No. 125 Brgy.

San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

MS05-03: COST-VOLUME-PROFIT ANALYSIS

“Most business organizations, if not all, are geared towards earning profit. As such, management, at the
minimum, needs to know the fundamentals of analyzing the factors affecting profit. In doing this,
management accountants should be able to properly aid management by identifying and analyzing
information that will have impact on revenue, cost, and profit.”

DEFINITION OF COST-VOLUME-PROFIT ANALYSIS

Cost-Volume-Profit (CVP) Analysis illustrates the association among various variables namely
volume of activity, selling price and cost, which consequently affects profit. It is a method of
determining how profit will be affected by various changes in the volume of units sold, unit selling
price, unit variable cost, and total fixed costs. In a nutshell, CVP analysis is guided by the following
formula:

IMPORTANCE OF COST-VOLUME-PROFIT ANALYSIS

CVP Analysis is important to organizations (including not-for-profit organizations) because they
can plan for their operations. Based on the general formula, it can be deduced that CVP Analysis
can answer the following questions:
a. How many units should I sell to cover up my fixed cost?
b. How many units should I sell to cover up my fixed cost and earn a certain amount of
profit?

BASIC ASSUMPTIONS IN COST-VOLUME-PROFIT ANALYSIS

a. Total costs can be separated between variable (varying based on output) and fixed
component.
b. Unit selling price, unit variable cost, ant total fixed cost are constant.
c. Total costs and total revenues are linear and within the relevant range.
d. Sales mix, in a multiple product entity, is constant.
e. Beginning and ending inventory levels are the same.
f. Time value is insignificant in the analysis.

IMPORTANCE OF CONTRIBUTION MARGIN INCOME STATEMENT

In CVP Analysis, the traditional format of the income statement is not recommended because it
only classifies cost according to function (i.e. cost of goods sold, selling expenses, and
administrative expenses). As such, internal users of financial information normally require
accountants to prepare the contribution margin income statement because it properly classifies
cost according to behavior (i.e. fixed or variable), which is very useful in CVP analysis.

Contribution margin is the difference between sales and variable cost or simply the portion of
sales that contributes to fixed cost recovery and profit earning.

Sales xxx
Less: Variable Cost xxx
Contribution margin xxx
Less: Fixed cost xxx
Net income before tax xxx
Less: Tax (xx %) xxx
Net income after tax xxx

VARIOUS METHODS IN COST-VOLUME-PROFIT ANALYSIS

A. Graphical Method – this method involves plotting data regarding fixed cost, total cost, and
revenue to predict profit/loss at certain level of activity.

1|P a g e JBUGATAN/JSARIPADA
 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

B. Equation Method: it involves the use of algebra using the general profit formula.

C. Contribution Margin Approach: it is a variation of the equation method expressed as follows:

CVP ANALYSIS: FIXED COST RECOVERY OR ZERO PROFIT- SINGLE PRODUCTS

(BREAKEVEN ANALYSIS)

Breakeven analysis pertains to forecasting the required level of sales in order to recover the fixed
cost inherent to the operations. At breakeven point, the organization is neither at a loss or profit.

CVP ANALYSIS: FIXED COST RECOVERY WITH PROFIT; INCLUDING EFFECT OF TAX
RATE – SINGLE PRODUCT

The method is similar to that of breakeven analysis. This pertains to forecasting the required level
of sales to cover the fixed cost as well as earning a certain amount of profit. Under this section,
CVP analysis treats profit as a fixed cost that must be recovered.

CVP ANALYSIS AND THE CONCEPT OF MARGIN OF SAFETY

The concept of margin of safety gives management an idea whether their projected level of
operations will result in profit or loss. Breakeven analysis plays an important part in the concept
of margin of safety because as represented in the formula for margin of safety:

Margin of Safety, therefore, is the portion of the company’s sales that will contribute to profit while
breakeven sales is the portion of the company’s sales that will be used to recover fixed cost.

CVP ANALYSIS AND THE CONCEPT OF OPERATING LEVERAGE

The concept of operating leverage summarizes the association between volume and profit.
Operating leverage summarizes the impact of change in volume to profit without going through
the process of preparing a contribution margin income statement. The formula for operating
leverage is:

Operating Leverage = Contribution Margin / Net Income;

In analyzing operating leverage, the mix of the company’s variable and fixed cost (or often referred
to as cost structure) should be taken into account.

CVP ANALYSIS AND THE CONCEPT OF INDIFFERENCE POINT

The concept of indifference point in CVP analysis pertains to the level of sales where two
alternatives have the same profit. Simply put, it is a point where management is indiffirent between
two alternatives.

Alternative 1 = Alternative 2
Sales – Variable Cost – Fixed Cost (Alternative 1) = Sales – Variable Cost – Fixed Cost
(Alternative 2)

2|P a g e JBUGATAN/JSARIPADA
 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

CVP ANALYSIS: FIXED COST RECOVERY OR ZERO PROFIT (SIMPLY BREAKEVEN

ANALYSIS) – MULTIPLE PRODUCTS

Most organizations have multiple products with various characteristics. Due to this, breakeven
analysis shall be modified to incorporate this factor.

References:
1. Hilton, 9th Edition. Managerial Accounting. Irwin Mc-Graw Hill.
2. Garrison/Noreen, 12th Edition. Managerial Accounting. Irwin Mc-Graw Hill.
3. Various reviewers in Management Advisory Services.
4. Actual AICPA/Philippine CPA Board Examinations in Management Advisory

3|P a g e JBUGATAN/JSARIPADA
 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

MS05-03: QUIZZER IN COST VOLUME PROFIT ANALYSIS

DISCUSSION PROBLEMS
Answer each of the requirements correctly. Show your computations in good form.

1. CVP Analysis (Graphical Approach): Identify the data required in using the graphical
method

Breakeven chart Profit Volume Chart

I
H
B
E
A

G
C

2. CVP Analysis (Basic Concepts) Rafaello Company produces a single product. The projected
income statement for the coming year is as follows:
Sales (50,000 units @ P100) P5,000,000
Less: Variable costs 2,880,000
Contribution margin P2,120,000
Less: Fixed costs 1,632,824
Operating income P 487,178

Required:

a. Compute the unit contribution margin and the units that must be sold to break even.
Suppose that 30,000 units are sold above breakeven. What is the profit?
b. Compute the contribution margin ratio and the break-even point in pesos.
c. How many units must be sold to earn a profit equal to 10 percent of sales?
d. Assume that the tax rate is 40 percent. How many units must be sold to earn an
after-tax profit of P360,000?
e. Compute the margin of safety and margin of safety ratio
f. Compute the operating leverage. Compute the new profit level if sales are 20 percent
higher than expected.

3. CVP Analysis (Reconstruction): Consider each of the following situations:

a. A company has breakeven sales of P144,000, variable cost ratio of 75%, and net
income ratio of 5%. What is the actual sales?

b. Harry Company has fixed expenses of P60,000, a contribution margin ratio of 40%
and a margin of safety ratio of 25% for a quarter’s operations. Compute the company’s
profit for the quarter.

c. The accountant of Sirus Company is trying to prepare comparative income

statements for the first two months of the year 2021. However, he obtained only that
Sales (January) is P500,000, Variable cost ratio is 60% for January and 64% for
February, and Margine of Safety Ratio is 30% and 24% in January and February,
respectively. Changes in the ratio are due to decrease in sales price and fixed cost.
Compute the change in fixed cost.

4|P a g e JBUGATAN/JSARIPADA
 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

4. CVP Analysis (Degree of Operating Leverage): There are two companies in the vicinity
namely Pagod and Chillax. For the past year ended December 31, 2021, both companies
earned the same net income amounting to P50,000. The contribution margin income
statements of the two companies are shown below and are ready for analysis.

