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Module 3 - CVP Analysis

The document discusses cost-volume-profit (CVP) analysis, which examines the relationship between costs, volume, and profit. It outlines key assumptions of CVP analysis and defines important terms like break-even point, contribution margin, margin of safety, and degree of operating leverage. An illustration shows how to calculate these measures using an example income statement. CVP analysis is used for planning, pricing, marketing, and other business decisions.

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Emma Mariz Garcia
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1K views4 pages

Module 3 - CVP Analysis

The document discusses cost-volume-profit (CVP) analysis, which examines the relationship between costs, volume, and profit. It outlines key assumptions of CVP analysis and defines important terms like break-even point, contribution margin, margin of safety, and degree of operating leverage. An illustration shows how to calculate these measures using an example income statement. CVP analysis is used for planning, pricing, marketing, and other business decisions.

Uploaded by

Emma Mariz Garcia
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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ST.

MICHAEL’S COLLEGE
Higher Education Department
College of Accountancy
“Management Services”
Cost-Volume-Profit (CVP) Analysis
COST-VOLUME-PROFIT ANALYSIS
- it is a systematic examination of the relationship among costs, cost driver, and profit.
- Generally used in planning and decision making in relation to the relationship
mentioned above. Specifically, it is used in the following:
a) Type of product to produce and sell
b) Pricing policy and strategy
c) Marketing strategy
d) Type of productive facilities to acquire
e) Profit planning

Basic or Inherent Assumptions used in CVP Analysis


1. All COSTS are categorized as VARIABLE or FIXED (cost classification is based on its
behavior).
2. COST AND REVENUE relationships are PREDICTABLE and LINEAR over a relevant
range of activity.
3. TOTAL VARIABLE COSTS change DIRECTLY with cost driver, but VARIABLE COST
PER UNIT is constant over a RELEVANT RANGE of activity.
4. TOTAL FIXED COSTS are CONSTANT but FIXED COST PER UNIT changes
INVERSELY with cost driver over a RELEVANT RANGE of activity.
5. SELLING PRICES are CONSTANT while REVENUES change PROPORTIONATELY
with VOLUME.
6. PRODUCTION EQUALS SALES, thus there is NO CHANGE in INVENTORY LEVELS.
7. TECHNOLOGY as well as PRODUCTIVE EFFICIENCY is CONSTANT.
8. SALES MIX is CONSTANT.
9. TIME VALUE OF MONEY is IGNORED.

BREAK-EVEN POINT
 The break-even point (BEP) or break-even level represents the sales amount—in
either unit (quantity) or revenue (sales) terms—that is required to cover total costs,
consisting of both fixed and variable costs to the company. Total profit at the break-
even point is zero.
 Simply stated, the level of sales volume level where total revenues equal total costs,
thus profit is zero. At breakeven point, contribution margin is equal to total fixed
costs.

BREAK-EVEN POINT (BEP) is the sales level at which profit is ZERO


CONTRIBUTION MARGIN
 A measure of company’s ability to cover variable costs with revenues.
 It is known as marginal income, profit contribution, contribution to fixed cost or
incremental contribution

MARGIN OF SAFETY is the maximum amount by which sales could decrease


without incurring loss.

Illustration 1
A company earned P200,000 selling 100,000 units at P8 per unit. Its fixed costs are
P400,000.
1. What is variable cost per unit?
𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡+𝑇𝑎𝑟𝑔𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
Target Sales = , 𝐶𝑀𝑈
Variable Cost = Selling Price - CMU
400,000+200,000
100,000 = 𝐶𝑀𝑈
= 8 – 6 = 2
600,000
CMU = 100,000
CMU = P6.00
2. What is total contribution margin?
Contribution Margin = P6.00
3. What would income be if sales increased by 5,000 units?
Sales (115,000 units x 8) 920,000
Variable Cost (115,000 * 2) (230,000)
Contribution Margin 690,000
Less: Fixed Cost (400,000)
Income 290,000

2
Illustration 2:
A company has return on sales of 20%, income of P50,000, selling price of P10, and a
contribution margin of 40%.
1. What are fixed costs?
𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡+𝑇𝑎𝑟𝑔𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
Target Sales = ,
𝐶𝑀𝑈
𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡+50,000
50,000/20% =
40%
250,000(40%) = Fixed Cost + 50,000
Fixed Cost = 100,000 – 50,000
= 50,000

2. What are variable costs per units?


Variable cost per unit = P10 * 60% = P6

3. What are sales in units?


Sales in units = 250,000 / P10 = 25,000 units or

𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡+𝑇𝑎𝑟𝑔𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 50,000+50,000


Target Sales in units = , = = 25,000 units
𝐶𝑀𝑅 4

4. What are sales in dollars? Answer: 250,000

INDIFFERENCE POINT is the level of volume at which total costs or profits are the same
between two alternatives under consideration

SALES MIX is the proportion of different products that comprise the company’s total sales.
Also known as product mix

3
DEGREE of OPERATING LEVERAGE (DOL)
- Measures how sensitive the pre-tax profit is to sales volume increases and decreases.
Also known as operating leverage factor

o The extent to which a company uses fixed costs in its cost structure
o Leverage is achieved by increasing fixed costs while lowering variable cost
o A HIGHER value of DOL indicates a higher risk
 When sales volume is strong, it is desirable to have a high level of leverage
 When sales volume begins to fall, the lower leverage is preferred

Illustration:
Below is an income statement for Thompson Company:
Sales 400,000
Variable Cost 125,000
Contribution Margin 275,000
Fixed Costs 200,000
Profit before tax 75,000
1. Compute for Thompson’s degree of operating leverage?
𝐶𝑀 275,000
Solution: DOL = 𝑃𝑟𝑜𝑓𝑖𝑡 𝑏𝑒𝑓𝑜𝑟𝑒 𝑡𝑎𝑥 = 75,000 = 3.67

2. What was Thompson’s break-even point in peso?


𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡 200,000
BEP in peso = 𝐶𝑀𝑈
= 275,000/400,000
= 290,909

3. What was Thompson’s margin of safety?


Margin of Safety = Sales - Breakeven point
= 400,000 – 290,909
= 109,091
4. Assuming that the fixed costs are expected to remain at 200,000 for the coming year
and the sales price per unit and variable costs per unit are also expected to remain
constant, how much profit before taxes will be produced if the company anticipates
sales for the coming year rising to 130 percent of the current year’s level?
Increase to 130%
Sales 400,000 * 130% 520,000
Variable Cost 125,000 * 130% 162,500
Contribution Margin 275,000 * 130% 357,500
Fixed Costs 200,000 200,000
Profit before tax 75,000 157,000

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