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Cost Volume Profit Analysis

CVP analysis - is useful for profit planning by way of systematic analysis of the profit’s relationship with various costs
and volume of sales.
Factors affecting profits
If there is an increase in: Then profit tends to:
1. Selling price Increase
2. Unit variable cost Decrease
3. Fixed cost Decrease
4. Volume (unit sales) Increase

In multi-product companies, a change in sales mix may also affect company profit.
Underlying CVP Assumptions (limitations)
1. Relevant range, time and linearity assumptions are also assumed in CVP analysis
2. Unless indicated otherwise, unit selling price is constant even if sales volume changes.
3. Inventories do not change significantly from period to period
4. IN case of multi-product company, sales mix is constant
5. Labor productivity, production technology and market conditions remain stable.

Terms used in CVP analysis


1. Contribution margin – is the difference between sales and variable cost. It is otherwise known as marginal income,
profit distribution, contribution to fixed cost or incremental contribution.
CM ratio = CM /sales = Unit CM /Unit Selling Price

2. Break- Even Point – a level of activity, in units (break even volume) or in pesos (break even sales) at which total
revenues equal total costs. At break-even point, there is neither a profit nor loss.
a. BEP = Fixed cost / CM per unit

b. BEP in peso sales = Fixed cost/ CM ratio

c. Unit sales with target profit = (fixed costs + Profit before tax) / CM per unit

d. Peso Sales with target return on sales = Fixed Costs


CM ratio – Return on sales
If Profit after tax / (100% - tax rate)

3. Margin of safety - the difference between actual sales and break even sales. It indicates the maximum amount by
which sales could decline without incurring a loss.
a. Margin of Safety = Sales – Break even sales

b. Margin of safety ratio = Margin of safety / Sales

c. CM ratio x Margin of safety ratio = net profit ratio


Where: CM ratio = CM / Sales
Margin of safety ratio = Margin of safety / sales
Net Profit ratio = Profit / sales

4. Indifference Point - the level of volume at which two alternatives being analyzed would yield equal amount of total
costs or points.
Alternative A Alternative B
1.(unit CM x Q) – Fixed Cost = (unit CM x Q) – Fixed cost
2. Fixed cost + (unit VC x Q) = Fixed cost + (unit VC x Q)

Note: Q – number of units (indifference point)

5. Sales mix – the relative combination of quantities of sales of various products that make up the total sales of a
company
1. Overall BEP units = Fixed costs / Weighted Average CM per unit

2. Overall BEP peso sales = Fixed costs / Weighted Average CM ratio


6. Degree of Operating leverage (DOL) – measures how a percentage change in sales will affect company profits. It
indicates how sensitive the company is to sales volume increases and decreases. It is also known as operating leverage
factor.
1. DOL = CM / Profit before tax
2. change % sales x DOL = change % profit before tax
Exercises:
Problem 1 ABC manufactures and sells a single product. The company’s sales and expenses for a recent month
follows:
Sales (1,500 units) P37,500
Less: Variable Cost 15,000
CM 22,500
Less: Fixed Cost 15,000
Profit P7,500

Required:
1. Determine the following:
a. Unit selling price
b. Unit Variable cost
c. CM ratio

2. For profit planning purposes, compute the following:


a. BEP in units
b. BEP peso sales

3. What unit sales are required to earn P9,000 profit for the month?
4. What peso sales are required to earn an after tax profit of P7,200 (assuming tax rate is 20%)?
5. Assume that ABC is currently selling 800 units per month and that the company president believes that sales
would increase if advertising were increased by P6,000 How many units should sales increase to give the company
same profit or loss that is currently earning?
(note: although you know how many units are being sold, you do not need this info. To solve the problem)
6. What is the margin of safety at its present sales of P37,500?
7. ABC currently pays its sales people a monthly salary of P4,000 per month without any commission. However, the
company considers a plan whereby the salespeople would receive a 10% commission, but the monthly salary would
fall to 2,500. What sales level will the company be indifferent between two compensation plans.

