ICAN/AKSG STUDY CENTER, UYO.

LECTURE SERIES

PERFORMANCE MANAGEMENT

TOPIC – COST-VOLUME-PROFIT ANALYSIS

BY

DR SUNDAY A. OKPO, FCA

[email protected].
08037864947

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 COST-VOLUME-PROFIT ANALYSIS
This is the systematic method of examining the relationship between changes in activity
(i.e. output) and changes in the total sales revenue, expenses and net profit.

The main objective of CVP analysis is to establish what will happen to financial
results if specified level of activity or volume fluctuates. This information is vital to
management, since one of the most important variable influencing total sales revenue,
total cost and profit is output or volume.

Understanding the relationship between total sales revenue, total cost and profit
enables managers to plan in advance the output or volume to be made in order to
achieve a predetermined profit.

BREAK-EVEN POINT
The breakeven point can be defined as the quantity of production or sales value in
which the fixed cost is fully recovered and the contribution of any production above
this point results in profit. It is the volume of production which organisations’ revenue
and costs are the same. The BEP can be measured either in units or sales values. It is
the quantity produced or sales where the company neither makes profit nor loss. Thus
at breakeven point the profit is zero.

Assumptions of Break Even Point

The operationalisation of break-even point is premised on some assumptions which
include:
a. The behaviour of total revenue is linear. This implies that the product price
remains the same as the volume changes.
b. The behaviour of total cost remains linear over relevant range.
c. Costs are classified as either fixed or variables.
d. The total fixed cost remains constant over the relevant range.
e. The total variable cost varies as the activities change.
f. The efficiency of production process and workers remain constant.
g. The number of units produced should equal the number of units sold. That
means there should be no opening or ending inventory.

Computation of Break-Even Point

There are three methods of calculating break-even point. These include:
 The equation method
 The formular method.
 The graphical method.

The Equation Method

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Under this method the profit is obtained by deducting the total fixed cost and total
variable costs from the sales value. Note that at break-even point the profit is zero.

Sales Revenue – Fixed cost – Variable cost = 0

Illustration
YAKNO NIGERIA LIMITED produces a special blend of ‘zobo’ from natural
ingredients which is packed in a bottle. The selling price per one bottle of ‘zobo’ has
been determined at N250. In order to produce one unit of the product requires material
worth N90 and labour cost of N40 and variable expenses of N20. The company incurs
period cost of N1,440,000 in the production of the product.
Required
Calculate how many units of ‘zobo’ the company must produce in order to break even.

Formular Approach
The various formulars for the computation of the break-even point are stated below.
Fixed Cost
1. Break Even Point in units =
Contribution per unit
Fixed Cost
2. Break Even Point in Value = .
Contribution Margin Ratio
Sales-Variable Cost
Where Contribution Margin Ratio (CMR) = .
Sales
This can also be obtained by multiplying the break-even point in units by the
selling price.
Fixed Cost+Target Proft
3. Break Even Point in units to achieve a target Profit = .
Contribution per unit
Break Even Point in Naira value to achieve a target profit =
Fixed Cost+Target Profit
Contribution Margin Ratio

4. Break Even Point when an additional fixed cost is incurred =

Fixed Cost + Additional Fixed Cost
Contribution per unit
Profit After Tax
Fixed Cost+
1-Tax Rate
5. Break Even Point to earn a desired after tax profit =
Contribution per unit
Fixed Cost-Donation
6. Break Even Point when there is donation = .
Contribution per unit
The Graphical Method
This method involves plotting the sales against the total cost. The meeting point of
these two curves produce the BEP. The number of units is obtained by reading-off the
value on the horizontal axis while the value of sales is read-off on the vertical axis.

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Margin of Safety
This is the difference between actual or budgeted sales and the breakeven sales. It
indicates to management the quantity produced or sold above the breakeven point in
which the fixed cost would have been fully recovered. The margin of safety draws
management attention to the sales quantity or value in which the contribution is equal
to the profit of the organisation. It also indicates to management a feel of how close
projected activities are to organisation’s breakeven point. Thus management may use it
to plan to increase its activities.

BREAK-EVEN POINT OF MULTI PRODUCT

When a company produces more than one product incurring jointly the fixed cost the
break-even point can be calculated using the following steps:

i. Calculate the contribution for each product and in total

ii. Determine the number of units for each product and in total.

iii. Calculate the weighted contribution per unit by dividing the contribution by the
total number of product.

iv. Divide the fixed cost by the weighted contribution margin to have the BEP in
total.

v. Apportion the break-even point to each product in the proportion of their

products.

QUESTION ONE

R. A. Ro and Company, maker of quality of quality handmade pipes has experienced a

steady growth in sales for the past few years. However, increased competition has led
Mr Ro, the president, to believe that and aggressive advertising campaign will be
necessary next year to maintain the company’s present growth.

To prepare for next year’s advertising campaign, the company’s accountant has
prepared and presented Mr Ro with the following data for the current year 2022.

