The document outlines concepts related to cost-volume-profit (CVP) analysis, including absorption vs. direct costing methods in inventory accounting. It explains the differences in how fixed manufacturing costs are treated under each method and provides examples of income statements prepared using both approaches. Additionally, it discusses the importance of CVP analysis in understanding how costs, volume, and profits interact, and outlines assumptions essential for effective CVP analysis.

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JIMMA UNIVERSITY
COLLEGE OF BUSINESS AND ECONOMICS
DEPARTMENT OF ACCOUNTING AND FINANCE
Cost and Management Accounting-II
Belay W.

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Chapter one
COST-VOLUME-PROFIT ANALYSIS,
ABSORPTION, AND VARIABLE COSTING

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COST-VOLUME-PROFIT ANALYSIS, ABSORPTION, AND
VARIABLE COSTING
1. Absorption versus Direct Costing
2. The concept of profit contribution
3. Cost-volume-profit (CVP) analysis: understanding the
concepts of break-even and margin of safety
4. Cost Volume Profit Analysis under Absorption Costing
5. The use of linear, curvilinear and step functions and how
their calculations are used to analyze cost behavior
6. The concepts of cost units, cost centers and profit centers

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1. Absorption Costing versus Direct Costing
• Direct costing
– Is a method of inventory costing in which
• All variable manufacturing costs (direct and indirect) are
included as inventorable costs.
• All fixed manufacturing costs are excluded from inventorable
costs and instead treated as period costs
– Another common term used to describe this method is
variable costing.

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Cont.
• Absorption costing
– Is a method of inventory in which
• All variable manufacturing costs and all fixed manufacturing
costs are included as inventorable costs,
– The inventory ‘absorbs’ all manufacturing cost.
– Another common term used to describe this method is full
costing.

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Cont.
• Similarity
–Under both direct costing and absorption costing,
• All variable manufacturing costs are
inventorable and
• All non-manufacturing costs, whether variable
or fixed are period costs and are recorded as
expenses when incurred.

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Cont.
• Difference
– How fixed manufacturing costs are accounted for is the
main difference between direct costing and absorption
costing.
– Under direct costing,
• fixed manufacturing costs are treated as an expense of the
period.
– Under absorption costing,
• fixed manufacturing costs are inventorable costs.

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Illustration 1:
• Stassen Company’s management wants to prepare an income
statement for 2012 (the fiscal year just ended) to evaluate the
performance of the telescope product line. The operating
information for the year are given below:
– For simplicity and to focus on the main idea, we assume the
following about Stassen Company:
• Stassen incurs manufacturing and marketing cost only.
• The cost driver for all variable manufacturing costs is units produced.
• The cost driver for variable marketing costs is units sold.
• There are no batch level costs and no product sustaining cost.
• Work in process inventory is assumed to be zero
• The budgeted level of production for 2012 is 800 units which are used to
calculate the budgeted fixed manufacturing cost per unit.

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Cont.
Beginning inventory 0
Production 800 units
Sales 600units
Ending Inventory 200 units
Selling price Br.100
Variable manufacturing cost per unit
 Direct material cost per unit 11
 Direct manufacturing labor cost per unit 4
 Manufacturing overhead cost per unit 5
Total variable manufacturing cost per unit 20
Variable marketing cost per unit ( all indirect) 19
Fixed manufacturing costs (all indirect) 12,000
Fixed marketing costs (all indirect) 10,800

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Cont.
• For Stassen, Inventorable costs per unit in 2012 under the
two methods is calculated as follows:
Direct
costing
Absorption
costing
Variable Manufacturing cost per unit produced
 Direct material cost per unit Br.11 Br.11
 Direct manufacturing labor cost per unit 4 4
 Manufacturing overhead cost per unit 5 5
Fixed manufacturing cost per unit produced - 15
Total invntorable cost per unit Br.20 Br. 35
As you see in the above table, fixed manufacturing cost is added under absorption
costing but is not included under direct costing.
• If inventory levels changes, operating income will differ between the two methods
because of the difference in accounting for fixed manufacturing costs.

