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MAS 8903

MANAGEMENT ADVISORY SERVICES

COST-VOLUME-PROFIT ANALYSIS

COST-VOLUME-PROFIT ANALYSIS (CVP analysis) examines the behavior of total revenues, total

costs, and operating income as changes occur in the output level, selling price, variable cost

per unit, or fixed costs of a product.

BREAK-EVEN SALES – that point of activity level (sales volume) where total revenues equal total

costs, i.e., there is neither profit nor loss.

1. Equation Method or algebraic approach

2. Contribution margin method or formula approach

3. Graphic approach

The cost-volume-profit graph depicts the relationships among cost, volume, and profits.

Profit

Total Cost

Break-Even Point

Loss

Units Sold

The point where the total revenue line and the total cost line intersect is the break-even point.

1. Changes in the level of revenues and costs arise only because of changes in the number

of product (or service) units produced and sold.

2. Total costs can be separated into a fixed component that does not vary with the output

level and a component that is variable with respect to the output level.

3. When represented graphically, the behavior of total revenues and total costs are linear

(represented as a straight line) in relation to output level within a relevant range and

time period.

4. The selling price, variable cost per unit, and fixed costs are known and constant.

5. The analysis either covers a single product or assumes that the sales mix, when

multiple products are sold, will remain constant as the level of total units sold changes.

6. All revenues and costs can be added and compared without taking into account the time

value of money.

MULTIPLE-PRODUCT ANALYSIS

When CVP analysis is used for a multiple-product firm, the product is defined as a package

of products. For example, if the sales mix is 3:1 for Products A and B, the package would consist of

3 units of Product A and 1 unit of Product B.

Break-even in packages for a multiple-product firm is then calculated as:

Break-even packages = Fixed Costs/Weighted average contribution margin

MAS 8903 COST-VOLUME-PROFIT ANALYSIS Page 2 of 9

SALES MIX - the composition of total sales in terms of various products, i.e., the percentage of each

product included in total sales.

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 the 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.

changes in sales volume. DOL measures the percentage of change in profit that results from

a percentage of change in sales.

Degree of Operating Leverage (DOL) or Operating Leverage Factor (OLF) – a measure, at a given

level of sales, of how a percentage change in sales volume will affect profits.

DEGREE OF OPERATING LEVERAGE (DOL)

OR = Contribution Margin / Operating income

OPERATING LEVERAGE FACTOR (OLF)

> The higher the degree of operating leverage, the greater the change in profit when sales

change.

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.

1. Selling price per unit 4. Fixed cost

2. Variable cost per unit 5. Sales mix

3. Volume or number of units

EXERCISES:

1. Feather Friends, Inc. distributes a high-quality wooden birdhouse that sells for P20 per unit.

Projected operating results for the coming year are as follows:

Less: Variable expenses 160,000

Contribution margin P240,000

Less: Fixed expenses 180,000

Operating income P 60,000

REQUIRED:

1. Compute the contribution margin per unit and calculate the break-even point in units.

Calculate the contribution margin ratio and the break-even sales revenue.

2. The divisional manager plans to increase the advertising budget by P20,000. This will

increase the projected sales revenues by 40%. By how much will operating income

increase or decrease as a result of this action? Profit increase:

a. How much sales must be generated to earn pre-tax profit of P180,000?

MAS 8903 COST-VOLUME-PROFIT ANALYSIS Page 3 of 9

b. How many units must be sold to earn an after-tax profit of P75,600? Assume a tax

rate of 30 percent.

c. How much must sales be to earn pre-tax profit of 20% of such sales?

4. Compute the margin of safety based on the original income statement showing the

projected operating results for the coming year.

5. Compute the degree of operating leverage based on the original income statement. DOL

If sales revenues are 20 percent greater than expected, what is the percentage increase

in profits?

2. Pampalakas Cpmpany makes a high-energy protein drink. The selling price per liter is P10.80,

and variable cost per liter is P6.48. Total fixed cost per year is P474,900. The company is

currently selling 120,000 liters per year.

a. What is the margin of safety in liters?

b. What is the degree of operating leverage?

c. If the company can increase sales in liters by 25 percent, what percentage increase will it

experience in income? Prove your answer using the income statement approach.

Product 2. Manufacturing cost information follows.

Product 1 Product 2

Annual fixed costs P264,000 P408,000

Variable cost per unit 39.60 30

Regardless of which product is introduced, the anticipated selling price will be P60 and the

company will pay a 10% sales commission on gross peso sales. Zalucki will not carry an

inventory of these items.

REQUIRED:

At what unit-volume level will the profit/loss on Product 1 equal the profit/loss on

Product 2?

4. The Zapatos Company produces its famous shoe, the Walker, that sells for P3,000 per pair.

Operating income for this year is as follows:

Variable cost (P1,200 per pair) 2,400,000

Contribution margin P3,600,000

Fixed cost 2,000,000

Operating income P1,600,000

Zapatos Company would like to increase its profitability over the next year by at least 25%. To

do so, the company is considering the following options:

1. Replace a portion of its variable labor with an automated machining process. This would

result in a 20% decrease in variable cost per unit, but a 10% increase in fixed costs.

Sales would remain the same.

2. Spend P300,000 on a new advertising campaign, which would increase sales by 20%.

3. Increase both selling price by P500 per unit and variable costs by P200 per unit by using

a higher quality leather material in the production of its shoes. The higher priced shoe

would cause demand to drop by approximately 10%.

4. Add a second manufacturing facility which would double Zapatos’ fixed costs, but would

increase sales by 50%.

REQUIRED:

Evaluate each of the alternatives considered by Zapatos. Do any of the options meet or exceed

Zapatos’ targeted increase in income of 25%?

MAS 8903 COST-VOLUME-PROFIT ANALYSIS Page 4 of 9

5. Rue’s Bagel Shop sells only coffee and bagels. Rue estimates that every time she sells one bagel,

she sells four cups of coffee. The budgeted cost information for Rue’s products for 2021 follows:

COFFEE BAGELS

Unit sales 4,000 1,000

Selling price P50 P80

Product ingredients 5 10

Hourly sales staff (cost per unit) 10 20

Packaging 5 10

Fixed costs:

Rent on store and equipment P100,000

Marketing and advertising costs 40,000

REQUIRED:

a. Calculate the breakeven points in units and in pesos for coffee and bagels.

b. If the sales mix is four cups of coffee to one bagel, how many units of each product does

Rue need to sell to earn operating income before tax of P40,000?

6. Dackers Company, a wholesaler of jeans, had the following income statement for last year:

Cost of sales 800,000

Gross margin P 600,000

Selling expenses P350,000

Administrative expenses 190,000 540,000

Income P 60,000

Mr. Dackers informs you that the only variables costs are cost of sales and P2 per unit selling

costs. All administrative expenses are fixed. In planning for the coming year, Mr. Dackers

expects his selling price to remain constant, with unit volume increasing by 20%. He also

forecasts the following changes in costs and is concerned about how they will affect profitability.

Variable costs:

Cost of goods sold up P1.50 per unit

Selling costs up P0.10 per unit

Fixed costs:

Selling costs up P40,000

Administrative costs up P30,000

REQUIRED:

1. Compute the expected income for the coming year, assuming that all forecasts are

met. P17,200

2. Determine the number of units that Dackers will have to sell in the coming year to

earn the same profit as the current year. 51,754 units

3. Mr. Dackers is disturbed at the results of requirements 1 and 2. He asks you by how

much he must raise his selling price to earn P60,000 selling 48,000 units. P35.89 – P35 =

P0.89

7. Gosnell Company produces two products: squares and circles. The projected income for the

coming year, segmented by product line, follows:

Sales P300,000 P2,500,000 P2,800,000

Less: Variable expenses 100,000 500,000 600,000

Contribution margin P200,000 P2,000,000 P2,200,000

Less: Direct fixed expenses 28,000 1,500,000 1,528,000

Product margin P172,000 P 500,000 P 672,000

Less: Common fixed expenses 100,000

Operating income P 572,000

MAS 8903 COST-VOLUME-PROFIT ANALYSIS Page 5 of 9

The selling prices are P30 for squares and P50 for circles.

