2. Determine the number of units that must be sold to break even or to earn
a targeted profit.
Calculate the amount of revenue required to break even or to earn a
targeted profit.
Apply cost-volume-profit analysis in a multiple-product setting.
Prepare a profit-volume graph and a cost-volume-profit graph, and
explain the meaning of each.
Explain the impact of risk, uncertainty, and changing variables on cost
volume-profit analysis.
Discuss the impact of activity-based costing on cost-volume-profit
analysis.
AFTER THE COMPLETION OF THIS
CHAPTER, YOU WILL LEARN TO:
3. ❑ Managers are constantly faced with decisions about selling prices, variable costs, and
fixed costs. To be able to choose from among the alternative actions, it is necessary to
have a good estimate of the product costs that would result from each choice.
❑ Management needs to know the costs that are likely to be incurred under normal
operating conditions and how they might vary if conditions change.
❑ Managers, in making their decisions affecting the business operations must understand the
interrelationship of cost, volume and profit through the use of the information and analysis
that cost accounting department will provide to them.
3
THE BASICS OF COST-VOLUME-PROFIT (CVP)
ANALYSIS
4. Cost-Volume-Profit (CVP) Analysis - is a method of cost accounting that looks at
the impact that varying levels of costs and volume have on operating profit. Also
known as break-even analysis, is a financial planning tool that leaders use when
determining short-term strategies for their business.
o CVP is one the most powerful tools that managers have at their command.
o It helps the manager understand the interrelationship between cost, volume,
and profit in an organization by focusing on interactions between the following
five elements, to wit;
1. prices of products
2. volume or level of activity within the relevant range
3. Variable costs per unit
4. Total Fixed costs
5. Mix of products sold
SIGNIFICANCE OF COST-VOLUME-PROFIT ANALYSIS
5. Contribution Margin per unit or marginal income per unit – is the excess of unit
selling price over unit variable costs and the amount each unit sold
contributes toward 1. covering fixed costs and 2. providing operating profits.
CM per unit = Unit selling price – unit variable costs
Contribution Margin ratio – the percentage of contribution margin to total
sales.
CM ratio = Contribution Margin
Sales
CONTRIBUTION MARGIN (CM) PER UNIT AND RATIO
6. The CM ratio is very useful. It shows how the contribution margin will be
affected by a given peso change in total sales.
Example: If a company’s CM ratio is 40%, it means that for each peso
increase in sales, total contribution margin will increase by P0.40. Net income
likewise will increase by P0.40 assuming that there are no changes in fixed
costs.
The CM ratio is particularly valuable in those situations where the manager
must make trade-offs between change in selling price and change in
variable costs.
CONTRIBUTION MARGIN (CM) PER UNIT AND RATIO (cont.)
7. Break-even point (BEP)– is the level of sales volume where total revenues and total
expenses are equal, that is, there is neither profit or loss. It is the starting point in many
business plans.
Break-even point can be computed as follows:
1. Break-even point (units) = Total Fixed Costs
Contribution Margin per unit
2. Break-even point (pesos) = Total Fixed Costs
Variable Costs
Sales
CVP ANALYSIS FOR BREAK-EVEN PLANNING
1-
9. CVP Analysis can be used to determine the level of sales needed to achieve a
desired level of profit. The equation that may be used to compute for target sales
follows:
Sales (units) = Total Fixed Costs + Desired Profit
Contribution Margin per unit
Sales (pesos) = Total Fixed Costs + Desired Profit
Contribution Margin ratio
CVP ANALYSIS FOR REVENUE AND COST PLANNING
10. Under the graphical approach, sales revenue, variable costs and fixed costs are
plotted on the vertical (y) while volume is plotted on the horizontal axis (x).