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Income statement under the two costing method
• Both I/st formats include product costs and period costs,
although they define these cost classifications differently.
• The direct costing income statement uses the contribution
margin formats whereas the absorption costing income
statement uses the gross margin format.
• In general, the income measurements (Operating Income)
under the two methods will differ
– when production and sales amount differs.
• The f/gs are the formats used to prepare I/St under the two
methods:

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Cont.
Format of Absorption Costing
Income Statement
Sales --------------------------------------- XX
Cost of goods sold:
Direct material ---------- xx
Direct labor ------------ xx
Variable MOH ---------- xx
Fixed MOH -------------- xx ------(XX)
Gross profit ---------------------------- XX
Variable operating expense ---------xx
Fixed operating expense ------------ xx
Operating income --------------------- XX
Format of Direct costing
Income Statement
Sales revenue -----------------------------XX
Variable cost :
Direct material -----------xx
Direct labor ----------------xx
Variable MOH -------------xx
Variable expense ---------xx____(XX)
Contribution margin ----------------------XX
Fixed MOH cost ----------------------------XX
Fixed operating expense ----------------XX
Operating income -------------------------XX

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Illustration 2:
– For Stanssen, income statement under the two approaches
can be prepared as follows

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Cont.
Stanssen Company
Absorption costing income statement
For the year ended December 31, 2012
Sales (600xBr.100) Br.60,000
Cost of goods sold
Direct material cost (600xBr. 11) Br. 6,600
Direct labor cost (600xBr.4) 2,400
Variable overhead cost ( 600xBr.5) 3,000
Fixed overhead cost ( 600x Br.15) 9,000
Cost of goods sold 21,000
Gross profit 39,000
Variable marketing expense (600xBr.19) 11,400
Fixed marketing expense 10,800
Operating Income Br.16,800

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Cont.
Stanssen Company
Direct costing income statement
For the year ended December 31, 2012
Sales (600xBr.100) Br.60,000
Variable cost and expenses:
Direct material cost (600xBr. 11) Br. 6,600
Direct labor cost (600xBr.4) 2,400
Variable overhead cost ( 600xBr.5) 3,000
Variable marketing expense ( 600xBr.19) 11,400
Total variable costs and expenses 23,400
Contribution margin Br.36,600
Fixed overhead cost 12,000
Fixed marketing expense 10,800
Operating Income Br.13,800

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Cont.
• In the above two income statement, we can see how the fixed
manufacturing cost of br.12, 000 are accounted for under the two
methods.
– The income statement under direct costing
• Deducts the lump sum br.12, 000 as an expense for the year.
– In contrast, under absorption costing
• The br. 12,000 is initially treated as an inventorable cost of the
year.
• Of this br. 9000 (br.15 x 600) subsequently becomes a part of
cost of goods sold in the year and
• Br.3000 (br.15 x 200) remains as an asset part of ending finished
goods inventory on December 31, 2012.

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Cont.
– Operating income is Br 3, 000 higher under absorption
costing compared to direct costing.
– The variable manufacturing costs are accounted the same
way under both methods.
– The base of the difference between direct costing and
absorption costing is
• how fixed manufacturing costs are accounted for.

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Inventory Level Changes
– If inventory level changes, operating income will differ
between the two methods because of the difference in
accounting for fixed manufacturing cost.
– To see this, let’s compare telescope sales of 600, 700 and
800 units by stassen in 2012, when 800 units were
produced and the Br.12,000 total fixed manufacturing
costs, the amount expressed in the year 2012 income
statement would be:

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Cont.
Direct costing Absorption costing
Fixed Manufacturing
cost
Fixed Manufacturing cost
Units
sold
End
Inventory
Included in
inventory
Amount
expensed
Included in inventory
15xEnd Inventory
Amount expensed
15xunits sold
600 200 0 12,000 3,000 9,000
700 100 0 12,000 1,500 10,500
800 0 0 12,000 0 12,000
• Where 8,000 units are produced and sold, both variable and
absorption costing report the same income because
inventory levels are unchanged.

