ratio in the company to decline, resulting in less
total contribution margin for a given amount of sales. Thus, net
operating income would decline. With a lower contribution margin
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Cost-Volume-Profit Relationships Chapter 13
ratio, the break-even point would be higher since it would require more
sales to cover the same amount of fixed costs.
II. Exercises
Requirement 1
Total Per Unit
Sales (30,000 units × 1.15 = 34,500 units) ................................P172,500 P5.00
Less variable expenses ................................................................
103,500 3.00
Contribution margin................................................................
69,000 P2.00
Less fixed expenses................................................................
50,000
Net operating income................................................................
P 19,000
Requirement 2
Requirement 3
Requirement 4
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Chapter 13 Cost-Volume-Profit Relationships
Requirement 1
The fixed expenses of the Extravaganza total P8,000; therefore, the break-
even point would be computed as follows:
Alternative solution:
Break-even Fixed expenses
point =
Unit contribution margin
in unit sales
P8,000
=
P20 per person
= 400 persons
Requirement 2
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Cost-Volume-Profit Relationships Chapter 13
Requirement 3
Cost-volume-profit graph:
P22,000
P20,000
P18,000
Total Sales
P16,000
P12,000
Pesos
P6,000
P4,000
P2,000
P0
0 100 200 300 400 500 600
Number of Persons
Requirement 1
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Chapter 13 Cost-Volume-Profit Relationships
Alternative solution:
Break-even Fixed expenses
point =
Unit contribution margin
in unit sales
P1,350,000
=
P270 per lantern
= 5,000 lanterns
or at P900 per lantern, P4,500,000 in sales
Requirement 2
Requirement 3
Present: Proposed:
8,000 Lanterns 10,000 Lanterns*
Total Per Unit Total Per Unit
Sales ................................................................
P7,200,000 P900 P8,100,000 P810 **
Less variable expenses ................................
5,040,000 630 6,300,000 630
Contribution margin................................ 2,160,000 P270 1,800,000 P180
Less fixed expenses................................ 1,350,000 1,350,000
Net operating income................................
P 810,000 P 450,000
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Cost-Volume-Profit Relationships Chapter 13
Requirement 4
Alternative solution:
Unit sales to Fixed expenses + Target profit
attain target profit =
Unit contribution margin
P1,350,000 + P720,000
=
P180 per lantern
= 11,500 lanterns
Requirement 1
= 6
Requirement 2
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Chapter 13 Cost-Volume-Profit Relationships
Requirement 1
Model E700 Model J1500 Total Company
Amount % Amount % Amount %
Sales P700,000 100 P300,000 100 P1,000,000 100
Less variable expenses................................
280,000 40 90,000 30 370,000 37
Contribution margin ................................
P420,000 60 P210,000 70 630,000 63 *
Less fixed expenses ................................ 598,500
Net operating income ................................ P 31,500
Requirement 2
Requirement 3
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Cost-Volume-Profit Relationships Chapter 13
This answer assumes no change in selling prices, variable costs per unit,
fixed expenses, or sales mix.
Requirement 1
Alternatively:
Requirement 2
Requirement 3
Unit sales to Fixed expenses + Target profit
attain target profit =
Unit contribution margin
P150,000 + P18,000
=
P12 per unit
= 14,000 units
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Chapter 13 Cost-Volume-Profit Relationships
Total Unit
Sales (14,000 units × P40 per unit)................................ P560,000 P40
Less variable expenses
(14,000 units × P28 per unit) ................................................................
392,000 28
Contribution margin
(14,000 units × P12 per unit) ................................................................
168,000 P12
Less fixed expenses................................................................
150,000
Net operating income ................................................................
P 18,000
Requirement 4
= 16.7% (rounded)
Requirement 5
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Cost-Volume-Profit Relationships Chapter 13
Alternative solution:
Since in this case the company’s fixed expenses will not change, monthly
net operating income will increase by the amount of the increased
contribution margin, P24,000.
