Formulas:

Total Contribution Margin = Sales- Variable costs

Total Contribution Margin = Sales in units x Contribution margin per unit

Contribution margin
Contribution margin ratio=
Sales

Contribution margin per unit= Selling price per unit- variable costs per unit
Contribution margin per unit= Contribution margin
number of units sold

Contribution margin
Number of units sold =
CM per unit

At breakeven:
Fixed costs= Contribution margin
Fixed costs
Breakeven points in units=
CM per unit

With target net income

Required units to sell= Fixed cost + target net income

Contribution margin per unit

Required sales= Fixed cost + target net income

Contribution margin ratio
Illustrative Example:
Len O Company prepared the following projected income statement:

Sales (15,000 units @ P8) 120,000.00

Less: Variable Costs 75,000.00
Contribution Margin 45,000.00
Less: Fixed Costs 37,500.00
Operating Income 7,500.00

Required
1. Calculate the contribution margin per unit and the contribution margin ratio
2. Calculate the break-even point in number of units and the break-even point in pesos
3. How many units must the company sell to earn operating income equals to P9,900
4. How much revenue must the company generate to earn operating income equal to P9,900 before tax
5. If the company desires to earn pre-tax profit of 10% of sales , how much should sales be?
6. If the company desires to earn an after-tax profit of 3.75% of sales.
The income tax rate is 25% how much should sales be?
7. How many units must be sold to earn a desired pre-tax profit of P2 per unit?
8. How many units must be sold to earn a desired after-tax profit of P.75 per unit?

Solution:
1. a. Contribution Margin per unit
Since the total contribution margin and number of units sold are given,
use this formula to solve the problem
Contribution margin per unit= Contribution margin
number of units sold

Contribution margin per unit= ₱45,000.00

₱15,000.00
Contribution margin per unit= ₱3.00

1. b. Contribution margin ratio

Contribution margin
Contribution margin ratio=
Sales

₱45,000.00
Contribution margin ratio=
₱120,000.00
Contribution margin ratio= 37.50%

Question: Does contribution Margin change if the number of units sold change?
Answer: No. Fluctuation of units sold does not affect contribution margin ratio
To test this, get the contribution margin ratio of using the income statement at breakeven
 ₱37,500.00
Contribution margin ratio=
₱100,000.00
Contribution margin ratio= 37.50%

Now, try getting the contibution margin using unit cost and selling price

₱3.00
Contribution margin ratio=
₱8.00
Contribution margin ratio= 37.50%

Note: Contribution margin does not change unless the cost per unit or selling price changes

2.a. Breakeven points in units

Take note that in order to breakeven, the contribution margin is equal to total fixed costs
In this case fixed costs is P37,500, so we'll assume that the contribution margin is also P37,500
Use this formula to compute breakeven points in number of units
Fixed costs
Breakeven points in units=
CM per unit
Breakeven points in units= ₱37,500.00
₱3.00
Breakeven points in units= 12,500

To check if our solution is correct, plot the income statement of Len O company
Income statement at breakeven point
Total Per unit
Sales (12,500 units @ P8) ₱ 100,000.00 ₱ 8.00
Less: Variable Costs ₱ 62,500.00 ₱ 5.00
Contribution Margin ₱ 37,500.00 ₱ 3.00
Less: Fixed Costs ₱ 37,500.00
Operating Income ₱ -

Note: At breakeven point, there no profit or loss.

