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CVP Analysis - CVP

Bachelor of Science in Accountancy (Polytechnic University of the Philippines)

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MANAGEMENT ADVISORY SERVICES

Cost-Volume-Profit & Break-Even Analysis

Variable Costing Income Statement

Sales xx
Less: Variable cost of goods sold xx
Manufacturing margin xx
Less: Variable selling & administrative cost xx
Contribution margin xx
Less: Fixed costs:
Fixed factory overhead xx
Fixed selling & administrative costs xx xx
Profit (loss) xx

CVP Analysis – is a useful management tool that helps managers in planning for profit by way of a systematic examination of
the interrelationship among costs, volume (activity level) and profit.

Factors affecting profit

If there is an increase in… Then profit will…

1. Selling Price Increase
2. Variable Cost Per Unit Decrease
3. Fixed Cost Decrease
4. Unit Sales (Volume) Increase

CVP-related terminologies

Contribution Margin – is the difference between sales and variable cost. It is otherwise known as marginal income, profit
contribution, contribution to fixed cost or incremental contribution.
 CM Ratio = CM ÷ Sales; or
CM per unit ÷ SP per unit; or
∆ CM ÷ ∆ Sales

Note: Under CVP assumptions, CM ratio is constant regardless of the number of units sold or produced.

Break-Even Point – is a level of activity, in units (break-even volume) or in pesos (breakeven sales), at which total revenues
equal total costs, i.e., there is neither a profit nor a loss.
 BEP unit = Fixed costs ÷ CM per unit
 BEP peso sales = Fixed costs ÷ CM ratio

Illustration:

Clark Company manufactures and sells a single product. The company’s sales and expenses for a recent month follow:
Sales (15,000 units) P 600,000
Less: Variable costs 420,000
Contribution Margin P 180,000
Less: Fixed costs 150,000
Profit P 30,000

Required:
1. Determine the following:
a. Selling price per unit P40 b. Variable cost per unit P28 c. CM ratio 30%
2. What is the monthly break-even point in units sold and in pesos? 12,500; P500,000
3. Without resorting to computation, what is the total contribution margin at the break-even point? P150,000

Margin of Safety – is the difference between actual sales volume and break-even sales. It indicates the maximum amount by
which sales could decline without incurring a loss.
 MS = Actual sales – Breakeven sales
 MS Ratio = MS ÷ Actual sales

Illustration:

Kent Company’s break-even sales are P528,000, the variable cost ratio is 60%, while the profit ratio is 8%.

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Required: Compute the following:

1. Fixed Costs P211,200 4. Margin of Safety P132,000
2. Actual Sales P660,000 5. Margin of Safety Ratio P20%
3. Profit P52,800

Indifference Point – is the level of volume at which two alternatives being analyzed would yield equal amount of total costs or
profits.
Alternative A Alternative B
 (CM per unit x Q) – FC = (CM per unit x Q) – FC
 FC + (VC per unit x Q) = FC + (VC per unit x Q)

Note: Q = number of units (indifference point)

Illustration: Indifference Point

Toriko Co. sells its only product at P32 per unit. Variable costs are P24 per unit and fixed costs amounted to P100,000 per
month.

Required:
1. If Toriko can sell 15,000 units in a particular month, what will be its income? P20,000
2. What is the break-even point in units and in pesos? 12,500; P400,000
3. What amount of unit sales is required to earn after-20% tax profit of P32,000 for the month? 17,500
4. What sales, in pesos, are required to earn after-20% tax profit of P32,000 for the month? P560,000
5. Suppose that Toriko is currently selling 10,000 units per month. The marketing manager believes that sales would
increase if advertising were increased by P5,000. By how much would unit sales have to increase to give Toriko the
same income or loss that is currently earning? 625
6. If Toriko is selling 20,000 units per month at P32, what is its margin of safety? P240,000
7. Toriko currently pays its salespeople salaries for a total of P40,000 per month, but no commissions. The sales
department is considering a plan whereby the salespeople would receive a 5% commission, but their salaries would fall
to a total of P25,000 per month. At what sales level is the company indifferent between the two compensation plans?
P300,000

