Cost, volume and profit analysis

Cost-volume-profit (CVP) / Breakeven analysis are the study of interrelation

ship between cost, volume and profit at various level of activity.

The management of an organization usually wishes to know the profit likely to be

made if the aimed-for production and sales for the year are achieved. Management
may also be interest to know the following.
 The breakeven point which is the activity level at which there is neither profit
nor loss.
 The amount by which actual sales can below anticipated sales, without a loss
being incurred.

Contribution Margin OR Contribution to sales

Contribution margin is a measure to how much contribution is earned. It can be
calculated as follows.
Contribution margin = Sales – Variable cost
Variable cost includes direct material, direct labour, variable overhead, variable
selling and variable administrative overhead.

Contribution Margin Ratio (CM %) OR Contribution to sales ratio (C/S %)

Contribution margin is a measure of how much contribution is earned from each Rs.1
of sales. It can be calculated as follows.
Contribution margin ratio (CM%) = Contribution margin x 100
Sales
OR
Contribution margin ratio (CM%) = Sales – variable cost x 100
Sales

Breakeven Sales in Amount (Rs.)

At the breakeven point, sales revenue = total cost and there is no profit. At the
breakeven point total contribution = fixed cost.
Breakeven Sales in amount = Fixed Cost
CM%

Breakeven sales in units

Breakeven points in units mean show many units to be sold to require to neither
profit nor loss.
Breakeven Sales in unit = Fixed cost
CM per unit
CM per unit = Sales per unit – Variable cost per unit

Sales are required to earned profit if amount of profit is given

How many sales are required to sales to earned profit.

1
 Sales are required to earn profit (Rs.) = Fixed Cost + Profit
CM%
OR
Sales are required to earned profit in units = Fixed Cost + Profit
CM per unit

Sales are required to earned profit if % of profit on sales is given

How many sales are required to sell to earned profit if % of profit on sales is given.
Sales are required to earned profit (Rs.) = Fixed Cost
CM% - TP%

Sales are required to earned profit after tax if amount of profit is given
How many sales are required to sales to earned profit after tax if amount of profit is
given.
Sales are required to earned profit after tax (Rs.) = Fixed Cost + Target profit
1-tax rate
CM%

Sales are required to earned profit after tax if % of profit on sales is given
How many sales are required to sales to earned profit after tax if amount of profit is
given
Sales are required to earned profit after tax (Rs.) = Fixed cost
CM% - Target profit %
1 – tax rate

Margin of safety (MOS)

The margin of safety is the difference in units between the budgeted sales volume
and the breakeven sales volume. It is some time as percentage of budgeted sales
volume. The margin of safety may also be express as the difference between the
budgeted sales revenue and breakeven sales revenue express as a percentage of
the budgeted sales revenue.

Margin of safety = Budgeted sales revenue – Breakeven sales revenue

OR
Margin of safety ratio (%) = Budgeted sales revenue – Breakeven sales revenue x 100
Budgeted sales revenue

Question # 1

2
The fixed cost of an enterprise for the year is Rs.400,000. The variable cost per unit
for a single product being made is Rs.20. Each units sells at Rs.100.

Required
a) Breakeven point.
b) If the turnover for the next year is Rs.800,000, calculate the estimated
contribution and profit, assuming that the cost and selling price remain the
same.
c) A profit target of Rs.400,000 has been desired for the next year. Calculate the
turnover required to achieve the desired result.

Solution # 1

3
Question # 2
The Parrot Company sold 150,000 units @ Rs. 30 each, Variable cost is Rs. 20
(Manufacturing Rs. 15 & Marketing Rs. 5), Fixed Cost is Rs. 1,200,000 annually
which occurs evenly throughout the year (Manufacturing Rs. 800,000 & Marketing
Rs. 400,000).

Required
I. Breakeven point in units
II. Breakeven point in Rupees
III. Number of units to be sold to earn profit before tax of Rs. 200,000
IV. Number of units to be sold to earn after tax profit of Rs. 100,000 if tax rate is
25%
V. The breakeven point in units if selling price is increased by Rs. 3 and variable
cost by Rs. 2 per unit.

Solution # 2

4
Question # 3
Gala Promotions Limited is planning a concert in Karachi. The following are the
estimated costs of the proposed concert:
Rs. (000)
Rent of premises 1,300
Advertising 1,000
Printing of tickets 250
Ticket sellers, security 400
Wages of Gala Promotions Limited Personnel employed at the concert 600
Fee of artist 1,000

There are no variable costs of staging the concert. The company is considering a
selling price for tickets at either Rs.4,000/- or Rs.5,000/- each.

Required:
i. Calculate the number of tickets which must be sold at each price in order to
break-even.
ii. Recalculate the number of tickets which must be sold at each price in order to
break-even, if the artist agrees to change from fixed fee of Rs. 1 million to a
fee equal to 25% of the gross sales proceeds.
iii. Calculate the level of ticket sales for each price, at which the company would
be indifferent as between the fixed and percentage fee alternative.
iv. Comment on the factors, which you think, the company might consider in
choosing between the fixed fee and percentage fee alternative.