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Cont.
– If production is equal to sales, the operating income under
absorption costing is the same as operating income under
direct costing
– If production is greater than sales, the operating income
under absorption costing is greater than operating income
under direct costing
– If production is less than sales, the operating income under
absorption costing is less than operating income under
direct costing

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2. Cost-Volume-Profit (CVP) Analysis
• CVP analysis examine...
– the relationships among cost, volume, and profit by focusing
on interactions among the following five elements:
1. Prices of products,
2. Volume or level of activity,
3. Unit variable costs,
4. Total fixed costs, and
5. Mix of products sold.
– how operating income changes with changes in output level,
selling prices, variable costs, fixed costs, and sales mix.
– shifts in costs and volume and their resulting effects on profit

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Cont..
• In CVP analysis, volume refers to some measure of profit-
generating activity.
• Volume can be measured by:
• Sales in units,
• Sales in Dollar/Birr,
• Production in units,
• Hours worked by employees, or
• Any other activity that might be important.

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Cont..
• Is one of the most powerful tool used by managers:
– To plan and control operations effectively.
– To estimate break even point and target profit at different
levels of activity.
– In making decisions about
• product pricing,
• product mix,
• adding or dropping a product line, and
• accepting special orders.
– what products and services to offer,
– what marketing strategy to employ, and
– what basic cost structure to use.

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Cont..
– In sensitivity analysis to measure the effects of alternative
courses of action, such as...
• changing variable or fixed costs,
• expanding or contracting sales volume, and
• increasing or decreasing selling prices.
– as it answers questions like: what would be the effect of change in
Selling price, VC, FC and sales Mix on profits?

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2.1. Assumptions of CVP Analysis
1. Changes in volume of activity are the only factors that affect
revenues and costs.
– Changes in the levels of revenues and costs arise only because of changes
in the number of product (or service) units sold.
2. Costs can be classified accurately as either variable or fixed.
– Total costs can be separated into two components: a fixed component that
does not vary with units sold and a variable component that changes with
respect to units sold.
3. Behavior of both costs and revenues is linear throughout the
relevant range of the activity.
– When represented graphically, the behaviors of total revenues and total
costs are linear (meaning they can be represented as a straight line) in
relation to units sold within a relevant range and time period.

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Cont...
4. Selling price, variable cost per unit, and total fixed costs
(within a relevant range and time period) are known and
constant.
– Total contribution margin (total revenue – total variable costs) is
linear and increase proportionally with output.
5. What is produced is sold (production & sales are equal).
– In manufacturing companies, inventories do not change (i.e., all units
produced are sold).
6. In multi-product companies, the sales mix is constant.
– When more than one type of product is sold, the sales mix will
remain constant.

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Cont...
7. There will be no capacity additions during the period under
consideration.
– If such additions were made, fixed (and, possibly, variable) costs would
change. Any changes in fixed or variable costs would violate assumptions 1
through 4.
8. There is either no inflation or, if it can be forecasted, it is
incorporated into the CVP model.
– This eliminates the possibility of cost changes.
9. Labor productivity, production technology, and market conditions
will not change.
– If any of these changes occur, costs would change correspondingly and
selling prices might change. Such changes would invalidate assumptions 1
through 4.

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2.2. Essentials of CVP Analysis
• Example: Emma Frost is considering selling GMAT Success, a
test prep book and software package for the business school
admission test, at a college fair in Chicago.
– Emma knows she can purchase this package from a
wholesaler at $120 per package, with the privilege of
returning all unsold packages and receiving a full $120
refund per package.
– She also knows that she must pay $2,000 to the organizers
for the booth rental at the fair. She will incur no other costs.
She must decide whether she should rent a booth.

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Cont...
– The booth-rental cost of $2,000 is a fixed cost because it
will not change no matter how many packages Emma sells.
– The cost of the package itself ($120 per package) is a
variable cost because it increases in proportion to the
number of packages sold.
• To get an idea of how operating income will change as a
result of selling different quantities of packages,
– Emma calculates operating income if sales are 0, 5, 25 or
40 packages. Having selling price of $200.