III. Problems
Requirement 1
Contribution margin P15
CM ratio = = = 25%
Selling price P60
Variable expense P45
Variable expense ratio = = = 75%
Selling price P60
Requirement 2
Alternative solution:
X = 0.75X + P240,000 + P0
0.25X = P240,000
X = P240,000 ÷ 0.25
X = P960,000; or at P60 per unit, 16,000 units
Requirement 3
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Chapter 13 Cost-Volume-Profit Relationships
Since the fixed expenses are not expected to change, net operating income
will increase by the entire P100,000 increase in contribution margin
computed above.
Requirement 4
Requirement 5
Requirement 6
Contribution margin P300,000
a. Degree of operating leverage = = 5
Net operating P60,000
=
income
b. Expected increase in sales........................................ 8%
Degree of operating leverage ................................... x 5
Expected increase in net operating income............... 40%
c. If sales increase by 8%, then 21,600 units (20,000 x 1.08 = 21,600) will
be sold next year. The new income statement will be as follows:
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Cost-Volume-Profit Relationships Chapter 13
Percent of
Total Per Unit Sales
Sales (21,600 units) ............... P1,296,000 P60 100%
Less variable expenses........... 972,000 45 75%
Contribution margin .............. 324,000 P15 25%
Less fixed expenses ............... 240,000
Net operating income ............ P 84,000
Thus, the P84,000 expected net operating income for next year
represents a 40% increase over the P60,000 net operating income earned
during the current year:
P84,000 – P60,000 P24,000
= = 40% increase
P60,000 P60,000
Note from the income statement above that the increase in sales from
20,000 to 21,600 units has resulted in increases in both total sales and
total variable expenses. It is a common error to overlook the increase in
variable expense when preparing a projected income statement.
Requirement 7
a. A 20% increase in sales would result in 24,000 units being sold next
year: 20,000 units x 1.20 = 24,000 units.
Percent of
Total Per Unit Sales
Sales (24,000 units) ............... P1,440,000 P60 100%
Less variable expenses........... 1,152,000 48* 80%
Contribution margin .............. 288,000 P12 20%
Less fixed expenses ............... 210,000†
Net operating income ............ P 78,000
Note that the change in per unit variable expenses results in a change in
both the per unit contribution margin and the CM ratio.
c. Yes, based on these data the changes should be made. The changes will
increase the company’s net operating income from the present P60,000
to P78,000 per year. Although the changes will also result in a higher
break-even point (17,500 units as compared to the present 16,000 units),
the company’s margin of safety will actually be wider than before:
Requirement 1
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Cost-Volume-Profit Relationships Chapter 13
Alternative solution:
= 15,000 units
= P300,000 in sales
Requirement 2
Since the company presently has a loss of P9,000 per month, if the changes
are adopted, the loss will turn into a profit of P4,000 per month.
Requirement 3
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Chapter 13 Cost-Volume-Profit Relationships
Requirement 4
Alternative solution:
= 17,500 units
Requirement 5
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Cost-Volume-Profit Relationships Chapter 13
= 16,000 units
c. Whether or not one would recommend that the company automate its
operations depends on how much risk he or she is willing to take, and
depends heavily on prospects for future sales. The proposed changes
would increase the company’s fixed costs and its break-even point.
However, the changes would also increase the company’s CM ratio
(from 30% to 65%). The higher CM ratio means that once the break-
even point is reached, profits will increase more rapidly than at present.
If 20,000 units are sold next month, for example, the higher CM ratio
will generate P22,000 more in profits than if no changes are made.
The greatest risk of automating is that future sales may drop back down
to present levels (only 13,500 units per month), and as a result, losses
will be even larger than at present due to the company’s greater fixed
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Chapter 13 Cost-Volume-Profit Relationships
costs. (Note the problem states that sales are erratic from month to
month.) In sum, the proposed changes will help the company if sales
continue to trend upward in future months; the changes will hurt the
company if sales drop back down to or near present levels.
If more than 16,857 units are sold, the proposed plan will yield the greatest
profit; if less than 16,857 units are sold, the present plan will yield the
greatest profit (or the least loss).
Requirement 1
Products
Sinks Mirrors Vanities Total
Percentage of total sales ................................
32% 40% 28% 100%
Sales ................................................................
P160,000 100 % P200,000 100 % P140,000 100 % P500,000 100 %
Less variable expenses ................................