2.b. Breakeven point in peso

Fixed costs 37,500
Divide:Contribution Margin ratio 37.50%
Breakeven point in peso 100,000.00

AlternativeSolution:
Breakeven Point in units 12,500
Multiply: Selling Price 8.00
Breakeven point in peso 100,000.00
CVP with target net income
3. How many units must the company sell to earn operating income equals to P9,900
In this case, there is desired net income so we have to workback the income statement to get the required units

Desired Operating income ₱9,900.00

Add: Fixed cost ₱37,500.00
Contribution Margin ₱47,400.00
Divide: Contribution Margin per unit ₱3.00
Number of units to sell 15,800

4. How much revenue must the company generate to earn operating income equal to P9,900 before tax
Number of units to sell 15,800 (refer to number 3)
Multiply: Selling price ₱8.00
Sales revenue ₱126,400.00

Alternative Solution:
Contribution Margin ₱47,400.00
Divided by: CM Ratio 37.50% (refer to 2.a.)
Sales revenue ₱126,400.00

Items 5 and 6 will use ratios to solve the problem

5. If the company desires to earn pre-tax profit of 10% of sales , how much should sales be?
Plot the income statement using the ratios if the desired profit is 10%
Ratio
Sales 100.00%
Less: Variable Costs 62.50%
Contribution Margin 37.50%
Less: Fixed Costs 27.50%
Operating Income 10.00%

Question:Which of the components of income statement is already given

Answer: Fixed cost. Regardless of the level of income or sales the amount of fixed cost will not change
To compute:
Gross up the fixed cost to get the sales
Fixed cost 37,500.00
Fixed cost Ratio 27.50%
Sales Revenue 136,363.64
Divide:Selling Price 8.00
Number of units to sell 17,045.00
*round off to nearest peso since we are computing for number of units
Alternative Solution:
Use mathematical Equation
Net Income= Sales-Variable cost-Fixed cost
.10x=1x-.675x-37500
37500-1x-.675x-.10x
37500=27.5x
37500/27.5=x
136,363.64=x

To check:
Ratio
Sales (17,045 unitsx P8) ₱ 136,360.00 100.00%
Less: Variable Costs (17,045x P5) ₱ 85,225.00 62.50%
Contribution Margin ₱ 51,135.00 37.50%
Less: Fixed Costs ₱ 37,500.00 27.50%
Operating Income ₱ 13,635.00 10.00%

6. If the company desires to earn an after-tax profit of 3.75% of sales.

The income tax rate is 25% how much should sales be?
Ratio
Sales 115,384.00 100.00%
Less: Variable Costs 72,115.00 62.50%
Contribution Margin 43,269.00 37.50%
Less: Fixed Costs 37,500.00 32.50%
Operating Income 5,769.00 5.00% 100%
Income tax 1,442.25 1.25% 25%
Net Income after Tax 4,326.75 3.75% 75%

Note: that Income tax is 25% of operating profit not of sales

Items 7 and 8 will use per unit costs to solve the problem
7. How many units must be sold to earn a desired pre-tax profit of P2 per unit?

Plot the income statement using the desired profit

Sales ₱ 8.00
Less: Variable Costs ₱ 5.00
Contribution Margin ₱ 3.00
Less: Fixed Costs ₱ 1.00
Desired income per unit ₱ 2.00

Note: Same with item number 5 we will use the fixed cost since it is the amount that will not change
regardless of level of sales
To compute:
Fixed cost 37,500.00
Divide: Fixed cost per unit 1.00
Number of units to sell 37,500.00

To check
Sales (37500x8) ₱ 300,000.00
Less: Variable Costs (37500x5) ₱ 187,500.00
Contribution Margin ₱ 112,500.00
Less: Fixed Costs (37500*1) ₱ 37,500.00
Desired income (37500*2) ₱ 75,000.00

8. How many units must be sold to earn a desired after-tax profit of P.75 per unit?

Plot the income statement using the desired profit

Per unit Total
Sales ₱ 8.00 150,000.00
Less: Variable Costs ₱ 5.00 93,750.00
Contribution Margin ₱ 3.00 56,250.00
Less: Fixed Costs ₱ 2.00 37,500.00
Operating income ₱ 1.00 18,750.00
Income tax ₱ 0.25 4,687.50
Desired income after tax per unit ₱ 0.75 14,062.50

To compute:
Fixed cost 37,500.00
Divide: Fixed cost per unit 2.00
Number of units to sell 18,750.00