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Cont...
Contribution Margin Format Income Statement for
Different Quantities of GMAT Success Packages Sold

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Revenues and Variable Costs
• How much revenue will Emma receive if 40 units of GMAT
Success Packages are sold?
– Total Revenues = Selling Price × No. of units sold
– $200 × 40 = $8,000
• How much variable costs will Emma Incur if 40 units of
GMAT Success Packages are sold?
– Total variable costs = VC Per Unit × No. of units sold
– $120 × 40 = $4,800

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Total Contribution Margin (CM) /or simply Contribution Margin/
• Is total revenue minus total variable costs.
– All variable costs related to production, selling, and administrations
are subtracted from sales to determine total contribution margin
(CM).
• It is the amount available to cover fixed costs and to
contribute to target profit.
• Indicates how operating income changes as the number of
units sold changes.

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Cont..
– Contribution Margin = Total revenues - Total variable costs
Or
– Contribution Margin = CM per unit × No. of units sold
Or
– Contribution Margin = CMR × Revenues (in dollars)

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Cont...
• What will be Emma’s total contribution margin if 40 units of
GMAT Success Packages are sold?
– Contribution Margin = Total Revenue –Total Variable costs
– $8,000 - $4,800 = $ 3,200

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Contribution Margin Per Unit (CM Per Unit)
• Is selling price per unit minus variable cost per unit.
– CM Per Unit = Selling Price - Variable Cost Per Unit
– Or
– CM Per Unit = TCM / No. of Units Sold

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Cont...
• What will be Emma’s contribution margin per unit?
– CM Per Unit = Selling Price - Variable Cost Per Unit
– $200 - $120 = $80

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Contribution Margin Percentage (Ratio)
• Is the contribution margin per dollar of revenue.
• Shows the percentage of each dollar of sales available to
cover fixed costs and to contribute to target operating
income (profit).
– CMR = CM Per Unit / Selling Price
– Or
– CMR = Total Contribution Margin / Total Revenue

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Cont...
• What will be Emma’s contribution margin percentage?
– CMR = CM Per Unit / Selling Price
– $80 / $200 = 0.4 = 40%

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Cont...
• Show the r/nship b/n CM and CM Per Unit, and CM and CMR, assuming
if 40 units of GMAT Success Packages are sold?
• Given that of 40 units of sales, $80 CM Per Unit, and 40% CMR:
– Contribution Margin = Total Revenue – Total Variable costs
– $8,000 - $4,800 = $ 3,200
– Contribution Margin = CM per unit × No. of units sold
– $80 × 40 = $3,200
– Contribution Margin = CMR × Revenues (in dollars)
– 40% × $8,000 = 0.4 × $8,000 = $3,200

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Operating Income (OI)
• Is total contribution margin minus total fixed costs.
• Is total revenue from operation minus cost of goods sold and
all operating expenses.
• All fixed costs related to production, selling, and administration
are subtracted from total contribution margin to determine
operating income.
– OI = Revenues - Variable Costs - Fixed Costs
– Or
– OI = Total Contribution Margin – Fixed Costs

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Cont...
• What will be Emma’s Operating Income if 40 units of GMAT
Success Packages are sold?
– OI = Revenues - Variable Costs - Fixed Costs
– $8,000 - $4,800 - $2,000 = $1,200
– Or
– OI = Total Contribution Margin – Fixed Costs
– $3,200 - $2,000 = $1,200

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Net Income (NI)
• Is operating income plus non-operating revenues minus
non-operating costs minus income tax.
Net income= (Operating income) + (non-operating revenue)
– (non-operating cost) – (income tax)
• For the purpose of CVP analysis, we assume non-operating
revenue and non-operating cost are zero. Therefore
–Net income = Operating income – Income taxes

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Assignment-1: Essentials of CVP Analysis
• Assume Tecno Phone Manufacturing Plc has the following
relevant data for the year 2020:
• Compute the Following:
– Unit Contribution Margin(CMU)
– Total CM, If 1,600 phones are sold
– CMR
Unit selling price of cell phone $500
Unit variable costs $300
Total annual fixed costs $200,000

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2.3. EXPRESSING CVP RELATIONSHIPS
1. The equation method
2. The contribution margin method
3. The graph method

