LESSON 3: COST-VOLUME-PROFIT ANALYSIS

Learning Objectives:
At the end of the lesson, you should be able to:
1. describe the concept and importance of cost-volume-profit relationships;
2. compute for the cost, volume, profit, breakeven point in unit sales and peso
sales;
and
3. identify the concepts of margin of safety and degree of operating leverage.

LET’S ENGAGE!
You should know by now how an income statement looks like. An income statement
presents how the operations of an entity went at a particular accounting period.

Could you present the income statement format below using the functional
method of presentation? Use the following account title: (a) Sales Revenue; (b) Cost
of Goods Sold; (c) Selling and Distribution Expenses; (d) General and Administrative
Expenses of Firefly Incorporated for the year ending December 31, 2019.
Present your answer below:

LET’S EXPLORE!
Preparing an income statement under Philippine Accounting Standards (PASs) is
generally easy. You have learned how to present it since you were in your first
semester with the department. If you took Accountancy and Business Management in
Senior High, then you’re quite lucky since this topic was formally introduced to you
way back then. To be able to prepare an income statement, you need to classify all
accounts as to whether they belong to either revenue or to an expense account. From
that, presenting the revenue first before expenses is the right way. Just a reminder,
never ever forget your heading.
Let’s see whether your income statement presentation is correct. Compare it
with Figure 3.

Firefly Incorporated
Income Statement
For the year ended December 31, 2019
 Sales Revenue P xx
Less: Cost of Goods Sold xx
Gross Profit xx
Less: Selling and Distribution Expenses xx
General and Administrative Expenses xx xx
Net Income xx
Figure 3. Income
Statement
Moving forward, we will explore on a new income statement, an Income
Statement prepared using a Contribution Approach. This type of income statement is
vital in decision making for internal users. Remember that the income statement
prepared under the PASs is vital for all type of users.

LET’S TALK ABOUT IT!

A cost-volume-profit (CVP) analysis helps managers to understand the
interrelationship between cost, volume and profit in an organization by focusing on
interactions between the following five elements:
1. Prices of products
2. Volume or level of activity
3. Per unit variable cost
4. Total fixed cost
5. Mix of products sold

CVP Analysis assists managers in making decisions such as what products to

manufacture or sell, what pricing policy to follow, what marketing strategy to employ,
and what type of productive facilities to acquire.

Your foundation in understanding CVP analysis is hemmed in the Income

Statement prepared using a contribution approach. Please refer to Figure 4.

Name of the Company

Income Statement
For the period ended _____________________

Sales Revenue P xx
Less: Variable Cost of Sales xx
Contribution margin – manufacturing xx
Less: Variable selling and administrative xx
expenses
Contribution margin – final xx
Less: Traceable fixed costs xx
Segment margin xx
 Less: Allocated fixed costs xx
Income before taxes xx

Figure 4. Contribution Margin Income Statement

Note the following information under CVP Relationships.

1. All costs can be categorized as fixed or variable.
a. Variable costs change proportionately with volume within the
relevant volume range.
b. Fixed costs are constant within the relevant volume range
2. Revenues change proportionately with volumes with selling
price remaining constant.
3. Price is constant for all volumes within the relevant range.

Now, try to answer the following multiple-choice questions by writing

your answer on the space provided after each item.

1. Samoki Furniture House makes handmade furniture. Although the company is very
successful, it is unable to hire enough skilled workers to meet the demand for many
of its products. The company will be most profitable if it produces those products with
the highest:
A. contribution margin per direct labor hour.
B. contribution rate.
C. sales price per unit.
D. contribution margin per unit.
Answer: _____
2. Which of the following is an example of a fixed cost for an airline?
A. Depreciation on the corporate headquarters
B. Fuel costs
C. Income taxes expenses
D. Passengers’ meals
Answer: _____
3. The break-even point in a cost-volume-profit graph is always found:
A. at 50% of full capacity
B. at the sales volume resulting in the lowest average unit cost.
C. at the volume at which total revenue equals total variable costs.
D. at the volume at which total revenue equals total fixed costs plus total variable
costs.
Answer: _____
4. A 45% contribution rate means that:
A. the company should contribute 45% of its operating income to qualified charities
for maximum tax benefits.
B. 55% of the company’s revenue is consumed by fixed and variable costs.
 C. the company’s revenue has increased by 45% during the current accounting
period.
D. 45% of the company’s revenue is available to cover fixed costs and to contribute
toward operating income.
Answer: _____
5. The contribution income statement would require a firm to:
A. separate fixed and variable costs.
B. separate revenue into different categories.
C. round off amounts to the nearest peso.
D. ignore some estimated fixed expenses, such as depreciation.
Answer: _____

