Topic 7: Cost-Volume-Profit (CVP)

Analysis
Dr Muhammad Iqmal Hisham Kamaruddin
Learning Outcome
At the end of this topic, students should be able to:
Explain the concept of CVP.
Calculate break even point (BEP) and its interpretations.
Compute Margin of Safety (MOS).
Make target profit analysis.
Cost Behaviours
FIXED COST VARIABLE COST MIXED COST

Per Unit Cost

Per Unit Cost

Total Cost
Total Cost

Total Cost
Total Units Produced Total Units Produced Total Units Produced

 Total fixed costs do not  Total variable costs  Mixed costs include both fixed
change as volume change in proportion to and variable cost components.
changes. volume changes.  Mixed costs is greater than zero
 Unit fixed costs  Unit variable costs stay when volume is zero (fixed
decreases as volume the same as volume component) and increases steadily
increases. changes. in proportion to increases in
volume (variable component.
Fixed Cost & Relevant Range
The relevant range of activity pertains 90
to fixed cost as well as variable costs.

Rent Cost in Thousands of

For example, assume office space is
available at a rental rate of $30,000 Relevant
60
per year in increments of 1,000 Range The relevant range of

Dollars
square feet. activity for a fixed cost
is the range of activity
30 over which the graph
Fixed costs would increase in a step
fashion at a rate of $30,000 for each of the cost is flat.
additional 1,000 square feet. 0
0 1,000 2,000 3,000
Rented Area (Square Feet)
Mixed Cost – High-Low Method
Production Total Difference in Total cost
(Units) Cost Variable Cost per Unit =
Difference in Production
June 1,000 RM45,550
July 1,500 52,000 2,100 units
August 2,100 61,500 RM61,500 750 units
September 1,800 57,500 41,250 1,350 units
October 750 41,250 RM20,250

RM20,250
Variable Cost per Unit = = RM15
1,350 units
Mixed Cost – High-Low Method
Total Cost = (Variable Cost per Unit x Units of
Production Total Production) + Fixed cost
(Units) Cost RM61,500 = (RM15 x 2,100 units) + Fixed cost
June 1,000 RM45,550
July 1,500 52,000
August 2,100 61,500 RM61,500 = (RM15 x 2,100 units) + Fixed cost
September 1,800 57,500 RM61,500 = RM31,500 + Fixed cost
October 750 41,250 RM61,500 – RM31,500 = Fixed cost
RM30,000 = Fixed cost
Using the highest level of If the lowest level had been chosen, the
production, we insert the total cost results of the formula would provide
and units produced in the formula. the same fixed cost of RM30,000.
 Quick Test
The manufacturing cost of Perusahaan Alisa for the first three months of the year are provided below:

Total Cost Production

January RM80,000 1,000 units
February RM125,000 2,500
March RM100,000 1,800
Using the high-low method, determine the:
(a)variable cost per unit, and
(b)the total fixed cost
Cost-Volume-Profit Analysis
 Cost-volume-profit analysis is the systematic examination of the relationships among selling prices,
sales and production volume, costs, expenses, and profits.

 Managers use cost-volume-profit analysis to make predictions such as:

 How many units must we sell to break even?
 What sales volume is needed to earn a target income?
 How much will income change if we buy a new machine to reduce labor costs?
 What is the change in income if selling prices decline and sales volume increases?
 How will income change if we change the sales mix of our products or services?
Contribution Margin Analysis
 Shows the aggregate amount of revenue available after variable costs to cover fixed expenses
and provide profit to the company.
Contribution Margin Formula
 Contribution margin per unit is the amount by which a product’s unit selling price exceeds its
variable costs per unit.

 Contribution margin ratio is the percent of each sales dollar that remains after deducting the unit
variable cost
Contribution Margin Example

Sales (50,000 units) RM1,000,000 100% RM20

Variable costs 600,000 60% 12
Contribution margin RM 400,000 40% RM 8
Fixed costs 300,000 30%
Income from operations RM 100,000 10%

The contribution margin can be expressed three ways:

1. Total contribution margin in RM.
2. Contribution margin ratio (percentage).
3. Unit contribution margin (RM per unit).
 Quick Test
Syarikat Molly sells 20,000 units at RM12 per unit. Variable costs are RM9 per unit, and fixed costs are
RM25,000. Determine the (a) contribution margin ratio, (b) unit contribution margin, and (c) income
from operations.
Break-Even Point
 Sales level where total sales equal total costs, resulting in zero income.
 Can be stated in units or dollars of sales.
 Three methods to find break-even point:

Contribution
Formula Method Margin Income Cost-Volume-Profit
Statement Chart
Break-Even Point: Formula Method
Syarikat Bakar fixed costs are estimated to be RM90,000. The unit contribution margin is calculated
as follows:
Unit selling price RM25
Unit variable cost 15
Unit contribution margin RM10