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Cont...
• Abbreviations
– SP or P = Selling price
– VCU or V = Variable cost per unit
– Q = Quantity of Output Units Produced and Sold
– CMU or CMPU = Contribution margin per unit
– CM% or CMR = Contribution margin percentage (ratio)
– FC = Fixed Costs (Total Fixed Costs)
– OI = Operating income
– TOI = Target operating income
– TNI = Target net income
– T = Tax rate

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Cont...
• Abbreviations
– R or TR = Revenues (Total sales revenues)
– VC or TVC = Variable costs (Total Variable costs)
– TC = Total Costs
• Total Costs = Variable costs + Fixed costs

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Equation Method
• Operating income = Revenues - Variable costs - Fixed costs
– Revenues = Selling price (SP) × Quantity of units sold (Q)
– Variable costs = Variable cost per unit (VCU) × Quantity of units sold (Q)
• So,
OI = (SP× Q) –(VCU×Q) – FC ............. Eq/n-1.

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Cont...
• For example, the calculation of operating income when
Emma sells 5 packages is
• OI = (SP x Q) – (VCU x Q) – FC
• OI = ($200 * 5) - ($120 * 5) - $2,000
• OI = $1,000 - $600 - $2,000
• OI = -$1,600

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Contribution Margin Method
• Is a short version of the equation technique (eq/n-1)
– OI = (SP x Q) – (VCU x Q) – FC ……………….. eq/n-1.
• Rearranging eq/n-1 by taking Q as a common factor
– OI = (SP-VCU) × (Q) – FC
• And since, SP – VCU = CMU
• So, (SP – VCU) × (Q) = CMU × Q
• Thus,
OI = (CMU× Q) – FC ……………….. Eq/n-2.

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Cont...
• In our GMAT Success example, CMU is $80 ($200-$120), so
when Emma sells 5 packages, Operating income
• OI = (CMU × Q) – FC
• OI = ($80 * 5) - $2,000
• OI = $400 - $2,000
• OI = -$1,600.
– i.e., Each unit sold helps Emma recover $80 (in contribution margin)
of the $2,000 in fixed costs.

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Graph Method
• It represent (plot) TC and TR graphically,
– by plotting TC and TR lines at different activity level.
• Only two points are needed to plot the TC and TR lines.
– B/c of assumption-4, TC and TR have a linear r/nship with volume.
• In a CVP graph (sometimes called a break-even chart),
– Unit volume (Q) is represented on the horizontal (X) axis and
– Dollar amounts on the vertical (Y) axis.

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Cont...
• Figure 1 illustrates the graph method for GMAT Success.
Preparing a CVP graph involves:
• Plot FC: as a straight line parallel to the horizontal axis
– Fixed Cost for Emma is:
– FC = $2,000
• Plot TC & TR lines:
– choose any two convenient points (volume of sale) and
– determine the corresponding TC and TR.

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Cont...
If we chose a volume of 0 units and 40 units of GMAT
Success, TC & TR of each activity level would be as follows:
– Total Cost function for Emma is:
• TC= VC + FC
• TC = $120 *Q + $2,000
– Total Revenues function for Emma is:
• TR= SP*Q
• TR = $200 *Q

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Cont...
Volume of output
level (Q)
TC = $120 * Q + $ 2,000 Points
0 $120 * 0 + $ 2,000 = $0 A (0, $2,000)
40 $120 * 40 + $ 2,000 = $6,800 B (40, $6,800)
Volume of output
level (Q) TR = $200 * Q Points
0 $200 * 0 = $0 C (0, $0)
40 $200 * 40 = $8,000 D (40, $8,000)

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Figure-1: Cost-Volume Graph for GMAT Success

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2.4. BREAKEVEN POINT (BEP)
• Is the quantity of output sold at which total revenues equal
total costs.
– i.e., the quantity of output sold that results in $0 of OI.
• Is that level of activity (in units or dollars/Birr), at which
total revenues equal total costs or operating profit
becomes zero.
• It an be expressed either in units or in sales dollars/birr.

