CVP Analysis and Marginal Costing

☛COST-VOLUME PROFIT ANALYSIS ☛BASIC ASSUMPTIONS WITHIN THE RELEVANT

RANGE
 Cost-volume profit analysis is a systematic
examination of the relationships among Linearity – the behaviour of sales and costs is linear.
costs, cost driver, and profit.
Behaviour of sales, costs and expenses:
☛ELEMENTS OF CVP ANALYSIS  Sales – it changes directly in relation to the
level of units sold.
1. Sales
a. Selling Price  Fixed costs – total fixed cost is constant
b. Units of Volume without regard to the change in the level of
2. Total fixed cost units of production and sales; unit fixed cost
3. Variable cost per unit changes
4. Sales mix  Variable costs – total variable costs change
in direct proportion with the level of units
☛APPLICATIONS OF CVP ANALYSIS produced and sold; unit variable cost is
constant
Planning and decision-making, which may involve
choosing the: Selling price – assumed to be constant

1. Type of product to produce and sell; WIP inventory – disregarded, there is no WIP
2. Pricing policy to follow; inventory
3. Marketing strategy to use; and
FG inventory – no change in the FG inventory
4. Type of productive facilities to acquire

☛INHERENT SIMPLIFYING ASSUMPTIONS OF CVP

ANALYSIS

1. All costs are classifiable as either variable or

fixed
2. Cost and revenue relationships are
predictable and linear over a relevant range
of activity and a specified period of time
3. Total variable costs change directly with the
cost driver, but variable costs per unit are
constant over the relevant range
4. Total fixed costs are constant over the
relevant range, but fixed costs per unit vary
inversely with the cost driver or volume
5. Selling prices per unit and market conditions
remain unchanged
6. Production equals sales, i.e., 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
 Products and sales mix: ∆ Profit = ∆CM - ↑ in FC
-There is only one product, or ∆ Profit = ∆CM + ↓ in FC
-If there are 2 or more products produced BEP
and sold, the sales mix is assumed to be constant BEP (units) = FC / UCMargin
FORMULAS USED IN CVP ANALYSIS BEP (pesos) = FC / CMRatio
Contribution Margin Comp. BEP (units) = FC / Average UCM
Sales – Variable costs Comp. BEP (pesos) = FC / Average CMR
CM = Sales x CMR BEP (units) = Actual sales x (1 –
CM = Fixed costs + IBIT MSRatio)
CM = Quantity sold x UCM At BEP: Profit (loss) = 0
CMR Sales = Total cost
CMR = 100% -VCRatio CM = Total fixed cost
CMR = UCM / USP Fixed Cost
CMR = ∆EBIT / ∆Sales (if FC FC = CM (at BEP)
remains the same) FC = CM= Profit
CMR = CM / Sales FC = BEP (units) x UCM
CMR = NPR / MSR VCRatio
UCM VCRatio = VC / Sales
UCM = USP – UVC VCRatio = UVC / USP
UCM = FC / BEP (units) VCRatio = 100% -CMR
UCM = CM / Quantity sold VCRatio = ∆Costs / ∆Sales
Profit VCRatio = (∆Costs - ↑ in FC) /
Profit = CM – Fixed costs ∆Sales
Profit = Sales x MSRatio x VCRatio = (∆Costs + ↓ in FC) /
CMRatio ∆Sales
Profit = Sales x NPRatio

Multiple-Product/ Service Break-even Calculations

where: BEPP= Break-even Point in Pesos

BEPP= FC/WaCMR
WaCMR = Weighted Average Contribution Margin Ratio

WaCMR= CMR(Product 1) x SMRP CMR= Contribution Margin Ratio per Product

+ CMR(Product 2) x SMRP…

SMRP= Total Sales in Pesos of a Single Product

Total Sales in Pesos SMRP= Peso Sales Mix Ratio

where: BEPU = Break-even Point in Units

BEPU= FC/WaUCM WaUCM= Weighted Average Unit Contribution Margin

WaUCM = UCM(Product 1) x SMRU

UCM= Unit Contribution Margin per Product
+ UCM(Product 2) x SMRU….