Sales Mix – is the relative combination of quantities of sales of various products that make up the total sales of a company.
 BEP units = Fixed costs ÷ Weighted average CM per unit
 BEP peso sales = Fixed costs ÷ Weighted average CM ratio

Illustration: Sales Mix

Inuyasha Company produces and sells two products, tables and chairs. Following is next month’s income budget:
Chairs Tables Total
Sales in units 600 150 750
Sales in pesos P1,200.00 P187.50 P1,387.50
Variable costs 1,050.00 112.50 1,162.50
Contribution Margin P 150.00 P 75.00 P 225.00
Fixed costs 90.00
Income P 135.00

Required:
1. How many units of chairs and tables should be sold next month to break-even?
2. How many units of chairs and tables should be sold to earn a profit of P150?

Degree of Operating Leverage – measures how a percentage change in sales from the current level will affect company profits.
It indicates how sensitive the company to sales volume increases and decreases. It is also known as operating leverage factor.
 DOL = Contribution margin ÷ Profit before tax
 ∆ % sales x DOL = ∆ % profit before tax

Illustration:

Bruce has recently opened Lee Slimmers Gym for malnourished individuals. Actual operating results for the shop’s first year of
operations are presented as follows:
Sales P 250,000
Variable Costs (100,000)
Contribution Margin P 150,000
Fixed Costs (120,000)
Income P 30,000

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Bruce is unhappy about the results of his shop’s first year of operations. He observed that despite the very high contribution
margin, income was still low because of the very high fixed costs. He feels that an increase in sales would not yield a
satisfactory increase in profit.

Required:
1. Compute the leverage factor. 5x
2. If sales increase by 10%, then how many percent would income increase, ceteris paribus?
(Determine the percentage ∆ by using the operating leverage factor.) 50%

Comprehensive Illustration:

Knicks Corporation operates a chain of stores around the country. The stores carry many styles of shoes that are sold at the
same price. To encourage sales personnel to be aggressive in their sales efforts, the company pays a substantial sales
commission on each pair of shoes sold. Sales personnel also receive a small basic salary.

The following cost and revenue data relate to New York sales outlet and are typical of the company’s many sales outlets:

Selling price P 800

Variable expenses:
Invoice costs P 360
Sales commission 140
Total P 500
Fixed expenses per year:
Rent P 1,600,000
Advertising 3,000,000
Salaries 1,400,000
Total P 6,000,000

1. How many units are required for the company’s New York sales outlet to breakeven? 20,000 pairs
2. If 18,000 pairs of shoes are sold in a year, what would be New York sales’ outlet’s net income? (P600,000)
3. The company is considering paying the store manager of New York sales outlet an incentive commission of P75 per
pair of shoes (in addition to the salesperson’s commission). If this change is made, what will be the new breakeven in
pairs of shoes? 26,667
4. Instead of paying the manager a straight P75 per pair of shoes commission on all pairs of shoes sold, the company is
considering paying the store manager of P50 commission on each pair of shoes sold in excess of the breakeven point.
If this change is made, what will be the sales outlet’s net income or loss if 25,000 pairs of shoes are sold? P1,250,000
5. If the company would pay the manager P50 commission on each pair of shoes sold in excess of the breakeven point,
how many pairs of shoes are required to earn P900,000 profit? 23,600
6. The company is considering eliminating sales commissions entirely in its stores and increasing fixed salaries by
P2,142,000 annually. If this change is made, what will be the number of pairs of shoes to be sold by New York outlet to
be indifferent to commission basis? 15,300

REVIEW QUESTIONS (TRUE OR FALSE; MULTIPLE-CHOICE)

1. At the break-even point, total contribution margin is

a. Zero c. Equal to totals costs
b. Equal to total fixed costs d. Equal to total variable costs

2. An increase in contribution margin ratio reduces the break-even point. TRUE

3. If the tax rate increases, then the break-even point also increases. FALSE

4. An increase in the income tax rate

a. Raises the break-even point
b. Lowers the break-even point
c. Decreases sales required to earn a particular after-tax profit
d. Increases sales required to earn a particular after-tax profit