REQUIRED:

1. Compute the number of units of each product that must be sold for Gosnell Company

to break even. 7,400; 37,000

2. Compute the revenue that must be earned to produce an operating income of 10

percent of sales revenues. P2,374,216

3. Assume that the marketing manager changes the sales mix of the two products so that

the ratio is three squares to five circles. Repeat Requirements 1 and 2. 18,786; 31,310;

P2,449,225

4. Refer to the original data. Suppose that Gosnell can increase the sales of squares with

increased advertising. The extra advertising would cost an additional P45,000, and

some of the potential purchasers of circles would switch to squares. In total, sales of

squares would increase by 15,000 units, and sales of circles would decrease by 5,000

units. Would Gosnell be better off with this strategy? P55,000 increase in profit. This is a

good strategy

8. Hay! Co. produces a single product. Sales have been very erratic, with irregular monthly

operating results. The company’s income statement for the most recent month is given below:

Less variable expenses _315,000

Contribution Margin 135,000

Less fixed expenses 150,000

Net Loss P(15,000)

REQUIRED:

1. Compute the company’s CM ratio and its break-even point in both units and

pesos. 30%; 16,666.67; P500,000

2. The sales manager feels that a P20,000 increase in the monthly advertising

budget, combined with an intensified effort by the sales staff, will result in a

P100,000 increase in monthly sales. If the sales manager is right, what will be

the effect on the company’s monthly net income or loss? ↑P10,000

3. The president is convinced that a 10% reduction in the selling price, combined

with a P50,000 increase in the monthly advertising budget, will cause unit sales

to double. What will the new income statement look like if these changes are

adopted? P20,000 loss

4. Refer to the original data. The company’s advertising agency thinks that a new

package for the company’s product would help sales. The new package being

proposed would increase packaging costs by P3 per unit. Assuming no other

changes in cost behavior, how many units would have to be sold each month to

earn a profit of P9,000? 26,500

5. Refer to the original data. By automating certain operations, the company could

slash its variable expenses to half. However, fixed costs would increase to

P250,000 per month.

a. Compute the new CM ratio and the new break-even point in both units

and pesos. 65%; 12,820.5 units; P384,615

b. Assume that the company expects to sell 20,000 units next month.

Prepare two income statements, one assuming that operations are not

automated and one showing that they are. Not, P30,000; Auto: P140,000

c. Would you recommend that the company automate its operations?

Explain. Automate

9. Great Wall Ski Company recently expanded its manufacturing capacity, which will allow it to

produce up to 15,000 pairs of cross-country skis of the mountaineering model or the touring

model. The Sales Department assures management that it can sell between 9,000 pairs and

13,000 pairs of either product this year. Because the models are very similar, Great Wall will

produce only one of the two models.

MAS 8903 COST-VOLUME-PROFIT ANALYSIS Page 6 of 9

Per-Unit (Pair) Data

Mountaineering Touring

Selling price P88.00 P80.00

Variable costs 52.80 52.80

Fixed costs will total P369,600 if the mountaineering model is produced but will be only

P316,800 if the touring model is produced. Great Wall Ski is subject to a 40 percent income tax

rate.

