Republic of the Philippines

City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314

DETAILED LEARNING MODULE

Title: Cost-Volume-Profit Analysis

Module No. 2

I. Introduction
In this module, a systematic examination of the relationships among costs, cost driver and profit
will be discussed. The basic assumptions in Cost-Volume-Profit Analysis are anchored on the
general assumption that costs and expenses are separable into their fixed and variable
components. The concept of contribution margin is premised on this assumption as well. For
purposes of profit analysis and control, managers give emphasis in the contribution margin
along with the breakeven point and margin of safety.

II. Learning Objectives

After studying this module, you should be able to:
1. Understand the relationship of volume, sales, and cost to profit.
2. Apply the cost-volume-profit analysis in planning and decision-making.
3. Compute the breakeven point and target sales.
4. Calculate and understand the importance of contribution margin.
5. Determine and explain operating leverage.

III. Topics and Key Concepts

1. Cost-Volume-Profit Analysis

CVP Analysis (Cost-Volume-Profit Analysis) is a systematic examination of the relationships

among costs, cost driver, and profit.

CVP Analysis is applied in planning and decision-making which may involve choosing the:
(1) type of product to produce and sell; (2) pricing policy to follow; (3) marketing strategy to
use; and (4) type of productive facilities to acquire.

The variables of profit are (1) unit sales price; (2) unit variable cost; (3) total fixed cost; (4)
number of units sold, and (5) sales mix. If any of these changes, either individually or
collectively, profit changes.

i. Elements of CVP Analysis

1. Sales
a. selling price
b. units or volume
2. Total Fixed Cost
3. Variable Cost per Unit
4. Sales Mix

Managerial Accounting. 1st Sem 2021-2022 NOT FOR SALE. EXCLUSIVE FOR GORDON COLLEGE ONLY
 Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314

ii. Underlying Assumptions

1. All costs are classifiable as either variable or fixed.

2. Cost and revenue relationships are predictable and linear within the relevant range of
activity and a specified period.
3. Total variable cost change directly with the cost driver, but variable cost per unit are
constant within the relevant range.
4. Total fixed cost is constant within the relevant range, but fixed cost per unit vary
inversely with the cost driver.
5. Selling prices per unit and market conditions remain unchanged.
6. There is no change in finished goods inventory, which means, that production equals
sales.
7. There is only one product, or, in case of multi-product operations, the sales mix is
constant.
8. Technology, as well as productive efficiency, is constant.
9. The time value of money is ignored.

iii. Contribution Margin Analysis

Contribution Margin is the difference between sales and variable cost. It is the amount
used to absorb fixed costs and contribute profit.

The Contribution Margin Income Statement is prepared for management’s own use which
facilitates CVP analysis. The costs and expenses in CM Income Statement are classified as
to behavior: variable and fixed.

Proforma Statement:

Sales (units x selling price) P xx

Less: Variable Cost (units x variable cost per unit) xx
Contribution Margin P xx
Less: Total Fixed Cost xx
Operating Income P xx

Expanded Proforma Statement:

Sales P xxx
Less: Variable Cost xxx
Manufacturing Margin P xxx
Less: Variable Expenses xxx
Contribution Margin xxx
Less: Direct fixed cost and expense xxx
Segment (direct) Margin P xxx
Less: Indirect (allocated) fixed cost and expense xxx
Operating Income P xxx

Managerial Accounting. 1st Sem 2021-2022 NOT FOR SALE. EXCLUSIVE FOR GORDON COLLEGE ONLY
 Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314

Basic Points:

1. To avoid operating loss, contribution margin should at least equal to fixed cost.
2. Any amount of contribution margin in excess of fixed cost is profit.
3. The relevance of contribution margin is based on the premise that, an increase in
contribution margin means an increase in profit; a peso increase in contribution margin
is a peso increase in operating profit.

Illustration: Contribution Margin

Unit sales price P 200

Unit variable cost 120
Total fixed cost 400,000
Units sold 8,000 units

Determine the unit contribution margin, contribution margin ratio, and variable cost ratio.

Discussion:
Let us use this problem to discover the intriguing relationship of contribution margin,
fixed cost, and profit. Using the proforma statement, we will have the following solution:

Unit
Units Amount %
Prices
Sales 8,000 P 200 b P 1,600,000 100
Less: Variable Cost 8,000 120 c 960,000 f 60
Contribution Margin 8,000 a P 80 d P 640,000 g 40
Less: Fixed Cost 400,000
Operating Income e P 240,000

(a) Unit sales price – Unit variable cost = (200 – 120)

(b) Unit sales price x Units sold = (200 x 8,000)
(c) Unit variable cost x Units sold = (120 x 8,000)
(d) Unit contribution margin x Units sold = (80 x 8,000)
(e) Contribution Margin – Fixed Cost = (640,000 – 400,000)
(f) Variable Cost / Sales = (960,000 / 1,600,000)
(g) Contribution Margin / Sales = (640,000 / 1,600,000)

