Cost Profit Volume Analysis

CHAPTER 4
COST PROFIT VOLUME ANALYSIS

COST VOLUME PROFIT ANALYSIS
A means of showing the relationships among all factors affecting profits

which form the basis for profit planning:
• Selling prices
• Sales volume
• Unit variable costs
• Total fixed costs
• Mix of products sold
CVP ANALYSIS
HOW PROFITS RESPOND TO PRICES, COST AND
VOLUME
• BREAK-EVEN VOLUME
• MARGIN OF SAFETY
• CHANGES IN PRICES, COST AND VOLUME
BREAK EVEN ANALYSIS
• Estimates how much sales would have to be just to break even;

• Unit sales required to break even = FIXED EXPENSES/ UNIT CONTRIBUTION
MARGIN
MARGIN OF SAFETY
• Amount by which the company’s sales exceed the break-even sales;

• Degree of operating leverage allows quick estimation of what impact a given percentage
changes in sales would have on the company’s net operating income;
• The higher the degree of operating leverage, the greater is the impact on the company’s
profits;
• Degree of operating leverage is not constant-it depends on the company’s current level of
sales.
• The profits of a multi product company are affected by its sales mix. Changes in the sales
mix can affect the break-even point, margin of safety and other critical factors.
CONTRIBUTION MARGIN
SALES REVENUE P 200,000.00

LESS: VARIABLE EXPENSES 80,000.00
CONTRIBUTION MARGIN P 120,000.00
Amount available to cover fixed expenses and expected profits for the period. If
contribution margin is not sufficient to cover the fixed expenses, then a loss occurs
for the period.
COMPONENTS OF CVP ANALYSIS
• Level or volume of activity

• Unit selling prices
• Variable cost per unit
• Total fixed costs
COST BEHAVIOR
• It means how a cost will react or respond to changes in the level of company’s activity-
that is, will it increase, decrease or remain constant.
• Activity refers to a measure of organization’s output of products, services, or transactions
expressed as units sold, miles driven, rooms occupied, etc.
• As the activity increases or decreases, a particular cost may increase or decrease or may
remain constant.
• The manager must anticipate or predict when this will happen and identify the cost
drivers associated with such change.
VARIABLE COST
• Cost that changes, in total, directly proportional to the changes in the level of activity.
• When an activity increased by 20%, total variable cost will also increase by 20%, when
activity decreases, total variable cost also decreases,
• Variable cost is a rate per unit of activity or output.
• Thus, variable cost per unit remains constant across a reasonable range or activity.
• Reasonable ranges is also called the RELEVANT RANGE the firm’s normal activities
which reflects the company’s normal operating levels where the relationship of cost behavior
is assumed valid.
EXAMPLE OF VARIABLE COST OR FLEXIBLE
COSTS:
LEVEL OF ACTIVITY (1) UNIT VARIABLE COST TOTAL VARIABLE COST
(2) (3)
(1 X 2)
1 10.00 10.00
5 10.00 50.00
10 10.00 100.00
100 10.00 1,000.00
FIXED COST
• Cost that remains unchanged, in total, as the level of activity varies within the relevant
range.
• When the activity increases or decreases, fixed cost remains the same.
• Fixed cost is a lump sum of costs that is not divisible, thus, fixed cost per unit decreases
as activity or volume increases and increases as activity decreases.
• Thus, fixed cost per unit varies inversely proportional with the changes in activity .
• Also known as CAPACITY RELATED COST.
EXAMPLE OF FIXED COST OR CAPACITY RELATED COST :
LEVEL OF ACTIVITY (1) UNIT FIXED COST (2) TOTAL FIXED COST (3)
(3/1)
(1 X 2)
1 10,000.00 10,000.00
5 2,000.00 10,000.00
10 1,000.00 10,000.00
100 100.00 10,000.00
Total fixed cost is known or pre-determined, and the fixed cost per unit will vary
inversely proportional on the volume or number of units or activity produced.
MIXED COST OR SEMI-VARIABLE COST
• Consists of fixed and variable behavior.

• The High and Low method of segregating mixed cost is presented for proper
understanding of predicting costs for planning and controlling purposes.
• The availability of computer software or program will help managers segregate the mix
costs, what is important is for them to understand that accuracy of segregating costs will
give them a better result in forecasting or planning future costs of operations.
BEHAVIOR OF COSTS AND REVENUES
Most significant part in CVP Analysis = point where total revenues equal total costs (both
fixed and variable costs), resulting to NO INCOME, NO LOSS for the company
Assumptions underlying CVP analysis:
• Behavior of both costs and revenues are linear throughout the relevant range of activity.
• Costs can be classified accurately as either fixed or variable.
• Changes in activity are the only factors that affect costs.
• All units produced are sold (no ending finished good inventory).
• Product mix (ratio of each product to total sales) will remain constant,.
ASSUMPTIONS
• Constant sale price;

• Constant variable cost per unit;
• Constant total fixed;
• Units sold equal units produced.
CVP : PROFIT VOLUME RATIO = CONTRIBUTION MARGIN/SALES X 100