REQUIRED:

a. Compute the contribution margin for each product line. 35.20 or 40%; 27.20 or 34%

b. If Great Wall desires an after-tax net income of P22,080, how many pairs of touring

skis will the company have to sell? 13,000

c. How much would the variable cost per unit of the touring model have to change before

it had the same break-even point in units as the mountaineering model? dec. 2.97

d. Suppose the variable cost per unit of touring skis decreases by 10 percent, and the

total fixed cost of touring skis increases by 10 percent. Compute the new break-even

point. 10,729.06

e. Suppose management decided to produce both products. If the two models are sold

in equal proportions, and total fixed costs amount to P343,200, what is the firm’s

break-even point in units? 11,000

f. Suppose that Great Wall decided to produce only one model of ski. What is the total

sales revenue at which Great Wall would make the same profit or loss regardless of

the ski model it decided to produce? P880,000

g. If the Great Wall sales department could guarantee the annual sale of 12,000 pairs of

either model, which model would the company produce and why? M=52,800; T=9,600

10. Popoy Company and Basha Company both make wall clocks. They have the same production

capacity, but Popoy is more automated than Basha. At an output of 2,000 wall clocks per

year, the two companies have the following data:

Popoy Basha

Fixed costs P500,000 P300,000

Selling price 400 400

Variable cost per unit 100 200

REQUIRED:

By how much would each company’s income change if production and sales level

increase by 500 units per year? Increase by P150,000; P100,000

11. Following are data taken from the most recent income statement of Whitney Company:

Less cost of goods sold:

Direct materials P90,000

Direct labor 78,300

Manufacturing overhead 98,500 P266,800

Gross margin 183,200

Less operating expenses:

Selling expenses

Variable:

Sales commissions P27,000

Shipping 5,400 32,400

Fixed (advertising, salaries) 120,000

Administrative:

Variable (billing and other) 1,800

Fixed (salaries and other) 48,000 202,200

Net operating loss P(19,000)

MAS 8903 COST-VOLUME-PROFIT ANALYSIS Page 7 of 9

All variable expenses in the company vary in terms of unit sold, except for sales commissions

which are based on peso sales. Variable manufacturing overhead is P0.30 per unit. There were

no beginning or ending inventories. Whitney Company’s plant has a capacity of 75,000 units

per year.

The company has been at a loss for several years. Management is studying several possible

courses of action to determine what should be done to make next year profitable.

REQUIRED:

1. The president is considering two proposals prepared by his staff:

a. For next year, the vice president would like to reduce the unit selling price by

20%. She is certain that this would fill the plant to capacity. (4,000)

b. For next year, the sales manager would like to reduce the unit selling price by

20%, increase the sales commission to 9% of sales, and increase advertising by

P100,000. Based on marketing studies, he is confident this would increase unit

sales by one-third. Compute the amounts of income, one under the vice

president’s proposal and the other one under the sales manager’s proposal.

(168,200)

2. Refer to the original data. The president believes it would be a mistake to change the

unit selling price. Instead, he wants to use less costly raw materials, thereby reducing

unit costs by P0.70. How many units would have to be sold next year to earn a target

profit of P30,200? 48,000

3. Refer to the original data. Whitney Company’s board of directors believes that the

company’s problem lies in inadequate promotion. By how much can advertising be

increased and still allow the company to earn a target profit of 4.5% on sale of 60,000

units? 32,000

4. Refer to the original data. The company has been approached by an overseas distributor

who wants to purchase 9,500 units on a special price basis. There would be no sales

commission on these units. However, shipping costs would be increased by 50% and

variable administrative cost would be reduced by 25%. In addition, a P5,700 special

insurance fee would have to be paid by Whitney Company to protect the goods in transit.

What unit price would have to be quoted on the 9,500 units by Whitney Company to

allow the company to earn a profit of P14,250 on total operations? Regular business

would not be affected by this special order. 8.35

The company has no sales force of its own; rather, it relies completely on independent sales

agents to market its products. These agents are paid a commission of 15% of selling price

for all items sold.

Barbara Cruz, Pittman’s controller, has just prepared the company’s budgeted income statement for

next year. The statement shows the following:

Sales P16,000,000

Manufacturing costs:

Variable P7,200,000

Fixed overhead 2,340,000 9,540,000

Gross margin 6,460,000

Commissions to agents 2,400,000

Fixed marketing costs 120,000*

Fixed administrative costs 1,800,000 4,320,000

Net operating income 2,140,000

Less fixed interest cost 540,000

Income before income taxes 1,600,000

Less income taxes (30%) 480,000

Net income P1,120,000

*Primarily depreciation on storage facilities.