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Cont...
• The break-even point is always a point of interest in CVP
analysis
• Finding break-even point is often the first step in planning
decision to avoid operating losses
• Break-even point can be computed in 3-approaches :
1. Equation method
2. Contribution Method
3. Graphic method

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Equation method
• Recall eq/n-1:
 OI = (SP x Q) – (VCU x Q) – FC
• At BEP, operating income(OI) = 0; and let BEQ = Q
• That is,
 0 = (SP x Q) – (VCU x Q) – FC
 0 = Q (SP-VCU) - FC
 FC = Q (SP-VCU)
 Q = FC / (SP - VCU)
 BEQ = FC / (SP – VCU)
• And also, the BEP revenues will be:
 BER = BEQ x SP

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Cont...
BEQ
FC
SP – VCU
=
BER BEQ x SP
=
Equation method

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Cont...
• Example: Calculate the breakeven quantity and revenue of
Emma Frost using:
1. Equation method
2. Contribution margin method
3. Graphic method

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Cont...
• Example: Equation method
• BEQ = FC / (SP – VCU)
BEQ = $2,000 / ($200 - $120)
BEQ = $2,000 / $80
BEQ = 25 Unit
• BER = BEQ x SP
BER = 25 Units x $200 Per Unit
BER = $5,000

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Contribution Margin Method
• Recall eq/n-2:
 OI = (CMU × Q) – FC
• At BEP, operating income(OI) = 0; and let BEQ = Q
• That is,
0 = (CMU × Q) – FC
FC = CMU × Q
Q = FC / CMU
BEQ = FC / CMU
• And also, the BEP revenues will be:
BER = FC / CMR

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Cont...
BEQ
FC
CMU
=
Contribution Margin Method
BER
FC
CMR
=

64. 09/13/2024 Belay W. 70
Cont...
• Example: Contribution Margin Method
• BEQ = FC / CMU
BEQ = $2,000 / $80
BEQ = 25 Unit
• BER = FC / CMR
BER = $2,000 / 0.4
BER = $5,000

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Graphic Method
0 10 20 30 40 50
0
2000
4000
6000
8000
10000
Units
$ (TR/TC)
Revenue
Total costs
Breakeven
Fixed costs

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2.5. Target Operating Income (TOI)
• Is projected/planned profit before tax.
• Let....
– Q_TOI = Quantity of units required to be sold to attain the TOI
– R_TOI = Revenues needed to earn TOI

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Cont...
Q_TOI
FC + TOI
CMU
=
Contribution Margin Method
R_TOI
FC + TOI
CMR
=

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Cont...
• Example: How many units must Emma sell to earn an operating
income of $1,200?
• Q_TOI = (FC + TOI) / CMU
Q_TOI = ($2,000 + $1,200) / $80
Q_TOI = $3,200 / $80
Q_TOI = 40 Unites
• R_TOI = (FC + TOI) / CMR
R_TOI = ($2,000 + $1,200) / 0.4
R_TOI = $3,200 / 0.4
R_TOI = $8,000

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Profit-Volume Graph for GMAT Success

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2.6. Target Net Income (TNI) and Income Taxes
• The key steps:
1. Convert TNI into the corresponding TOI.
2. Then use the formula for TOI.
• Net income = Operating income - Income taxes
• Income Taxes = OI * Tax rate
• TNI = (TOI) - (TOI * Tax rate)
• TNI = (TOI) * (1 - Tax rate)
• TOI = TNI / (1 – Tax rate)

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Cont…
How many units must be sold(Q)?
How much sales should be made(sales)?
Fixed costs + Target Net Income
(1 – Tax rate)]
CMU
Fixed costs + Target Net Income
(1 – Tax rate)]
CMR

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Cont…
• For example, Emma may be interested in knowing the
quantity of units she must sell to earn a net income of $960,
assuming an income tax rate of 40%.
• TOI = TNI / (1 – Tax rate)
TOI = $960 / (1 – 0.4)
TOI = $960 / 0.6
TOI = $1,600
– In other words, to earn a TNI of $960, Emma’s TOI must be$1,600.