5. An increase in actual sales also increases the margin of safety. TRUE

6. A company that has a negative margin of safety necessarily operates at a loss. TRUE

7. 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

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8. The operating leverage factor is equal to

a. Gross margin ÷ profit after tax c. Contribution margin ÷ profit after tax
d. Gross margin ÷ profit before tax d. Contribution margin ÷ profit before tax

9. If the DOL is 2, then a 3% change in quantity sold should result in a 5% change in profit before tax. FALSE

10. If inventories are expected to change, the type of costing that provides the best information for breakeven analysis is
a. Job order costing b. Variable costing c. Joint costing d. Absorption costing

11. If a company’s variable costs are 70% of sales, which formula represents the computation of dollar sales that will yield
a profit equal to 10% of the contribution margin when S equals sales in dollars for the period and FC equals fixed costs
from the period?
a. S = 0.2 ÷ FC c. S = 0.27 ÷ FC
b. S = FC ÷ 0.2 d. S = FC ÷ 0.27

12. According to CVP analysis, a company could never incur a loss that exceeded its total
a. variable costs c. costs
b. fixed costs d. contribution margin

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MAS Integration
Quiz No. 2

Questions 1 and 2 are based on the following data:

Hope Co. sells a product with a unit selling price of P50 and a unit variable cost of P30. It needs to sell 40,000 units to
break-even. It expects to sell 90,000 units in the coming period from a previous of 75,000 units.

1. Hope’s degree of operating leverage is

a. 1.875 b. 1.8000 c. 2.143 d. 1.250

2. The percentage change in EBIT in the coming period as compared to the last period is
a. 42.86% b. 36.00% c. 37.50% d. 25.00%

3. The following data relate to Homer Company which sells a single product:
Unit selling price P 20.00
Unit purchase price 11.00
Sales commission, 10% of selling price 2.00
Monthly fixed costs 80,000

The firm’s salespersons would like to change their compensation from a 10% commission to a 5% plus P20,000 per
month in salary. They now receive only commissions. At what sales volume would the two compensation plans be
indifferent?
a. 12,500 b. 20,000 c. 22,222 d. 22,860

4. Mann Corp. has a CM ratio of 26%. It aims to have a net income of P320,000 with a sales volume of P2,000,000. Its
total fixed costs amount to
a. P 200,000 b. 83,200 c. P 230,777 d. 520,000

5. The degree of operating leverage is not affected by the change in

a. Interest expense c. Quantity of units sold
b. Variable cost per unit d. Fixed costs

6. RCJ Corp. has a CM ratio of 26%. It aims to have a net income of P320,000 with a sales volume of P2,000. Its total
fixed cost amount to
a. P 200,000 b. P 83,200 c. P 230,777 d. P 520,000

7. S & R Shop operates by selling sandwiches on the go in shopping malls. The average selling price of a sandwich is
P60. A new mall is opening where S & R wants to locate a shop but the location manager is not sure about the rent
method to accept. The mall operators offer two options for shop rentals as follows:

 Paying a base rent of P 40,000 plus 12% of revenue received.

 Paying a base rent of 20% of revenue received.

S & R will be indifferent between options 1 and 2 when its level of sales is
a. 1,667 b. 750 c. 8,333 d. 900

Questions 8 to 10 are based on the following data:

Metro Rugs is holding a two-week carpet sale at Ukayan, a local warehouse store. Metro Rugs plans to sell carpets for
P500 each. The company will purchase the carpets from a local distributor for P350 each, with the privilege of returning
any unsold units for a full refund. Ukayan has offered Metro Rugs two payment alternatives for the use of space.

Option 1 - A fixed payment of P5,000 for the sale period.

Option 2 - 10% of total revenues earned during the sale period.