SMRU= Total Sales in Units of a Single Product

Total Sales in Units SMRU = Unit Sales mix ratio
 RISKS AND UNCERTAINTY:

☛MARGIN OF SAFETY
 indicates the amount by which actual or planned sales may be reduced without incurring a loss. It is the
difference between actual or planned sales volume and break even sales

☛OPERATING LEVERAGE
 a measure of extent to which fixed costs are being used in an organization. The greater the fixed costs in
relation to variable cost, the greater is the operating leverage available and the greater is the sensitivity of
income to changes in sales.

☛DEGREE OF OPERATING LEVERAGE (DOL)

 a measure of the sensitivity of profit changes to changes in sales volume. DOL measures the percentage of
change in profit that results from a percentage of change in sales
Margin of Safety
MS = Actual sales – Actual break- where:
even sales
MS = Budgeted sales – Budgeted MS= margin of Safety
break-even sales MSR= Margin of Safety Ratio
MS = Sales x MSRatio NPR= Net Profit Ratio
MSR = MS / Actual (or Budgeted) CM/R= Contribution Margin/Ratio
sales BE= Break-even
MSR = NPR / CMR USP= Unit Selling Price
MSR = [1 – (BESales / Actual Sales)] DOL= Degree of Operating Leverage
NPRatio EBIT= Earnings Before Interests and
Taxes
NPRatio = Unit Profit Margin / USP
NPRatio = MSR x CMR
Degree of operating leverage
DOL = CM/ EBIT
DOL = %∆ in EBIT / % ∆in Sales

☛SENSITIVITY ANALYSIS
 a “what-if” technique that examines the impact of changes on an answer. For example, computer
spreadsheets are used to analyze changes in prices, variable costs, and fixed costs on expected
profits.
COMPREHENSIVE PROBLEM: f. P13X = P589,550 + P996,450
X = P1,586, 000 ÷ P13
Farm Land makes small plant stands that sell for P25
X = 122, 000 plant stands
each. The company’s annual level of production and
g. PBT = PAT ÷ (1 – tax rate) = P657, 800 ÷ (1 –
sales is 120,000 units. In addition to P430,500 of fixed
manufacturing overhead and P159, 050 of fixed 0.20) = P657, 800 ÷ 0.80 = P822, 250
administrative expenses, the following per-unit costs P13X = P589, 550 + P822, 250
have been determined for each plant stand. X = P1,411,800 ÷ P13
X = 108,600 plant stands
Direct Material P 6.00 h. X = Increase in FC ÷ CM
Direct Labor 3.00
X = P7,865 ÷ P13
Variable Manufacturing 0.80
Overhead X = 605 units over BEP
Variable Selling Expense 2.20 New BEP = 45, 350 + 605 = 45, 955 plant
Total Variable Cost P 12.00 stands
Required:

a. Calculate the unit CM in dollars and the CM

ratio for the plant stand
b. Determine the break-even point in number
of plant stands
c. Calculate the dollar break-even point in
number of plant stands
d. Determine Farm Land’s margin of safety in
units, in sales dollars, and as a percentage
e. Compute the company’s degree of operating
leverage. If the sales increase by 25%, by
what percentage will before-tax income
increase?
f. How many plant stands must the company
sell to earn P999,450 in before income tax?
g. If the company wants to earn P675,800 after
tax and is subject to a 20% tax rate, how
many units must be sold?
h. How many plant stands must be sold to
break-even if Farm Land’s fixed
manufacturing cost increases by P7,865?

Solution:

a. CM = SP – VC = P25 – P12 = P13 per unit

CM% = CM ÷ SP = P13 ÷ P25 = 52%
b. BEP = FC ÷ CM = P589,550 ÷ P13 = 45,350
plant stands
c. BEP = FC ÷ CM% = P589,550 ÷ 0.52 =
P1,133,750 plant stands
d. MSunits = Current unit Sales – BEP units
sales = 120,000 – 45,350 = 74,650 plant
stands
MSPesos = Current sales in pesos – BEP sales
in pesos = P3,000,000 – P1,133,750 = P1,
866,250
MS% = MS in units ÷ Current units sales =
74,650 ÷ 120,000 = 62%
e. DOL = Current CM ÷ Current Pre-tax Income
= P1, 560,000 ÷ P970,450 = 1.61
Increase in Income = DOL x % Increase in
Sales = 1.61 x 0.25 = 40.25 percent