• CVP simplifies the computation of BE analysis, and allows simple computation of target
income sales. It simplifies analysis of short run trade-offs in operational decisions.
• Management can use the break-even equation to predict the effects on the break-even
point of changes in any component of the equation, e.g. sales price, unit variable costs,
fixed costs, etc. Such prediction can help management in making a variety of operational
decisions.
UNIT SALES TO BREAK EVEN = Fixed Expenses / Unit Contribution Margin
PESO SALES TO BREAK EVEN = Fixed Expenses / Contribution Margin Ratio
PROBLEM A -
Nixon Company sold 800 units of products in September. The average sales price was P30.
during the month, fixed costs were P7,200 and variable costs were 60& of sales.
INSTRUCTIONS:
1. Determine the contribution margin in pesos, per unit and as a ratio.
2. Using the CM technique, compute the break-even point point.
ANSWER:
Contribution Margin in Pesos: Sales (800xP30) P24,000.00
Less: Variable Costs (60% of P24,000). 14,400.00
Contribution Margin P 9,600.00
Contribution margin per unit : Unit sales price P 30.00
Less: Variable cost per unit (P30 x 60%). 18.00
Contribution margin per unit P 12.00
Contribution margin ratio P 12.00 / P30.00 =. 40 %
2. Break-even sales (in pesos)

Fixed costs / Contribution margin ratio : P7,200 / 40% = P 18,000
Break even sales (in units)

Fixed costs / contribution margin per unit : P7,200 / P12 = 600 units
PROBLEM B -
BAXTER COMPANY
Income Statement
For the Year Ended Decemer 31, 2018
Sales (40,000 units) P 1,000,000

Variable Expenses 700,000
Contribution Margin 300,000
Fixed Expenses 330,000
Income (Loss) P (30,000).
REQUIRED:
Answer the following independent questions and show

computations using the contribution margin technique to support
your answers:
1. What was the company's break even point in sales pesos in

2018?
REQUIRED:
Answer the following independent questions and show

computations using the contribution margin technique to support
your answers:
1. What was the company's break even point in sales pesos in

2018?
Per Unit
SP. (P1,000,000/ 40,000 units) = P 25.00
Less: VC (P700,000/ 40,000 units). 17,50
Contribution Margin P 7.50
CM Rate
CM / Sales. P 7.50 / 25.00. x100 = 30%
SOLUTION:
1. BE Sales = Fixed Cost / CM Ratio

= P330,000/30%
=. P1,100,000
To check:
Sales. P 1,100,000
Less: Variable Cost (44,000 x 17.50) 770,000
Contribution Margin 330,000
Less: Fixed Cost 330,000
Net Profit (Loss) 0
SP /unit=1,000,000/40,000 units = P 25. P1,100,00/P25.00=44,000 units

VC/unit = P700,000/ 40,000 = P 17.50 44,000 units x P17.50=
2. HOW MANY ADDITIONAL UNITS WOULD THE COMPANY HAVE HAD
TO SELL IN 2019 IN ORDER TO EARN NET INCOME OF P30,000?
Total sales needed = Fixed Expenses + Desired Income

Unit Contribution Margin
=. P330,000. + P30,000
P 7.50
= 48,000 units. Additional units to be sold = 48,000-40,000
To check: =. 8,000 units
Sales. 48,000 x P25 =. P1,200,000
Less: Variable Cost 48,000 x 17.50 = 840,000
Contribution Margin P. 360,000
Less: Fixed Cost 330,000
Net Income P 30,000
3. If the company is able to reduce variable costs by P2.50 per
unit in 2019 and other costs and unit revenues remain unchanged,
how many units will the company have to sell in order to earn a
net income of P35,000?
3. 2018. Variable cost per unit = P 17.50 (P700,000 / 40,000 units)
Variable cost reduction = 2.50
2019 Variable cost per unit P 15.00
Expected contribution margin P10 (P25- P15)
P 330,000 + P. 35,000
P 10 = 36,500 units
•END

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CHAPTER 4

COST PROFIT VOLUME ANALYSIS

A means of showing the relationships among all factors affecting profits

• Estimates how much sales would have to be just to break even;

• Amount by which the company’s sales exceed the break-even sales;

SALES REVENUE P 200,000.00

• Level or volume of activity

• Consists of fixed and variable behavior.

• Constant sale price;

CVP : PROFIT VOLUME RATIO = CONTRIBUTION MARGIN/SALES X 100

2. Break-even sales (in pesos)

Break even sales (in units)

Sales (40,000 units) P 1,000,000

Answer the following independent questions and show

1. What was the company's break even point in sales pesos in

Answer the following independent questions and show

1. What was the company's break even point in sales pesos in

1. BE Sales = Fixed Cost / CM Ratio

SP /unit=1,000,000/40,000 units = P 25. P1,100,00/P25.00=44,000 units

Total sales needed = Fixed Expenses + Desired Income

Expected contribution margin P10 (P25- P15)

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