Fixed Costs
Break-Even Sales (units) = Unit Contribution Margin

RM90,000
Break-Even Sales (units) =
RM10

Break-Even Sales (units) = 9,000 units

Break-Even Point – Effect of Changes in
Fixed Cost
Syarikat Lazer is evaluating a proposal to budget an additional RM100,000 for advertising. Fixed costs
before the additional advertising are estimated at RM600,000, and the unit contribution margin is
RM20:
Fixed Costs
Break-Even Sales (units) = Unit Contribution Margin

Without additional advertising:

RM600,000 30,000
Break-Even in Sales (units) = RM20 = units

With additional advertising:

RM700,000 35,000
Break-Even in Sales (units) = RM20 = units
Break-Even Point – Effect of Changes in Variable
Cost
Syarikat Antah is evaluating a proposal to pay an additional 2% commission on sales to its salespeople
(a variable cost) as an incentive to increase sales. Fixed costs are estimated at RM840,000. The unit
contribution margin before the additional 2% commission is determined as follows:
Unit selling price RM250
Unit variable cost 145
Unit contribution margin RM105
Without additional 2% commission:
RM840,000 8,000
Break-Even in Sales (units) = RM105 = units

With additional 2% commission:

RM840,000 8,400
Break-Even in Sales (units) = RM100 = units

RM250 – [RM145 + (RM250 x 2%)] = RM100

Break-Even Point – Effect of Changes in Unit
Selling Price
Syarikat Jendi is evaluating a proposal to increase the unit selling price of a product from RM50 to
RM60. The following data have been gathered:
Current Proposed
Unit selling price RM50 RM60
Unit variable cost 30 30
Unit contribution margin RM20 RM30
Total fixed costs RM600,000 RM600,000
Without price increase:
RM600,000 30,000
Break-Even in Sales (units) = RM20 = units

With price increase:

RM600,000 20,000
Break-Even in Sales (units) = RM30 = units
 Quick Test
Nih Enterprise sells a product for RM60 per unit. The variable cost is RM35 per unit, while fixed costs
are RM80,000. Determine the (a) break-even point in sales units, and (b) break-even point if the
selling price were increased to RM67 per unit.
Target Profit
The sales volume required to earn a target profit is determined by modifying the break-even
equation.
Fixed Costs + Target Profit
Sales (units) = Unit Contribution Margin

Fixed costs are estimated at RM200,000, and the desired profit is RM100,000. Unit contribution
margin is RM30.
RM200,000 + RM100,000
Unit selling price RM75 Sales (units) =
Unit variable cost 45 RM30
Unit contribution margin RM30
Sales (units) = 10,000 units
 Quick Test
Syarikat Fika sells a product for RM140 per unit. The variable cost is RM60 per unit, and fixed costs
are RM240,000. Determine the:
(a) break-even point in sales units, and
(b) break-even point in sales units if the company desires a target profit of RM50,000.
Break-Even Point: Cost-Volume-Profit
Chart
Margin of Safety
 Margin of safety is the amount that sales can decline before the company incurs a loss. Margin of
safety is expressed in dollars, a percent of expected sales or units.
 Margin of safety is the difference between the current sales revenue and the sales revenue at the
break-even point.
Sales – Sales at Break-Even Point
Margin of Safety =
Sales
If sales are RM250,000, the unit selling price is RM25, and the sales at the break-even point are
RM200,000, the margin of safety is 20%, computed as follows:
RM250,000 – RM200,000
Margin of Safety = The margin of safety of 20% is equivalent to
RM250,000 RM50,000 in sales (RM250,000 x 20%). In units,
Margin of Safety = 20% the margin of safety is 2,000 units
(RM50,000/RM25)
 Quick Test
Syarikat Rariq has sales of RM400,000, and the break-even point in sales RM is RM300,000.
Determine the company’s margin of safety.
Degree of Operating Leverage
 The degree of operating leverage is a measure of the effects of change in the level of sales on
income.
 The degree of operating leverage formula:
Contribution Margin
Operating Leverage =
Income from Operations
Degree of Operating Leverage
Syarikat Salam Syarikat Sinar
Sales RM400,000 RM400,000
Variable costs 300,000 300,000
Contribution margin RM100,000 RM100,000
Fixed costs 80,000 50,000
Income from operations RM 20,000 RM 50,000
Operating leverage ? ?
Both companies have the same contribution
margin.

RM100,000 RM100,000
Syarikat Salam = Syarikat Sinar =
RM20,000 RM50,000
=5 =2
 Quick Test
Syarikat Tariq reports the following data.

Sales RM750,000
Variable costs RM500,000
Fixed costs RM187,500

Determine Syarikat Tariq’s operating leverage.

Assumptions in CVP Analysis
Costs can be classified as
variable or fixed
Costs are linear within the
relevant range
There is no change in the
inventory quantities during
the period
Sales mix is constant