Are you done? Now, you may check your own answer from the
suggested answers below.

1. B
2. B
3. A
4. A
5. B

Did you get the correct answers? If there are items where
your answer is incorrect, connect with our group messenger
for us to have an interesting brainstorming moment. Now
try to solve the following problems:
The following pertains to problems 1 and 2
Havana Village Association is planning another Riverboat Extravaganza. The
Extravaganza committee has assembled the following expected costs for the event:
Dinner (per person) P7
…………………………………………………….
Favors and program (per person) ……………………….. 3
………..
Band………………………………………………………………………. 1,500
Tickets and Advertising 700
………………………………………………
Riverboat rental 4,800
………………………………………………………..
Floorshow and strolling entertainers 1,000
……………………………..

The committee members would like to charge P30 per person for the evening
activities.
Problem 1. Compute for the break-even point for Extravaganza (in terms of the
number of persons that must attend) is _____________________________________.
 Present your supporting computation here:

Problem 2. Assume that only 250 persons attended the Extravaganza last year. If the
same number attends this year, what price per ticket must be charged to break
even?
Answer: ______________________________________________________________________.
Present your supporting computation here:

Are you done? Now, you may check your own answer from the
suggested answers below.

Problem 1

Sales = Variable expenses + Fixed expenses + Profits

P30Q = P10Q + 8,000 + 0
P20Q = P8,000
Q = P8,000 ÷ P20 per person
Q = 400 persons; or, at P30 per person, P12,000
 Problem 2
Variable cost per person (P7+3) P10
Fixed cost per person (P8,000 ÷ 250 32
persons
Ticket price per person to break even P42

Did you get the correct answers? If there are items where your
answer is incorrect, connect with our group messenger for us
to talk about it.

IT’S YOUR TURN!

Answer the following multiple choice test in this lesson.
Write the letter of your answer on the space provided
after each item. When solutions are required, place your
computation on the spaces provided, as well. Enjoy
answering!
1. To obtain the break-even point stated in terms of pesos of sales, total fixed costs are
divided by which of the following?
A. Variable cost per unit.
B. Variable cost per unit ÷ sales per unit
C. Fixed cost per unit
D. (Sales price per unit – variable cost per unit) ÷ sales price per unit.
Answer: _____
Situational
The following information pertains to questions 2 through 5.
Dyfran Company sells a single product. The company’s sales and expenses for
a recent month follow:
Total Per Unit
Sales P600,000 P40
Less: Variable expenses 420,000 28
Contribution margin 180,000 P12
Less: Fixed expenses 150,000
Net operating income P30,000

2. What is the monthly break-even point in units sold?

A. 12,000 units
B. 12,500 units
C. 15,200 units
D. 11,000 units
Answer: _____
 Show your computations here:

3. How many units would have to be sold each month to earn a minimum target profit of
P18,000?
A. 14,500
B. 12,000
C. 14,000
D. 14,700
Answer: _____
Show your computations:

4. What is the company’s margin of safety in percentage terms?

A. 15%
B. 20%
C. 25%
D. 16.7%
Answer: _____
Show your computations here:

5. If monthly sales increase by P80,000 and there is no change in fixed expenses, by

how much would you expect monthly net operating income to increase?
A. P20,000
B. P24,500
C. P24,000
D. P42,000
Answer: _____
Show your computations here: