MANAGEMENT ADVISORY SERVICES 04: COST VOLUME PROFIT ANALYSIS (CVP)

Basic Concepts
A. CVP (Cost Volume Profit Analysis) – examines the relationship 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
B. CVP analysis is a commonly used tool that provides management with information
for decision making. CVP analysis may be used for various purposes such as:
 Setting selling prices
 Selecting the mixed of products to sell
 Choosing among marketing strategies
 Analyzing the effects of changes in costs on profits
C. Assumptions and limitations
1. All cost are classified as either variable or fixed
2. Cost and revenue relationships are predictable and linear over a relevant
range of activity and a specified period of time
3. Total variable costs change directly with the cost driver, but variable costs
per unit are constant over the relevant range
4. Total fixed costs are constant over the relevant range, but fixed cost per
unit vary inversely with the cost driver or volume
5. Selling prices per unit and market conditions remain unchanged
6. Production equals sales. no change in inventory
7. If the company sells multiple products, sales mix is constant
8. Technology, as well as productive efficiency, is constant
9. The time value of money is ignored

Since CVP uses cost termed as variable or fixed, then Variable Costing format will
be used.

Review of the variable costing format

Units Total Ratio
Sales USP x US XX 100%
Variable Cost & Expenses UVC x US XX VC ratio
CONTRIBUTION MARGIN UCM x US XX CM ratio
Fixed Cost XX
Profit / Loss XX

USP Unit Selling Price

UVC Unit Variable Cost
UCM Unit Contribution Margin (USP – UCM)
VCR Variable Cost Ratio ( Total Variable Cost / Sales)
CMR Contribution Margin Ratio (Total Contribution Margin / Sales)

TRUE-FALSE STATEMENTS

1. A variable cost remains constant per unit at various levels of activity.

2. A fixed cost remains constant in total and on a per unit basis at various levels
of activity.
3. If volume increases, all costs will increase.
4. If the activity index decreases, total variable costs will decrease
proportionately.
5. Changes in the level of activity will cause unit variable and unit fixed costs to
change in opposite directions.
6. For CVP analysis, both variable and fixed costs are assumed to have a linear
relationship within the relevant range of activity.
7. The relevant range of activity is the activity level where the firm will earn
income.
8. Costs will not change in total within the relevant range of activity.
9. The high-low method is used in classifying a mixed cost into its variable and
fixed elements.
10. The fixed cost element of a mixed cost is the cost of having a service available.
11. The difference between the costs at the high and low levels of activity
represents the fixed cost element of a mixed cost.
12. When applying the high-low method, the variable cost element of a mixed cost is
calculated before the fixed cost element.
13. An assumption of CVP analysis is that all costs can be classified as either
variable or fixed.
14. In CVP analysis, the term “cost” includes manufacturing costs, and selling and
administrative expenses.
15. Contribution margin is the amount of revenues remaining after deducting cost of
goods sold.
16. Unit contribution margin is the amount that each unit sold contributes towards
the recovery of fixed costs and to income.
17. The contribution margin ratio is calculated by multiplying the unit contribution
margin by the unit sales price.
18. Both variable and fixed costs are included in calculating the contribution
margin.
19. A CVP income statement shows contribution margin instead of gross profit.
20. The break-even point is where total sales equal total variable costs.
21. The break-even point is equal to the fixed costs plus net income.
22. If the unit contribution margin is P1 and unit sales are 10,000 units above the
break-even volume, then net income will be P10,000.
23. A target net income is calculated by taking actual sales minus the margin of
safety.
24. The margin of safety is the difference between sales at breakeven and sales at a
determined activity level.
25. The margin of safety is the difference between contribution margin and fixed
costs.
26. The activity level is represented by an activity index such as direct labor
hours, units of output, or sales peso.
27. For purposes of CVP analysis, mixed costs must be classified into their fixed and
variable elements.
28. The contribution margin ratio of 40% means that 60 cents of each sales peso is
available to cover fixed costs and to produce a profit.
29. A cost-volume-profit graph shows the amount of net income or loss at each level
of sales.
30. If variable costs per unit are 70% of sales, fixed costs are P290,000 and target
net income is P70,000, required sales are P1,200,000.
31. The margin of safety ratio is equal to the margin of safety in peso divided by
the actual or (expected) sales.

MULTIPLE CHOICE QUESTIONS

1. For an activity base to be useful in cost behavior analysis,

A. the activity should always be stated in peso.
B. there should be a correlation between changes in the level of activity and
changes in costs.
C. the activity should always be stated in terms of units.
D. the activity level should be constant over a period of time

2. Two costs at Bradshaw Company appear below for specific months of operation.
Units
 Month Amount Produced
Delivery Septemb P 40,000
costs er 40,000
October 55,000 60,000
Utilities Septemb P 40,000
er 84,000
October 126,000 60,000
Which type of costs are these?