MAS 8903 COST-VOLUME-PROFIT ANALYSIS Page 8 of 9

As Barbara handed the statement to Karl Vega, Pittman’s president, she commented, “I went

ahead and used the agents 15% commission rate in completing these statements, but we’ve

just learned that they refuse to handle our products next year unless we increase the

commission rate to 20%.”

“That’s the last straw,” Karl replied angrily. “Those agents have been demanding more and

more, and this time they’ve gone too far. How can they possibly defend a 20% commission

rate?”

“They claim that after paying for advertising, travel, and the other costs of promotion, there’s

nothing left over for profit,” replied Barbara.

“I say it’s just plain robbery,” retorted Karl. “ And I also say it’s time we dumped those guys and

got our own sales force. Can you get your people to work up some cost figures for us to look

at?”

“We’ve already worked hem up,” said Karl. Several companies we know about pay a 7.5%

commission to their own salespeople, along with a small salary. Of course, we would have to

handle all promotion costs, too. We figure our fixed costs would increase by P2,400,000 per

year, but that would be more than offset by the P3,200,000 (20% x P16,000,000) that we would

avoid on agents’ commissions.”

Salaries:

Sales Manager P 100,000

Salespersons 600,000

Travel and entertainment 400,000

Advertising 1,300,000

Total P2,400,000

“Super,” replied Karl. “And I noticed that the P2,400,000 is just what we’re paying the agents

under the old 15% commission rate.”

It’s even better than that,” explained Barbara. “We can actually save P75,000 a year because

that’s what we’re having to pay the auditing firm now to check out the agent’s reports. So our

overall administrative costs would be less.”

Pull all of these numbers together and we’ll show them to the executive committee tomorrow,”

said Karl. “With the approval of the committee, we can move on the matter immediately.”

REQUIRED:

1. Compute Pittman Company’s break-even point in peso sales for next year assuming:

a. That the agent’s commission rate remain unchanged at 15%. 12M

b. That the agents’ commission rate is increased to 20%. 13,714,286

c. That the company employs its own sales force 15M

2. Assume that Pittman Company decides to continue selling through agents and pays the

20% commission rate. Determine the volume of sales that would be required to

generate the same net income as contained in the budgeted income statement for next

year. 18,285,714

3. Determine the volume of sales at which net income would be equal regardless of

whether Pittman Company sells through agents ( at a 20% commission rate) or employs

its own sales force. 18,600,000

4. Compute the degree of leverage that the company would expect to have on December

31 at the end of next year assuming:

a. That the agents’ commission rate remains unchanged at 15%. 6,400/1600=4

b. That the agents’ commission rate is increased to 20%. 5,600/800=7

c. That the company employs its own sales force. 7,600/475=16

13. ACR Company has fixed expenses of P200,000, a variable cost ratio of 60% and a margin of

safety ratio of 20% for a quarter’s operations.

MAS 8903 COST-VOLUME-PROFIT ANALYSIS Page 9 of 9

14. The accountant of ARZ Company is trying to prepare comparative income statements for the

first two months of the year. However, he obtained only the following information:

January February

Sales P1,200,000 -

Variable cost ratio 40% 75%

Break even sales ratio 85% 70%

Changes in the given ratios are due to the decrease in sales price and fixed costs.

REQUIRED:

1. Decrease in sales

2. Decrease in fixed costs

3. Compute the break-even point for February.

15. Pomfrey Company has annual fixed costs of P390,000. In the year 20B, sales increased by

20% from the 20A level of P3,000,000. Profit for the year 20B was P180,000 higher than in

20A.

REQUIRED:

1. If there is no need to expand the company’s capacity, how much should profit be in

the year 20C if the budgeted sales volume is P5,400,000?

2. What is the company’s break-even point?

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