Answers:
1.25 ; 10; 60%
2. 1,000 ; 25,000
3. 1,600
4. 40,000
5. 400
6. 12,500
7. 600
Solution guide
1,000 units (2) 1,600 units (3) 800 units (5)
Sales
Less: VC
CM
less: FC

Profit (loss)

Requirement 7
- Monthly FC will decrease by P1,500 under the proposal (P4,000 – P2,500)
- Unit VC increases by P2.50 (10% of 25)
Based on cost function “Y = a + bx”
Cost of old = Costs of new
15,000 + 10X = 13,500 + 12.5x
1,500 = 2.5 x
X = 600 units

Problem 2. ABC’ breakeven sales are P528,000. The VC ratio is 60%. While the profit ratio is 8%.
Required: Determine the following:
1. Fixed costs
2. Sales
3. Profit
4. Margin of safety
5. Margin of safety ratio
Answer:
1. 211,200
2. 660,000
3. 52,800
4. 132,000
5. 20%
Problem 3 ABC produces and sells two products, T and C. The following is next month’s income budget:
C T Total
Units Sales 60 units 15 units 75 units
Sales P1,200 187.50 1,387.50
VC 1,050 1,12.50 1,162.50
CM 150 75 225
FC 90
Profit 135

Required:
1. How many units of C should be sold next month to break even?
2. How many units of T should be sold to earn a profit of P120?
Solution guide:
C T
CM per unit 2.50 5.00
Sales Mix (4:1 = 80% and 20%) 80% 20%
Weighted average CM per unit

Problem 5: ABC has recently opened the XY Co. exclusive for not so good looking individuals. The result for the XY’
first year operation are presented as follows:
Sales 250,000
Less: VC 100,000
CM 150,000
less: FC 120,000
Profit (loss) 30,000

ABC is unhappy about the result of his XY Co first year of operations. She observed that despite the high CM, profit
was still low because of the high fixed co9sts. She concluded that an increase in sales would not yield a satisfactory
increase in profit.

Required:
1. Explain to ABC that his conclusion is not right by computing the operating leverage factor.
2. If sales increase by 10%, then how many percent would profit increase?
(Note: determine the % chage in profit by using the operating leverage factor)

Answer
1. 5 or 5X
2. 50%

6. At break even point, total CM is:


a. zero c. Equal to TC
b. equal to FC d. Equal to total VC

7. An increase in CM ratio reduces the BEP. (True or False)


8. If the tax arte increases, then the BEP also increases. (True or False)
9. An increase in actual sales also increases the margin of safety. (True or False)
10. A company that has a negative Margin of safety necessarily operates at a loss. (True or False)

11. An increase in the income tax rate.


a. Raises the BRP
b. Lowers BEP
c. Increases sales required to earn a particular after tax profit to cover tax expenses
d. Decreases sales required to earn a particular after tax profit to cover tax expenses

12. Under CVP analysis, which of the following is not assumed to be constant?
a. unit variable cost
b. unit fixed cost
c. Unit selling price
d. Sales mix

13. A % change in pre tax profit can be quickly computed by multiplying a % change in peso sales by the
a. Sales mix c. Indifference point
b. Margin of safety d. Degree of operating leverage

14. The operating leverage factor is equal to:


a. Gross margin / profit after tax c. CM / profit after tax
b. Gross margin / profit before tax d. CM / profit before tax
15. If inventories are expected to change, the type of costing that provides the best information for breakeven analysis
is:
a. Job order costing c. Joint Costing
b. Variable Costing d. Absorption costing

16. A recent income statement of Black Corporation reported the following data:

   

If these data are based on the sale of 20,000 units, the break-even point would be: 
A. 9,565 units (rounded).
B. 11,000 units (rounded).
C. 7,586 units (rounded).
D. 14,667 units (rounded).
E. an amount other than those above.

17. A recent income statement of Suni Corporation reported the following data:

   
If these data are based on the sale of 20,000 units, the break-even point would be: 
A. 7,500 units.
B. 11,628 units.
C. 12,500 units.
D. 33,333 units.
E. an amount other than those above

18. A recent income statement of Yang Corporation reported the following data:

   
If these data are based on the sale of 5,000 units, the break-even sales would be: 
A. P2,000,000.
B. P2,206,000.
C. P2,500,000.
D. P10,000,000.
E. an amount other than those above.

19. Lawson, Inc. sells a single product for P12. Variable costs are P8 per unit and fixed costs total P360,000 at a
volume level of 60,000 units. Assuming that fixed costs do not change, Lawson's break-even point would be: 
A. 30,000 units.
B. 45,000 units.
C. 90,000 units.
D. negative because the company loses P2 on every unit sold.
E. a positive amount other than those given above.

20. Grey, Inc. sells a single product for P20. Variable costs are P8 per unit and fixed costs total P120,000 at a volume
level of 5,000 units. Assuming that fixed costs do not change, Green's break-even sales would be: 
A. P160,000.
B. P200,000.
C. P300,000.
D. P480,000.
E. an amount other than those above.