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Cont...
• How many units must be sold (Q)?
• Q_TOI = (FC + TOI) / CMU
Q_TOI = ($2,000 + $1,600) / $80
Q_TOI = $3,600 / $80
Q_TOI = 45 Unites
 How much sales should be made (R)?
• R_TOI = (FC + TOI) / CMR
R_TOI = ($2,000 + $1,600) / 0.4
R_TOI = $3,600 / 0.4
R_TOI = $9,000

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3. CVP Analysis with Multiple Products
• Assume that Tecno Company also manufactures TV in
addition to phone and the following data are summarized
for 2020.
Unit Data Cell Phones TVs Total
Annual Sales of 2020 in units 1,500 500 2,000
Selling price $500 $1,000
Variable costs 300 720
Contribution margin $200 $ 280
Sales mix—units 75% 25%
Fixed costs $275,000

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3.1. BEP with Multiple Products
What is the BEQ and BER?
BEQ = Total fixed Cost
Weighted average CM per unit
Weighted average CM per unit = $200*.75+ $280*.25 = $220
BEQ= $275,000/ $220 = 1,250 units
of which
Cell phone = 1,250*.75= 937.5 units
TV = 1,250*.25 = 312.5 units

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Cont... Break-Even Revenue for the sales mix
BER = Total fixed Cost
Total CM Ratio
or
BER = BEQ1*P1+ BEQ2*P2….BEQn*Pn
Total CM Ratio =
200*1,500+280*500
500*1,500+1,000*500
= 0.352
Total CM
Total Revenue
Total CM Ratio =

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Cont... Break-Even Revenue for the sales mix
BER = $275,000 = $ 781,250
0.352
OR
From cell phone = 937.5 units *500 = $468,750
From TV = 312.5 units *1,000 = $312,500
Total $ 781,250

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3.2. Target Operating Income for Multiple Product
Quantity for TOI
=
Fixed costs + TOI
W.A. Unit contribution margin
Sales for TOI = Fixed costs + TOI
Total Contribution margin ratio

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Exercise on TOI for Multiple Product
• Assume the previous data for Tecno and a Before Tax
Target Profit (TOI) of $33,000
1. What total units need to be sold to achieve the target
profit
2. How many units of TV and cell phone need to be sold to
achieve the target profit
3. What should be the sales to achieve the target profit

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Cont...
Quantity for TOI
=
Fixed costs + TOI
W.A. Unit contribution margin
= 275,000+ 33,000
220
= 1,400 units
Phone = 1,400*.75 = 1,050 units
TV = 1,400*.25 = 350 units

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Cont...
Sales for TOI = Fixed costs + TOI
Total Contribution margin ratio
= 275,000+33,000
0.352
= $875,000
Or
From Phone = 1050*500= $525,000
From TV = 350*1000= 350,000
Total $875,000

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4. Sensitivity Analysis
• Sensitivity analysis is a “what if” technique that examine
how a result will change
– if the original predicted data are not achieved or
– if an underlying assumption changes
• In the context of CVP, sensitivity analysis answers questions
like:
– what will operating income be if the output, variable cost,
selling price, fixed cost and sales mix changes by a given
percentage from the original prediction?

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4.1. Margin of Safety
• Measures how close expected sales are to the break-even
point.
• Is the excess of projected sales over the break-even point.
• Difference between actual or expected sales and sales at the
break-even point.
• Measures the “cushion” that a particular level of sales
provides.
• May be expressed in dollars or as a ratio.

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Exercise on Margin of Safety
• Assuming actual/expected sales of Tecno is $750,000:
=

Actual (Excepted) Break - Even
Sales
Margi
Sale
n of Safety
in
s Dollars
$750,000 $500,000 = $250,000


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4.2. Margin of Safety Ratio
• Computed by dividing the margin of safety in dollars by the
actual (or expected) sales.
• Assuming actual/expected sales are $750,000:
=

Margin of Safety Actual (Excepted)
in Do
Marg
llars Sales
in of Safety
Ratio
• The higher the dollars or percentage, the greater the
margin of safety.
$250,000 $750,000 = %
33


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END OF CHAPTER ONE
10Q