8. Assume Metro Rugs will incur no other costs. At what level of revenues will Metro Rugs be indifferent between the two
payment options?
a. P50,000 b. P17,000 c. P10,000 d. 0

9. At a sales level of 100 units, the DOL under Option 2 is

a. 1.50 b. 5.00 c. 1.00 d. 5.50

10. Which of these alternatives would decrease Cm per unit the most?

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a. A 15% decrease in SP
b. A 15% increase in VC
c. A 15% increase in SP
d. A 15% decrease in VC

MSQ-2

1. Given the cost formula Y = P17,500 + P4x, at what level of activity will total cost be P42,500?
a. 10,625 units b. 4,375 units c. 6,250 units d. 5,250 units
2. A fixed cost that would be considered a direct cost is
a. A cost accountant’s salary when the cost objective is a unit of product.
b. The rental cost of a warehouse to store inventory when the cost objective is the Purchasing Department.
c. A production supervisor’s salary when the cost objective is the Production Department.
d. Board of Director’s fees when the cost objective is the Marketing Department.
3. A cost estimation method in which a cost line is fit using exactly 2 data points is
a. Least squares method c. Scatter diagram method
b. Accounts analysis method d. High low method
4. Tamarind Company earned P50,000 on sales of P400,000. It earned P70,000 on sales of P450,000. The amount of
total fixed costs for Tamarind Company is:
a. P -0- b. P50,000 c. P110,000 d. P180,000
5. Regal, Inc. sells Product Dulce for P5 per unit. The fixed costs are P210,000 and the variable costs are 60% of the
selling price. What would be the amount of sales if Regal is to realize a profit of 10% of sales?
a. P700,000 b. P472,500 c. P525,000 d. P420,000
6. The cost accountants at the Italy Company regressed total overhead costs and direct labor hours for the past 30
months and reported the following results:
Slope P 41.27
Intercept P 596.36
Correlation coefficient 0.934

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What is the estimated overhead cost if 225 direct labor hours are expected to be used in the upcoming period?
(Rounded to the nearest peso)
a. P10,534 b. P9,882 c. P9,230 d. P8,617

7. Product X has a selling price of P50 and a variable cost per unit of 70% of the selling price. If the fixed costs total
P30,000, how many units must be sold to earn a profit of P45,000?
a. 900 b. 1,500 c. 2,143 d. 5,000
8. England Company has developed the following cost formulas:
Material usage: Ym = P80x, r = 0.95
Labor usage (direct): Y1 = P20x, r = 0.96
Overhead activity: Yo = P350,000 + P100x, r = 0.75
Selling activity: Ys = P50,000 + P10x, r = 0.93
Where: X = Direct labor hours

The company has a policy of producing on demand that keeps very little, if any, finished goods inventory (thus, units
produced = units sold). The president of England Company has recently implemented a policy that any special orders
will be accepted if they cover the costs that the orders cause. The policy was implemented because England’s industry
is in a recession and the company is producing well below capacity (and expects to continue doing so the coming
years). The president is willing to accept orders that at least cover their variable costs so that the company can keep its
employees and avoid layoffs. Also, any orders above variable cost will increase overall profitability of the company.

Suppose that a multiple regression equation is developed for overhead: Y = P100,000 + P100 X1 + P5,000 X2 + P300
X3, where X1 = direct labor hours, X2 = number of setups, and X3 = engineering hours. The correlation coefficient for
the equation is 0.94. Assume that the order of 20,000 units requires 12 setups and 600 engineering hours.

How much is the total unit variable costs of the 20,000 units? (Assume that a unit of finished good inventory requires
one labor hour of input)
a. P232 b. P225 c. P222 d. P215
9. If a company’s variable costs are 70% of sales, which formula represents the computation of dollar sales that will yield
a profit equal to 10% of the contribution margin when S equals sales in dollars for the period and FC equals fixed costs
from the period?
a. S = 0.2 ÷ FC c. S = 0.27 ÷ FC
b. S = FC ÷ 0.2 d. S = FC ÷ 0.27
10. According to CVP analysis, a company could never incur a loss that exceeded its total
a. variable costs c. costs
b. fixed costs d. contribution margin

Quiz No. 2

2. RCJ Corp. has a CM ratio of 26%. It aims to have a net income of P320,000 with a sales volume of P2,000. Its total
fixed cost amount to
a. P 200,000 c. P 230,777
b. P 83,200 d. P 520,000

3. In multi-product situations, when sales mix shifts toward the product with the highest contribution margin, then:
a. total revenues will decrease
b. total contribution margin will decrease
c. operating income will decrease
d. breakeven quantity will decrease

4. A high percentage of a firm’s total costs are fixed, the firm’s operating leverage will be
a. High c. Unchanged
b. Low d. Unable to determine

5. If a company’s variable costs are 70% of sales, which formula represents the computation of dollar sales that will yield
a profit equal to 10% of the contribution margin when S equals sales in dollars for the period and FC equals fixed costs
from the period?