Contribution Margin Income Statement

For the Year Ended December 31, 2021

Pagod Chillax
Sales P 200,000 P200,000
Variable cost ( 50,000 ) ( 80,000)
Contribution margin P 150,000 P 120,000
Fixed cost ( 100,000 ) ( 70,000)
Net income P 50,000 P 50,000

Required: Compute the following:

a. Degree of operating leverage and breakeven point
b. New net income if sales decreased by 20%
c. New net income if sales increased by 20%

5. CVP Analysis (Indifference Point): Mine Ski Company recently expanded its
manufacturing capacity, which will allow it to produce up to 15,000 pairs of cross-country
skis of the mountaineering model or the touring model. The Sales Department assures
management that it can sell between 9,000 pairs and 13,000 pairs of either product this
year. Because the models are very similar, Mine will produce only one of the two models.

The following information was compiled by the Accounting Department.

Per-Unit (Pair) Data

Mountaineering Touring
Selling price P88.00 P80.00
Variable costs 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. Mine Ski is subject to a 40 percent income tax
rate.
Required: What is the indifference point in pesos and in units

6. CVP Analysis (Sales Mix): Marvel Co. manufactures and sells three products: Magneto,
Wolverine, and Capcom. Annual fixed costs are P6,670,000, and data about the three
products follow.

Magneto Wolverine Capcom

Sales in units 40,000 100,000 60,000
Selling price P150 P200 P100
Variable cost 45 120 81

Required:
a. Prepare the income statement of Marvel Co.
Magneto Wolverine Capcom Total
Sales
Variable cost
Contribution margin
Fixed cost
Net income

5|P a g e JBUGATAN/JSARIPADA
 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

b. Determine the sales mix in units and the sales mix in pesos.
c. Compute the weighted contribution margin per unit and breakeven point in units
d. Compute the weighted contribution margin ratio and breakeven point in pesos
e. Assuming the company wants to earn a net income of P8,000,000, how many units must
the company sell?

7. CVP Analysis (Multiple Product): The sales mix for Mulacki Enterprise is as follows:
Product Ey: 12 units @ P5.25 sales price; P4.85 variable cost per unit.
Product Bi: 10 units @ P7.50 sales price; P6.95 variable cost per unit.
Product Si: 6 units @ P12.25 sales price; P10.35 variable cost per unit.

Mulacki Enterprise's fixed costs are P75,950.

What is the breakeven point?

For the next three items: Priman Company is a small but growing manufacturer of telecommunications
equipment. The company has no sales force of its own; rather, it relies completely on independent sales
agents to market its products. These agents are paid a commission of 15% of selling price for all items
sold.

Jason Bugs, Priman’s controller, has just prepared the company’s budgeted income statement for next
year. The statement follows:

Priman Company
Budgeted Income Statement
For the Year Ended December 31
Sales P16,000,000
Manufacturing costs:
Variable P7,200,000
Fixed overhead 2,340,000 9,540,000
Gross margin 6,460,000
Selling and administrative costs:
Commissions to agents 2,400,000
Fixed marketing costs *120,000
Fixed administrative costs 1,800,000 4,320,000
Net operating income 2,140,000
Less fixed interest cost 540,000
Income before income taxes 1,600,000
Less income tax (30%) 480,000
Net income P 1,120,000
*Primarily depreciation on storage facilities

As Jason handed the statement to Reggie, Priman’s president, she commented, “I went ahead and used
the agents’ 15% commission rate in completing these statements, but we’ve just learned that they refuse
to handle our products next year unless we increase the commission rate to 20%.”

“That’s the last straw,” Reggie replied angrily. “Those agents have been demanding more and more,
and this time they’ve gone too far. How can they possibly defend a 20% commission rate?”

“They claim that after paying for advertising, travel, and the other costs of promotion, there’s nothing left
over for profit,” replied Jason.

“I say it’s just plain robbery,” retorted Reggie. “And I also say it’s time we dumped those guys and got
our own sales force Can you get your people to work up some cost figures for us to look at?”

“We’ve already worked them up,” said Jason. “Several companies we know about pay a 7.5%
commission to their own salespeople, along with a small salary. Of course, we would have to handle all
promotion costs, too. We figure our fixed costs would increase by P2,400,000 per

6|P a g e JBUGATAN/JSARIPADA
 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

year, but that would be more than offset by the P3,200,000 (20% x P16,000,000) that we would avoid on
agents’ commissions.”