A. Delivery costs and utilities are both variable.

B. Delivery costs and utilities are both mixed.
C. Utilities are mixed and delivery costs are variable.
D. Delivery costs are mixed and utilities are variable.

3. Cost behavior analysis is a study of how a firm's costs

A. relate to competitors' costs.
B. relate to general price level changes.
C. respond to changes in the level of business activity.
D. respond to changes in the gross national product.

4. If a firm increases its activity level,

A. costs should remain the same.
B. most costs will rise.
C. no costs will remain the same.
D. some costs will change, others will remain the same.

5. An activity index might be referred to as a cost

A. driver. C. element.
B. multiplier D. correlation.

6. Why is identification of a relevant range important?

A. It is required under GAAP.
B. Cost behavior outside of the relevant range is not linear, which distorts CVP
analysis.
C. It directly impacts the number of units of product a customer buys.
D. It is a cost that is incurred by a company that must be accounted for.

7. The relevant range of activity refers to the

A. geographical areas where the company plans to operate.
B. activity level where all costs are curvilinear.
C. levels of activity over which the company expects to operate.
D. level of activity where all costs are constant.

8. At the break-even point,

A. sales equal total variable costs.
B. contribution margin equals total variable costs.
C. contribution margin equals total fixed costs.
D. sales equal total fixed costs.

9. Boswell company reported the following information for the current year: Sales
(50,000 units) P1,000,000, direct materials and direct labor P500,000, other
variable costs P50,000, and fixed costs P270,000. What is Boswell’s break-even point
in units?
A. 24,546 C. 38,334
B. 30,000 D. 42,188

10. Walters Corporation sells radios for P50 per unit. The fixed costs are P420,000
and the variable costs are 60% of the selling price. As a result of new automated
equipment, it is anticipated that fixed costs will increase by P100,000 and variable
costs will be 50% of the selling price. The new break-even point in units is:
A. 21,000 C. 20,600
B. 20,800 D. 16,800

11. Cunningham, Inc. sells MP3 players for P60 each. Variable costs are P40 per unit,
and fixed costs total P90,000. What sales are needed by Cunningham to break even?
A. P120,000 C. P270,000
B. P225,000 D. P360,000

12. Cunningham, Inc. sells MP3 players for P60 each. Variable costs are P40 per unit,
and fixed costs total P90,000. How many MP3 players must Cunningham sell to earn net
income of P210,000?
A. 15,000 C. 3,750
B. 5,250 D. 4,500

13. Bruno & Court is a non-profit organization that captures stray deer bewildered
within residential communities. Fixed costs are P15,000. The variable cost of
capturing each deer is P10 each. Bruno & Court is funded by a local philanthropy in
the amount of P48,000 for 2013. How many deer can Bruno & Court capture during 2013?
A. 3,300 C. 6,300
B. 4,800 D. 3,000

14. At the break-even point of 2,000 units, variable costs are P55,000, and fixed
costs are P32,000. How much is the selling price per unit?
A. P43,50 C. P16.00
B. P11.50 D. P27.50

15. Variable costs for Abbey, Inc. are 25% of sales. Its selling price is P80 per
unit. If Abbey sells one unit more than break-even units, how much will profit
increase?
A. P60 C. P25
B. P20 D. P320

16. Aero, Inc. requires sales of P2,000,000 to cover its fixed costs of P400,000 and
to earn net income of P500,000. What percent are variable costs of sales?
A. 25% C. 20%
B. 55% D. 45%

17. Lansbury Manufacturing produces hair brushes. The selling price is P20 per unit
and the variable costs are P8 per brush. Fixed costs per month are P4,800. If
Lansbury sells 25 more units beyond breakeven, how much does profit increase as a
result?
A. P300 C. P200
B. P500 D. P1,000

18. Hayduke Corporation reported the following results from the sale of 6,000 units
in May:
sales P300,000, variable costs P180,000, fixed costs P90,000, and net income
P30,000. Assume that Hayduke increases the selling price by 10% on June 1. How
many units will have to be sold in June to maintain the same level of net income?

A. 4,800 C. 5,400
B. 5,160 D. 6,000

Question Nos. 19 through 22 are based on the following data:

Step Company produces toys and other items for use in beach and resort areas. A small,
inflatable toy has come onto the market that the company is anxious to produce and
sell. Enough capacity exists in the company’s plant to produce 16,000 units of the toy
each month. Variable costs to manufacture and sell one unit would be P12.50, and fixed
costs associated with the toy would total P350,000 per month.