21. Orion recently reported sales revenues of P800,000, a total contribution margin of P300,000, and fixed costs of
P180,000. If sales volume amounted to 10,000 units, the company's variable cost per unit must have been: 
A. P12.
B. P32.
C. P50.
D. P92.
E. an amount other than those above.

22. Strayer has a break-even point of 120,000 units. If the firm's sole product sells for P40 and fixed costs total
P480,000, the variable cost per unit must be: 
A. P4.
B. P36.
C. P44.
D. an amount that cannot be derived based on the information presented.
E. an amount other than those in choices "A," "B," and "C", but one that can be derived based on the information
presented.

23. Ribco Co. makes and sells only one product. The unit contribution margin is P6 and the break-even point in unit
sales is 24,000. The company's fixed costs are: 
A. P4,000.
B. P14,400.
C. P40,000.
D. P144,000.
E. an amount other than those above.

CVP Analysis (Exercises)


1. Flying Cloud Co. has the following operating data for its manufacturing operations:

Unit selling price P 250


Unit variable cost 100
Total fixed costs P840,000

The company has decided to increase the wages of hourly workers which will increase the unit variable cost by 10%.
Increases in the salaries of factory supervisors and property taxes for the factory will increase fixed costs by 4%. If
sales prices are held constant, the next break-even point for Flying Cloud Co. will be:
a. increased by 640 units
b. increased by 400 units
c. decreased by 640 units
d. increased by 800 units

2. If fixed costs are P750,000 and variable costs are 60% of sales, what is the break-even point (dollars)?
a. P1,875,000
b. P300,000
c. P2,500,000
d. P1,250,000

3. If fixed costs are P240,000, the unit selling price is P36, and the unit variable costs are P20, what is the break-even
sales (units)?
a. 12,000 units
b. 27,000 units
c. 15,000 units
d. 6,667 units

4. If fixed costs are P1,500,000, the unit selling price is P250, and the unit variable costs are P130, what is the
amount of sales required to realize an operating income of P200,000?
a. 14,166 units
b. 12,500 units
c. 16,000 units
d. 11,538 units

5. If fixed costs are P490,000, the unit selling price is P35, and the unit variable costs are P20, what is the break-even
sales (units) if fixed costs are reduced by P40,000?
a. 32,667 units
b. 14,000 units
c. 30,000 units
d. 24,500 units

6. If fixed costs are P400,000, the unit selling price is P25, and the unit variable costs are P15, what is the
break-even sales (units) if the variable costs are increased by P2?
a. 50,000 units
b. 30,770 units
c. 40,000 units
d. 26,667 units

7. If fixed costs are P240,000, the unit selling price is P32, and the unit variable costs are P20, what are the old and new
break-even sales (units) if the unit selling price increases by P4?
a. 7,500 units and 6,667 units
b. 20,000 units and 30,000 units
c. 20,000 units and 15,000 units
d. 12,000 units and 15,000 units

8. When the fixed costs are P120,000 and the contribution margin is P20, the break-even point is
a. 16,000 units
b. 8,000 units
c. 7,998 units
d. 6,000 units

9. If fixed costs are P39,600, the unit selling price is P42, and the variable costs are P24, what is the break-even sales
(units)?
a. 2,500
b. 943
c. 1,650
d. 2,200

10. If fixed costs are P39,600, the unit selling price is P42, and the variable costs are P24, what is the break-even sales
(unit ) if the variable costs are decreased by P2?
a. 1,650
b. 990
c. 1,980
d. 1,350

11. If sales are P400,000, variable costs are 80% of sales, and operating income is P40,000, what is the operating
leverage?
a. 0
b. 7.500
c. 2.0
d. 1.333

12. Assume that Corn Co. sold 8,000 units of Product A and 2,000 units of Product B during the past year. The unit
contribution margins for Products A and B are P30 and P60 respectively. Corn has fixed costs of P378,000. The
break-even point in units is:
a. 8,000 units
b. 6,300 units
c. 12,600 units
d. 10,500 units

13. If sales are P500,000, variable costs are 75% of sales, and operating income is P50,000, what is the operating
leverage?
a. 0
b. 1.25
c. 2.2
d. 2.5
14. The Rocky Company reports the following data.
Sales P700,000
Variable costs P300,000
Fixed costs P120,000

Rocky Company’s operating leverage is:


a. 3.33
b. 2.5
c. 1.0
d. 1.4