Solution # 3

5
Question # 4

6
The Sindh Engineering Company produces a bicycle which sells at Rs.1,000 per
unit. At 80% capacity utilization which is the normal level of activity, the sales are
Rs.180 million. Costs are as under:

Prime cost per unit Rs.400

Factory indirect cost Rs.30 million (including variable cost Rs.10million)
Selling costs Rs.25 million (including variable cost Rs.15million)
Distribution costs Rs.20 million (including variable cost Rs.11million)
Administration costs Rs.6 million
Commission and discounts are 5% of sales value.

Required:
i. Calculate the break-even sales value.
ii. Prepare statements showing sales, costs, profit and contribution margin at
each of the following levels:
a. at the normal level of activity;
b. if unit selling price is reduced by 5% thereby increasing sales and
production volume by 10% of the normal activity level;
c. if unit selling price is reduced by 10% thereby increasing sales and
production volume by 20% of the normal activity level.

Solution # 4

7
Question # 5

A company produces mineral water. Based on the projected annual sales of 40,000
bottles of mineral water, cost studies have produced the following estimates:
Total annual costs
(in rupees) Variable cost percentage
Material 193,600 100
Labour 90,000 70
Overhead 80,000 64
Administration 30,000 30
The production will be sold through dealers who would receive a commission of 8%
of sale price.

Required:
(i) Compute the sale price per bottle which will enable management to realize a
profit of 10 percent of sales.
(ii) Calculate the break-even point in rupees if sale price is fixed at Rs. 11 per
bottle.

Solution # 5

8
Question # 6
Dream world Resorts maintains a water park and has experienced a steady growth
in its sales for the past five years. Increased competition, however, has led the
owners to believe that an aggressive advertising campaign will be necessary next
year to maintain the present growth. In order to launch advertising campaign the next
year, following data has been compiled for the year 2005.

Variable cost Rs.137.50 per ticket

9
Total fixed cost for the year Rs.1,350,000
Sales price Rs.250.00 per ticket
Expected sales 2005 – 20,000 ticket Rs.5,000,000
Income tax rate 35%

The resort has set sales target for 2006 at a level of Rs.5,500,000 or 22,000 tickets.

Required:
i. The project after tax net income for the year 2005.

ii. Number of tickets at breakeven point during the year 2005.

iii. After tax net income for the year 2006 if an additional fixed marketing expense
of Rs.112,500 is spent on advertising in the year 2006 (with all other costs
remaining constant) to attain the sales target for the year 2006.

iv. The breakeven point in value for the year 2006 if additional Rs.112,500 is
spend on advertising.

v. The required sale (value) to equal after tax net income for the year 2005 if
additional Rs.112,500 is spent on advertising in the year 2006.

vi. The maximum amount that can be spent on additional advertising at a sales
level of 22,000 tickets, if an after tax net income of Rs.600,000 is desired.

Solution # 6

10
Question # 7
Gullever Engineering Ltd, manufactures lathe machines. Its budget data for next
year is as under:
Rs.
Sales (2,000 units) 8,000,000
Variable cost 3,000,000
Contribution margin 5,000,000
Fixed cost 2,000,000
Operating income 3,000,000

Required:
i. Calculate breakeven point in units and amount.
ii. Calculate margin of safety in units and amount

Solution # 7

11
 Practice Question
Question # 1
Normal annual capacity of Karachi Company is 200,000 units and the sales price is
Rs.32 per unit. Unit cost of components is as under:
Variable cost per unit (Rs.) Fixed Cost(Rs.)
Direct material 9.00 --
Direct labour 10.0 --
Factory overhead 2.00 400,000
Non-manufacturing cost 3.00 100,000
Total cost 24.0 500,000

12
Required:
i. Calculate the breakeven point in rupees and in units. Prove your answer.
ii. Compute amount of sales required to earn a profit of Rs.420,000. Prove

Question # 2
R Company has prepare the following projections for the coming year 2008:
Rs.
Sales 150,000
Variable cost 112,500
Contribution margin 37,500
Fixed cost 20,000
Net income 17,500

Required:
i. Compute the following:
a. Breakeven sales in rupees.
b. Margin of safety in rupee and in percentage.

ii. A minimum unit to be sold to breakeven, if the sale price is Rs.15/unit.

iii.
Question # 3
The following data has been taken out from the record of Osman Bros., based on the
financial result for the year ending 30th June 2008:
Breakeven sales Rs.2,000,000
Contribution margin ratio 40%
Profit for the year ending 30th June 2008 Rs.320,000

Required:
i. Calculate the following:
a) Fixed expenses for the year.
b) Sales for the year
c) Variable expenses for the year
d) Margin of safety ratio.

Question # 4

Variable cost Rs.10 per unit

Fixed cost Rs.42,000
Sales price Rs.16 per unit
Breakeven point 7,000 units

By matching Revenue & Expenses prove that 7,000 units are breakeven point.

13
Question # 5
Calculate the breakeven point in units when:
Sales price Rs.1 each
Sales Rs.60,000
Variable cost (0.5 per unit) Rs.30,000
Fixed cost Rs.20,000

14