The breakdown of the P2,400,000 cost figure follows:

Salaries:
Sales manager P 100,000
Salespersons 600,000
Travel and entertainment 400,000
Advertising 1,300,000
Total P2,400,000

“Super,” replied Reggie. “And I note that the P2,400,000 is just what we’re paying the agents under the
old 15% commission rate.”

“It’s even better than that,” explained Jason. “We can actually save P75,000 a year because that’s what
we’re having to pay the auditing firm now to check out the agents’ reports. So our overall administrative
costs would be less.”

“Pull all of these number together and we’ll show them to the executive committee tomorrow,” said
Reggie. “With the approval of the committee, we can move on the matter immediately.”

8. What is the breakeven point in pesos for next year assuming that the agents’ commission rate
remains unchanged at 15%?
A P10,650,000 C. P12,000,000
B. P9,000,000 D. P10,750,000

9. What is the breakeven point in pesos for next if the company employs its own sales force?
A. P15,157,895 C. P13,090,909
B. P12,954,545 D. P15,000,000

10. The volume of sales at which net income would be equal regardless of whether Priman Company
sells through agents (at a 20% commission rate) or employs its own sales force:

A. P11,625,000 C. P12,000,000
B. P19,200,000 D. P18,600,000

MULTIPLE CHOICE THEORIES

Directions: Choose the letter of the best answer.

1. To which function of management is CVP analysis most applicable?

a. Directing
b. Planning
c. Organizing
d. Controlling

2. A manager of a multi-product company prepared a CVP graph with sales dollars on the horizontal
axis. The sales mix then shifted toward products with higher contribution margin percentages.
The effect on the graph is:
a. an upward shift in the slope of the total revenue line
b. an upward shift n the slope of the total cost line
c. a downward shift in the slope of the total revenue line
d. a downward shift in the slope of the total cost line.

3. Which of the following is true for a multi-product company?

a. It cannot use CVP analysis.
b. It must use a separate CVP graph for each of its products.
c. It could use CVP analysis only if the contribution margin percentages on each product
are the same.
d. It could earn a higher than expected profit even though the total number of units sold was
less than expected.

7|P a g e JBUGATAN/JSARIPADA
 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

4. Cost-volume-profit analysis cannot be used if which of the following occurs?

a. Costs cannot be properly classified into fixed and variable costs.
b. The per unit variable costs change.
c. The total fixed costs change.
d. Per unit sales prices change.

5. Which of the following is not an assumption underlying C-V-P analysis?

a. The behavior of total revenue is linear.
b. Unit variable expenses remain unchanged as activity varies.
c. Inventory levels at the beginning and end of the period are the same.
d. The number of units produced exceeds the number of units sold.

6. A cost volume profit graph reflects relationships:

a. expected to hold over the relevant range
b. that reflect results over the past few years
c. that the firm’s managers would like to have happen
d. likely to prevail for the industry.

7. If a company raises its target peso profit, its

a. break-even point rises.
b. fixed costs increase.
c. required total contribution margin increases.
d. selling price rises.

8. It is reasonable for a manager to state a target profit in all of the following ways except as a:
a. peso amount per unit sold
b. percentage of total sales pesos
c. total peso amount
d. percentage of the profit at the break even point.

9. If a firm raises its target peso profit, which of the following is a necessary result?
a. Its breakeven point rises.
b. Its fixed costs increase.
c. Its required total contribution margin increases.
d. Its selling price rises.

10. The indifference point is the level of volume at which

a. the company earns no profit.
b. The company earns the same profit under different operating scheme
c. The company earns its target profit.
d. The company incurs a loss.

11. The effect of introducing income taxes into cost volume profit analysis is to:
a. raise the break even point.
b. Lower the break even point.
c. Increase the unit sales needed to earn a particular target profit.
d. Decrease the contribution margin percentage.