48,000 30 160,000 80 77,000 55 285,000 57
Contribution margin ................................
P112,000 70 % P 40,000 20 % P 63,000 45 % 215,000 43 %*
Less fixed expenses ................................ 223,600
Net operating income (loss) ................................ P ( 8,600)
Requirement 2
Break-even sales:
Break-even point Fixed expenses
in total peso sales =
CM ratio
P223,600
=
0.43
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= P520,000 in sales
Cost-Volume-Profit Relationships Chapter 13
Requirement 3
Although the company met its sales budget of P500,000 for the month, the
mix of products sold changed substantially from that budgeted. This is the
reason the budgeted net operating income was not met, and the reason the
break-even sales were greater than budgeted. The company’s sales mix was
planned at 48% Sinks, 20% Mirrors, and 32% Vanities. The actual sales
mix was 32% Sinks, 40% Mirrors, and 28% Vanities.
As shown by these data, sales shifted away from Sinks, which provides our
greatest contribution per peso of sales, and shifted strongly toward Mirrors,
which provides our least contribution per peso of sales. Consequently,
although the company met its budgeted level of sales, these sales provided
considerably less contribution margin than we had planned, with a resulting
decrease in net operating income. Notice from the attached statements that
the company’s overall CM ratio was only 43%, as compared to a planned
CM ratio of 52%. This also explains why the break-even point was higher
than planned. With less average contribution margin per peso of sales, a
greater level of sales had to be achieved to provide sufficient contribution
margin to cover fixed costs.
Requirement 1
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Chapter 13 Cost-Volume-Profit Relationships
Requirement 2
Break-even point Fixed expenses
in total sales =
CM ratio
pesos
P1,800,000
=
0.60
Requirement 4
Contribution margin P2,160,000
a. Degree of operating leverage = = 6
Net operating P360,000
=
income
b. 6 × 15% = 90% increase in net operating income.
Requirement 5
Last Year: Proposed:
28,000 units 42,000 units*
Total Per Unit Total Per Unit
Sales ................................................................
P4,200,000 P150.00 P5,670,000 P135.00**
Less variable expenses ................................
1,680,000 60.00 2,520,000 60.00
Contribution margin................................
2,520,000 P 90.00 3,150,000 P 75.00
Less fixed expenses................................
1,800,000 2,500,000
Net operating income................................
P 720,000 P 650,000
Requirement 6
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Cost-Volume-Profit Relationships Chapter 13
Requirement 1
Selling price................................................................................................
P30
Less variable expenses:
Purchase cost of the patches ................................................................
P15
Commissions to the student salespersons................................ 6 21
Contribution margin.............................................................................................
P 9
Since there are no fixed costs, the number of unit sales needed to yield the
desired P7,200 in profits can be obtained by dividing the target profit by the
unit contribution margin:
Target profit P7,200
= = 800 patches
Unit contribution margin P9 per patch
800 patches x P30 per patch = P24,000 in total sales
Requirement 2
Since an order has been placed, there is now a “fixed” cost associated with
the purchase price of the patches (i.e., the patches can’t be returned). For
example, an order of 200 patches requires a “fixed” cost (investment) of
P3,000 (200 patches × P15 per patch = P3,000). The variable costs drop to
only P6 per patch, and the new contribution margin per patch becomes:
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Chapter 13 Cost-Volume-Profit Relationships
Selling price................................................................................................
P30
Less variable expenses (commissions only).......................................................... 6
Contribution margin.............................................................................................
P24
Since the “fixed” cost of P3,000 must be recovered before Ms. Morales
shows any profit, the break-even computation would be:
If a quantity other than 200 patches were ordered, the answer would change
accordingly.
Problem 6
TR
600,000
500,000
TC
400,000
(P)
Break-even
300,000 point
200,000 13-22
FC
100,000
250,000
P 200,000
R
O
F 150,000
I
T
100,000
Break-even
50,000
point
0
5,000 10,000 15,000 20,000 25,000 30,000
50,000
100,000
L
O 150,000
S
S
200,000
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250,000
Chapter 13 Cost-Volume-Profit Relationships
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