Illustrative Problem 1: Construction of Break-even Graph
Prepare the break-even graph for MNO Corporation based on the following
information:
Total Per Unit
Net Sales P500,000 P10
VC 300,000 6
CM P200,000 P 4
FC 150,000 3
Net Profit P 50,000 P 1
Number of units sold = 50,000
BREAK-EVEN GRAPH
12. P/V Chart focuses more directly on how profits vary with changes in volume. Profits
are plotted on the vertical axis (y) while units of output are shown on the horizontal
axis (x). Using the data in illustrative problem no. 1, the P/V graph may be prepared
as follows:
PROFIT VOLUME CHART AND GRAPH
13. Illustrative Problem No. 2 (Break-even Analysis)The Income Statement for one of Manhattan Company’s product shows:
Sales (100 units at P100 a unit) P10,000
Cost of Goods Sold:
Direct labor P1,500
Direct materials used 1,400
Variable factory overhead 1,000
Fixed factory overhead 500 4,400
Gross profit P5,600
Marketing expenses:
Variable P 600
Fixed 1,000
Administrative expenses:
Variable 500
Fixed 1,000 3,100
Operating income P2,500 REQUIRED:
1. Compute the break-even point in units.
2. If sales increase by 25% how much will be the new operating income?
3. Compute the new BEP in pesos if fixed factory overhead will increase by P1,700.
SOLUTION: Illustrative Problems_SOLUTIONS.docx
14. Illustrative Problem No. 3 (CVP Analysis with Changes in Cost Structure)
The Don Company sold 100,000 units of its product at P20 per unit. Variable costs are P14 per unit
(manufacturing costs of P11 and marketing costs of P3). Fixed costs are incurred uniformly throughout
the year and amount to P792,000 manufacturing costs of P500,000 and marketing costs of P292,00).
REQUIRED: Compute
1. The break-even point in units and in pesos.
2. The number of units that must be sold to earn an income of P60,000 before income tax.
3. The number of units that must be sold to earn an after-tax income of P90,000. Income tax rate is 40%.
15. Cost-Volume-Profit Analysis (CVP analysis), is a way for companies to determine how
changes in costs (both variable and fixed) and sales volume affect a company's profit.
CVP Analysis Assumptions and Limitations
Variable costs change proportionately with volume range.
Fixed costs are constant within the relevant volume range.
Revenues change proportionately with volumes with selling price remaining
constant.
Changes in volume alone are responsible for changes in costs and revenues.
There is no significant change in inventories (physical units, sales volume equals
production volume).
There is constant product mix.
Changing Variables on Cost Volume-Profit Analysis
16. Illustrative Problem No. 4 (CVP Analysis for a Multi-Products Firm)
Lor, Inc. produces only two products, A and B. These account for 60% and 40% of the total sales
pesos of Lor’s respectively. Variable costs as a percentage of sales pesos are 60% for A and 85% for B.
Total fixed costs are P150,000. There are no other costs.
REQUIRED: Compute
1. Weighted contribution margin ratio.
2. Break-even point in sales pesos.
3. The sales pesos necessary to generate a net income of P9,000 if total fixed costs will increase by 30%.
17. Illustrative Problem No. 5 (Preparation of Break-even Graph)
The Mailing Company has the following income statement when 10,000 units were sold:
MAILING COMPANY
Income Statement
Sales P20,000
Expenses:
Variable expenses P12,000
Fixed expenses 6,000 18,000
Net Income P 2000
10,000 units were sold
REQUIRED: a. Prepare a break-even graph for the company.
b. From the graph, how many units must be sold to break-even?
c. What is the margin of safety in units?
19. Illustrative Problem No. 6 (Preparation of Profit-Volume Graph)
The Solo Company had the following revenue and cost data when 2,000 units were sold:
Selling price per unit P12.00
Variable cost per unit 6.00
Fixed Cost per unit 4.50
REQUIRED: a. Prepare a profit-volume graph for the company.
b. Determine the break-even point from the graph.
c. From the graph, determine how many units must be sold to generate a net income
of P3,000.
21. Activity-Based Costing (ABC) analysis is a method of assigning overhead and indirect
costs—such as salaries and utilities—to products and services. The ABC system of cost
accounting is based on activities, which are considered any event, unit of work, or task
with a specific goal.
CVP analysis is often used to evaluate the impact of changes in production,
marketing, or other factors on a company's profitability. ABC analysis, on the other
hand, is a more complex and detailed approach that assigns costs to specific
activities or processes within a company.
Impact of Activity-Based Costing on Cost-Volume-Profit Analysis