The company’s Marketing Department predicts that demand for the new toy will exceed the
16,000 units that the company is able to produce. Additional manufacturing space can be
rented from another company at a fixed cost of P10,000 per month. Variable costs in the
rented facility would total P14 per unit, due to somewhat less efficient operations
than in the main plant. The new toy will sell for P30 per unit.
19. The breakeven units for the new toy would be:
A. 20,000 B. 18,000 C. 21,000 D. 22,500

20. How many units should the company need to sell in order to earn a before-tax
profit of P150,000?
A. 9,143 B. 30,375 C. 31,875 D. 35,000

21. If the sales manager receives a bonus of P1.00 for each unit sold in excess of
the break-even point, how many units must be sold each month to earn a return of 25%
on the monthly investment in fixed costs?
A. 23,344 B. 27,000 C. 29,833 D. 30,000

22. Lowkey Company is contemplating of marketing a new product. Fixed costs will be
P800,000 for production of 75,000 or less and P1,200,000 if production exceeds
75,000 units. The variable cost ratio is 60% for the first 75,000 units.
Contribution margin percentage will increase to 50% for units in excess of 75,000.
If the product is expected to sell for P25 per unit, how many units must Lowkey sell
to breakeven?
A. 120,000 B. 111,000 C. 96,000 D. 80,000

23. SHE Inc. has the following revenue and cost for the two products it sells:
Plastic Frames Glass Frames
Sales price P50 P75
Direct materials (10) (15)
Direct labor (15) (25)
Fixed overhead (15) (20)
Net income/unit P10 P15
Budgeted unit sales 100,000 300,000

The budgeted unit sales equal the current unit demand, and total fixed overhead for
the year is budgeted P4,875,000. Assume that the company plans to maintain the
proportional mix. In numerical calculations, the company rounds to the nearest
centavo and unit. The total number of units the company needs to produce and sell to
break-even is

A. 300,000 units C. 150,000 units

B. 354,545 units D. 75,000 units

THE FOLLOWING INFORMATION APPLIES TO QUESTIONS 24 AND 25:

Four different lines of product are manufactured by ABCD Corporation. Selling price and
variable cost data are given below:

Product Line Selling Price Variable Cost

A P 45 P 30
B 80 60
C 35 30
D 20 10

Budget estimate show that the sales volume of Product A should be double the sales
volume of Product B. Product C and D are sold in equal volume with the combined volume
equal to the volume for Product B.

The fixed cost for the year has been estimated at P 230,000. The company plans a net
income after tax of P 80,500. The income tax is at the rate of 30% of income before
income tax.

24. The combined number of units that must be sold to break even is

A. 2,000 units C. 28,750 units

B. 34,783 units D. 16, 000 units
25. The number of units of each product line that must be sold during the year to
earn the desired profit is:

A. 12,000 units of Product A, 6,000 of Product B, 3,000 of Product C, and 3,000 units
of Product D
B. 2,000 units of Product D, 2,000 units of Product C, 4,000 units of Product B, and
8,000 units of Product A
C. 10,800 units of Product A, 5,400 of Product B, 2,700 of Product C, and 2,700 units
of Product D
D. 17,333 units of Product A, 8,667 of Product B, 4,333 of Product C, and 4,333 units
of Product D

26.1ncrease in contribution margin per unit _____.

A. decreases break-even point
B. increases break-even point
C. does not change break-even point
D. means there is a change in fixed cost per unit

27.Breakeven in units for a multi-product firm is calculated as fixed costs divided by

_____.
A. the sum of the contribution margin percentages for each product
B. the sum of the individual product contribution margins
C. the weighted average contribution margin of all the products
D. it is not possible to calculate breakeven in units for a multi-product firm

28. Production is one of the value-chain functions. Which one of the following is not
an example of a cost driver for production costs?
A. number of people supervised C. machine hours
B. labor hours D. sales peso

29. Managers use cost-volume-profit (CVP) analysis to ________.

A. forecast the cost of capital for a given period of time
B. to study the behavior of and relationship among the elements such as total
revenues, total costs, and income
C. estimate the risks associated with a given job
D. analyse a firm's profitability and help to decide wealth distribution among its
stakeholders

30. Which of the following is true of cost-volume-profit analysis?

A. The theory assumes that all costs are variable.
B. The theory assumes that units manufactured equal units sold.
C. The theory states that total variable costs remain the same over a relevant range.
D. The theory states that total costs remain the same over the relevant range.