 Unit Contribution Margin = P 80

 Contribution Margin Ratio = 40%
 Variable Cost Ratio = 60%

Managerial Accounting. 1st Sem 2021-2022 NOT FOR SALE. EXCLUSIVE FOR GORDON COLLEGE ONLY
 Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314

**Note the other ways to compute the following:

Contribution Margin = Sales – Variable Cost

Fixed Cost + Operating Income
Units Sold x Unit Contribution Margin
Sales x Contribution Margin Ratio

Operating Income = Contribution Margin – Fixed Cost

Variable Cost Ratio = Variable Cost / Sales

= Unit Variable Cost / Unit Sales Price

Contribution Margin Ratio = Contribution Margin / Sales

= Unit CM / Unit Sales Price
= 100% - VC Ratio

iv. Break-Even Analysis

Break-Even Point is the sales volume level (in pesos or in units) where total revenues
equals total costs, that is, there is neither profit nor loss.

a. Single Product/Service

BEPp = FxC / CMR

where: BEPp = break-even point in pesos; FxC = total fixed cost; CMR =
contribution margin ratio

BEPu = FxC / CMu

where: BEPu = break-even point in units; FxC = total fixed cost; CMu =
contribution margin per unit

b. Multiple Product/Service

BEPp = FxC / WaCMR

where: BEPp = break-even point in pesos; FxC = total fixed cost; CMR = weighted
average contribution margin ratio

BEPu = FxC / WaCMu

where: BEPu = break-even point in units; FxC = total fixed cost; CMu = weighted
average contribution margin per unit

Managerial Accounting. 1st Sem 2021-2022 NOT FOR SALE. EXCLUSIVE FOR GORDON COLLEGE ONLY
 Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314

Illustration: Break-Even Analysis

Unit sales price P 200

Unit variable cost 120
Total fixed cost 400,000
Units sold 8,000 units

Determine the break-even point in units and break-even point in pesos.

Discussion:
Applying the formulas, solution is as follows:

FxC FxC
BEPp = BEPu =
CMR CMU
400,000 400,000
= =
40% 80
= 1,000,000 = 5,000

 Break-Even Point in Pesos = P 1,000,000

 Break-Even Point in Units = 5,000 units

It should be observed that at break-even point, total contribution margin equals total fixed
cost, thus no income or loss. To prove:

Sales (5,000 units x P200) P 1,000,000

Less: Variable Cost (5,000 units x P120) 600,000
Contribution Margin (5,000 units x P80) 400,000
Less: Fixed Cost 400,000
Profit (Loss) P 0

v. Margin of Safety

Margin of Safety is the difference of actual (planned) sales and breakeven sales; it is the
amount of peso-sales or the number of units by which actual or budgeted sales may be
decreased without resulting into loss.

MSp = Sp - BEPp MSR = MSp

MSu = Su - BEPu Sp
MSp = MSu
=
SP Su

where: MSp = margin of safety in pesos; MSu = margin of safety in units; MSR = margin
of safety ratio; Sp = sales in pesos; Su = sales in units; BEPp = breakeven point in pesos;
BEPu = breakeven point in units; SP = selling price

Managerial Accounting. 1st Sem 2021-2022 NOT FOR SALE. EXCLUSIVE FOR GORDON COLLEGE ONLY
 Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314

Illustration: Margin of Safety

Unit sales price P 200

Unit variable cost 120
Total fixed cost 400,000
Units sold 8,000 units

Determine the margin of safety in units, margin of safety in pesos, and margin of safety
ratio.

Discussion:
Applying the formulas, solution is as follows:

MSp = 1,600,000 - 1,000,000 MSR = 600,000

= P 600,000 1,600,000
= 37.50%
MSu = 8,000 - 5,000
= 3,000 units

 Margin of Safety in Pesos = P 600,000

 Margin of Safety in Units = 3,000 units
 Margin of Safety Ratio = 37.50%

Actual (Budgeted) Sales (8,000 units x P200) P 1,600,000 100%

Less: Breakeven Sales (5,000 units x P200) 1,000,000 62.50%
Margin of Safety (3,000 units x P200) 600,000 37.50%

The presence of a margin of safety indicates profit. Since margin of safety is the amount
of sales in excess of breakeven point, it means that in every peso of margin of safety
there is a profit. And profit is the increase in contribution margin after the breakeven
point because all fixed costs are already covered up by the contribution margin at
breakeven point. Therefore:

Profit = Margin of Safety x CM Ratio

= 600,000 x 40%
= 240,000

Profit Ratio = MS Ratio x CM Ratio MS Ratio = Profit Ratio / CM Ratio

= 37.5% x 40% CM Ratio = Profit Ratio / MS Ratio
= 15%

Managerial Accounting. 1st Sem 2021-2022 NOT FOR SALE. EXCLUSIVE FOR GORDON COLLEGE ONLY
 Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314

vi. Target Sales with Desired Profit

The break-even formula may be expanded to compute for the required sales (in units or in
pesos) to earn a desired amount of profit.