12. It is reasonable for a manager to state a target profit in all of the following ways except as a:
e. peso amount per unit sold
f. percentage of total sales pesos
g. total peso amount
h. percentage of the profit at the break even point.

13. Jace Company has a higher degree of operating leverage than Dane Company. Which of the
following is true?
a. Jace has higher variable expense.
b. Jace is more profitable than DaneCompany’s.
c. Jace is more risky than Dane is.
d. Jace's profits are less sensitive to percentage changes in sales.

8|P a g e JBUGATAN/JSARIPADA
 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

14. A cost volume profit graph reflects relationships:

a. expected to hold over the relevant range
b. that reflect results over the past few years
c. that the firm’s managers would like to have happen
d. likely to prevail for the industry.

15. The effect of introducing income taxes into cost volume profit analysis is to:
a. raise the break even point.
b. Lower the break even point.
c. Increase the unit sales needed to earn a particular target profit.
d. Decrease the contribution margin percentage.

MULTIPLE CHOICE PROBLEMS

Directions: Choose the letter of the best answer.

1. 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 markdown average 10%,
what is the company’s contribution margin ratio?
a. 27.5%
b. 37.5%
c. 30.6%
d. 41.7%

2. Beryl Company sells products A, B & C. Beryl sells three times units of A for each unit of C, and two
units of B for each unit of A. The contribution margins are P1 per unit of A, P1.50 per unit of B and
P3 per unit of C. Fixed costs are P600,000. How many units of A would Beryl Co. sell at the
breakeven point?
a. 40,000
b. 120,000
c. 360,000
d. 400,000

3. Gryffindor Company's variable expenses are 70% of sales. At a P300,000 sales level, the degree of
operating leverage is 10. If sales increase by P60,000, the degree of operating leverage will be:
a. 12
b. 4
c. 10
d. 6

Do it yourself: CVP Analysis (Service Company) HOTEL SO-GOALS, a no-star hotel in

Quezon City, had started to employ decentralization during the year. So-Goals has various
departments assigned with different responsibilities. The main operating department of the hotel
is the room rental department. However, each occupant also receives various services from
other departments such us room service, collections, maintenance etc.

For the year ended December 31, 2020, the room rental department charges each occupant
P4,500 for 12 hours stay. The hotel has 200 rooms, operating 24 hours per day but only 360 days
a year. Therefore, each room of the hotel can accommodate 2 occupants within a day. The hotel
operated at an 80% capacity during the year.

The managerial accountant’s compilation of the costs showed the following:

# of occupants # of rooms
Food P115,200,000
Maintenance 18,000,000
Security services 38,000,000
General and administrative services 33,200,000
Cashier services 57,600,000
Depreciation 57,840,000
Laundry 34,560,000
Others 80,640,000
Total 288,000,000 147,040,000

9|P a g e JBUGATAN/JSARIPADA
 No. 125 Brgy. San Sebastian
Lipa City, Batangas, Philippines
Mobile : 0927 283 8234
Telephone : (043) 723 8412
Gmail : [email protected]

Apart from the costs enumerated above, the room rental department is allocated with
utilities cost based on varying level of operations:

At 144,000 occupants P33,360,000

From 129,600 occupants to 143,999 31,400,000
From 115,200 occupants to 129,599 28,600,000
From 80,000 occupants to 115,199 27,000,000

The company expects to operate at 90% capacity by next year due to favorable comments
received in their client’s suggestion box. Management is very confident that they will reach
90% bed occupancy in the next calendar year.

Required:
a. Estimated number of occupants during the year
b. Total Contribution Margin for 2020
c. Profit during 2020
d. At what percentage of operations is the company expected to breakeven?
e. How much is the margin of safety based on number of occupants in year 2020?
f. If the company's estimate will push through, how much would be the expected change in
revenue?
g. If the company's estimate will push through, how much would be the expected change in
profit?
h. Supposing the company would need to provide a 10% discount to achieve the 90%
capacity next year, what will be the total profit next year?

"There are no shortcuts to any place worth going" - Helen Keller

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