Variable cost per pipe:

Direct labour 800
Direct material 325
Variable overhead 250
Total variable cost 1,375
Fixed cost:
Manufacturing 2,500,000
Selling 4,000,000
Administration 7,000,000

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 Total fixed cost 13,500,000
Selling price, per price N2,500
Expected sales in 202x (20,000) N50,000,000
Tax rate - 30%
Required
a. What is the projected after-tax net income for 2022?
b. What is the break-even point in units and Naira value for 2022?
c. Mr Ro has set the sales target for 2023 at a level of N55,000,000 for 22,000
pipes. He believes an additional selling expense of N1,125,000 for advertising in
2023, with all other costs remaining constant, will be necessary to attain the
sales target. What will be the after-tax net income for 2023 if the additional
N1,125,000 is spent?
d. What will be the break-even point in Naira for 2023 if the additional N1,125,000
is spent for advertising?
e. If the additional N1,125,000 is spent for advertising in 2023, what is the required
sales level in Naira sales to equal 2022’s after-tax net income?
f. At a sales level of 22,000 units, what maximum amount can be spent on
advertising if an after-tax net income of N6,000,000 is desired?

QUESTION TWO
Colour-effects Limited retails two products: Common and Executive travelling bags.
The budgeted income statement for the year 2015 is as follows:

Common Bag Executive Bag Total

Units sold 300,000 100,000 400,000

N N N

Revenue at N200 and N300 per unit 60,000,000 30,000,000 90,000,000

Variable costs at N140 and N180/unit 42,000,000 18,000,000 60,000,000
Contribution margins at N60 and
N120/unit 18,000,000 12,000,000 30,000,000
Fixed costs: 12,000,000
Operating profit 18,000,000

Required:

a. Calculate the break-even units, assuming that the planned revenue is

maintained.

b. Determine the break-even point in units if only Common bags are sold and if
only Executive bags are cold.

c. Calculate the budgeted operating profit and break-even point if 200,000 units
are sold but only 20,000 are Executive bags. (ICAN NOV 2014)

QUESTION THREE

ADEBAYO NIGERIA LIMITED manufactures four products at its Aba plant in the state
capital of Abia. The budgeted sales and cost structure of the organisation in the
forthcoming year 2023 is as follows:

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Product Selling Price (N) Sales (N) Variable Cost (N) Contribution (N)

A. 30 540,000 432,000 108,000

B. 20 630,000 252,000 378,000

C. 45 405,000 81,000 324,000

D. 10 225,000 135,000 90,000

Total 1,800,000 900,000 900,000

The budgeted fixed cost for the period is N400,000.

Required:

a. How many units of each product would have to be sold in order to break-even?

b. How many units of each product would have to be sold to attain a profit of
N200,000?

c. If the variable cost as a percentage of sale for product C increases to 30%, how
would this affect your calculation in ‘a’ above?

QUESTION FOUR

OROYO LIMITED produces an electric multi-purpose tool which sells for N10.50.
Sales amount to N4,2 million represents 80% of capacity of the factory and this is
regarded as the normal level of activity with cost as follows:

Prime cost N4.50

Factory indirect costs N220,000 (include variable cost of N60,000)

Selling cost N70,000 (including variable cost of N80,000)

Distribution costs N100,000 (including variable cost of N60,000)

Administration N720,000

Local promotional commission payable averages 7½ % of sales value.

Required

a. Calculate the break-even level.

b. Prepare statements showing the sales income, cost and profit:

i. At normal level activity.

ii. If unit selling price is reduced by 5% thereby increasing sales volume by

12% of the normal activity level.

iii. If units selling price is reduced by 10% thereby increasing sales volume
by 15% of the normal activity level

c. Calculate the contribution margin ratio at the three levels of activity referred to
in (b) above.

d. Calculate the quantity to be sold under the price arrangements referred to in (b)

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 (iii) in order that the profit may be the same as in b (ii).

QUESTION FIVE

Ubachuks Ltd manufactures and sells a single product. The following data has been
extracted from the current year’s budget:

Item Amount
Contribution per unit N8.00
Total weekly fixed costs N10,000
Weekly profit N22,000
Contribution to sales ratio 40%
The company’s production capacity is not fully utilized in the current year and three
possible strategies are under consideration. Each strategy involves reducing the unit
selling price on all units sold with a consequential effect on the volume of sales.

The detailed effect of each strategy is as follows:

Strategy Reduction in unit Expected increase in weekly sales

Selling price volume over budget
% %
A 2 10
B 5 18
C 7 25
The company does not hold inventory of finished goods
Required:
Calculate:
a. The selling price per unit of the product for the current year.
b. The weekly sales in units and value for the current year.
c. The current year’s break-even point in units and value.
d. Determine, with a statement, which one of the three strategies should be adopted
by the company in order to maximise its weekly profits.
(ICAN NOVEMBER, 2017)