Illustration:

Unit sales price P 400

Unit variable cost 240
Total fixed costs 800,000

Determine the sales if profit is expressed as:

1. Income before income tax of P400,000
2. Income after tax of P480,000; tax rate is 40%
3. 20% of sales
4. P25 per unit

Discussion:

1. Sales in Units = FC + IBIT

UCM
Sales in Units = 800,000 + 400,000
160
Sales in Units = 7,500 units

Sales in Pesos = FC + IBIT

CMR
Sales in Pesos = 800,000 + 400,000
40%
Sales in Pesos = P3,000,000

2. Sales in Units = FC + (NI / 1 – Tax Rate)

UCM
Sales in Units = 800,000 + (480,000 / 1 – 40%)
160
Sales in Units = 10,000 units

Sales in Pesos = FC + (NI / 1 – Tax Rate)

CMR
Sales in Pesos = 800,000 + (480,000 / 1 – 40%)
40%
Sales in Pesos = P4,000,000

3. Sales in Pesos = FCosts

CMR – NPR
Sales in Pesos = 800,000
40% - 20%
Sales in Pesos = P4,000,000

Managerial Accounting. 1st Sem 2021-2022 NOT FOR SALE. EXCLUSIVE FOR GORDON COLLEGE ONLY
 Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314

4. Sales in Units = FCosts

UCM – UPM
Sales in Units = 800,000
160 - 25
Sales in Units = 5,926 units

Note:
CMR = Contribution Margin Ratio
FC = Fixed Costs
IBIT = Income Before Income Tax
NI = Net Income
NPR = Net Profit Percentage
UCM = Unit Contribution Margin
UPM = Unit Profit Margin

vii. Operating Leverage

Operating Leverage refers to the ability of the business to increase its profit in relation to
its contribution margin.

Leverage is achieved by increasing fixed costs while lowering variable costs.

Operating Leverage Factor (OLF) or Degree of Operating Leverage (DOL) is used to

measure the extent of the change in profit before tax resulting from the change in sales.

OLF / DOL = Contribution Margin / Profit before Tax

OLF / DOL = % Change in Profit before Tax / % Change in Sales

% Change in Profit = % Change in Sales x DOL

Illustration: Operating Leverage

Following is the company’s result of operations from its present sales level of 10,000 units:

Sales (10,000 units @ P5) P 50,000

Variable Cost (10,000 units @ P3) 30,000
Contribution Margin P 20,000
Fixed Cost 12,000
Profit before Tax P 8,000

Based on the above data:

OLF = Contribution Margin / Profit before Tax

OLF = 20,000 / 8,000
OLF = 2.5

Managerial Accounting. 1st Sem 2021-2022 NOT FOR SALE. EXCLUSIVE FOR GORDON COLLEGE ONLY
 Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314

If the company’s sale would increase by 10%, its profit before tax would increase by 25%.

% Change in Profit = % Change in Sales x DOL

% Change in Profit = 10% x 2.5
% Change in Profit = 25%

To prove:
Present Proposed

Sales P 50,000 P 55,000 (50,000 x 110%)

Variable Cost 30,000 33,000 (30,000 x 110%)
Contribution Margin P 20,000 P 22,000
Fixed Cost 12,000 12,000
Profit before Tax P 8,000 P 10,000 (8,000 x 125%)

** Notes:
1. Sales increased by only 10%, but profit increased 2.5 times the increase in sales, or by 25%
2. The increase of 10% in sales is due to change in units.
3. Since units changed by 10%, both the total variable cost and contribution margin increased
by the same percentage 10%.
4. Selling price, variable cost per unit, and total fixed cost are assumed to be constant.
5. If there is no change in selling price and variable cost per unit, CM per unit, CMR, and VCR
will all remain the same.

IV. Teaching and Learning Materials and Resources

1. Management Advisory Services by Agamata

2. Management Advisory Services by Roque
3. Management Accounting by Cabrera

V. Learning Task

Study Guides:
1. Describe the relationship of volume, sales, and cost to profit.
2. How does CVP analysis contribute to increasing the quality of decisions?
3. What is meant by the term relevant range?
4. Identify the similarities and differences between marginal and traditional income statement.
5. Discuss the role of contribution margin, breakeven point, margin of safety, and operating
leverage in decision making.

Managerial Accounting. 1st Sem 2021-2022 NOT FOR SALE. EXCLUSIVE FOR GORDON COLLEGE ONLY
 Republic of the Philippines
City of Olongapo
GORDON COLLEGE
Olongapo City Sports Complex, East Tapinac, Olongapo City
Tel. No. (047) 224-2089 loc. 314

VI. Reference

Agamata,F. T. (2004). Management Advisory Services. GIC Enterprises & Co., Inc.

Roque. R. S (2016). Management Advisory Services. GIC Enterprises & Co., Inc

Cabrera, M. E. B. (2011). Management Accounting. GIC Enterprises & Co., Inc

Managerial Accounting. 1st Sem 2021-2022 NOT FOR SALE. EXCLUSIVE FOR GORDON COLLEGE ONLY