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a. S = 0.2 ÷ FC c. S = 0.27 ÷ FC
b. S = FC ÷ 0.2 d. S = FC ÷ 0.27

6. According to CVP analysis, a company could never incur a loss that exceeded its total
a. variable costs c. costs
b. fixed costs d. contribution margin

7. A very high degree of operating leverage indicates a firm

a. has a high fixed costs c. has high variable costs
b. has a high net income d. is operating close to its breakeven point

8. Kanel Corporation wishes to market a new product for P12.00 a unit. Fixed costs to manufacture this product are
P800,000 for less than 500,000 units and P1,200,000 for 500,000 or more units. Contribution margin ratio is 20%. How
many units must be sold to realize a net income from this product of P500,000?
a. 433,333 c. 666,667
b. 500,000 d. 708,333
9. A retail company determines its selling price by marking up variable costs 60%. In addition, the company uses frequent
selling price markdowns to stimulate sales. If the markdowns average 10%, what is the company’s contribution margin
ratio?
a. 27.5% c. 37.5%
b. 30.6% d. 41.7%

10. A company manufactures a single product. Estimated cost data regarding this product and other information for the
product and the company area s follows:

Sales price per unit P 40

Total variable production cost per unit 22
Sales commission (on sales) 5%
Fixed manufacturing overhead P 5,598,720
Fixed general and administrative expense 3,732,480
Effective income tax rate 40%

The number of units the company must sell in the coming year in order to reach its breakeven point is
a. 388,800 units c. 583,200 units
b. 518,400 units d. 972,000 units

11. A company is concerned about its operating performance, as summarized below:

Sales (P12.50 per unit) P 300,000

Variable costs 180,000
Net operating loss 40,000

How many additional units should have been sold in order for the company to breakeven? a. 32,000
c. 12,800
b. 16,000 d. 8,000

Question Nos. 11 through 15 are based on the following:

Chicago Company recently expanded its manufacturing capacity to allow it to product up to 15,000 pairs of cross-
country skis of either the mountaineering model or the touring model. The sales department assures management that
it can sell between 9,000 and 13,000 pairs (units) of either product this year. Because the models are very similar,
Chicago will produce only one of the two models. The following data were compiled by the accounting department.

Mountaineering Touring
Selling price per unit P 88.00 P 80.00
Variable cost per unit 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. Chicago Company is subject to a 40% income tax rate.

12. If Chicago desires an after-tax net income of P24,000, how many pairs of touring model skis will the company have to
sell?
a. 13,118 c. 13,853
b. 12,529 d. 4,460

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13. The total sales revenue at which Chicago would make the same profit or loss regardless of the ski model it decided to
produce is
a. P880,000 c. P924,000
b. P422,400 d. P686,400

14. How much would the variable cost per unit of the touring model have to change before it had the same breakeven point
in units as the mountaineering model?
a. P2.68/unit increase c. P5.03/unit decrease
b. P4.53/unit increase d. P2.97/unit decrease

15. If the variable cost per unit of touring skis decreases by 10%, and the total fixed cost or touring skis increases by 10%,
the new breakeven point will be
a. 10,730 pairs
b. 13,007 pairs
c. 12,812 pairs
d. Unchanged from 11,648 pairs because the cost changes are equal and offsetting.

16. If the Chicago Company sales department could guarantee the annual sale of 12,000 skis of either model, Chicago
would
a. produce touring skis because they have a lower fixed cost.
b. produce only mountaineering skis because they have a lower breakeven point.
c. produce mountaineering skis because they are more profitable,
d. be indifferent as to which model is sold because each model has the same variable cost per unit.

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