Cost Behavior Assumptions:

1. Relevant Range Assumptions- refers to the band of activity within which the identified cost behavior
patterns are valid.
2. Time Assumption- the cost behavior patterns identified are true only over a specified period of time.

Variable Costs- Variable costs are a company's costs that are associated with the number of goods or
services it produces. A company's variable costs increase and decrease with its production volume.
Fixed Cost - a company's fixed costs do not vary with production volume.

Special Considerations
The more fixed costs a company has, the more revenue a company needs in order to break even, which
means it needs to work harder to produce and sell its products. While variable costs tend to remain flat,
the impact of fixed costs on a company's bottom line can change based on the number of products it
produces. So, when production increases, the fixed costs drop. The price of a greater amount of goods
can be spread over the same amount of a fixed cost. In this way, a company may achieve economies of
scale by increasing production and lowering costs.

Graphical Depiction of Variable Cost and Fixed Cost

Graphically, the total fixed cost looks like a straight horizontal line while the total variable cost line
slopes upward. Total fixed cost is constant regardless of the units produced or sold within the relevant
range. In contrast total variable cost increases with the number of units produced. Presented in a graph
the variable cost is skewed to the right, has an upward slope, or has a positive slope, or positively
correlated with quantity.

Fixed cost per unit decreases as quantity increases. This is the concept of Economies of Scale,
as production increases, the unit product cost decreases. Presented in a graph, fixed cost is skewed to
the left, has a downward slope,

or has a negative slope, or negatively correlated with quantity. In contrast Variable cost per unit is
constant per unit in the relevant range.

Total Costs - are composed of both total fixed costs and total variable costs.
Graphical Depiction of Total Cost- Presented in a graph, total cost is skewed to the right, has an
upward slope, or has a positive slope, or positively correlated with quantity because of the variable
component.

A Semi-variable cost, also called a semi-fixed cost or e mixed cost, is one that has both fixed and
variable components. Costs are constant for a certain level of output or consumption, end then they
become variable once that level is exceeded.

1.2.2.1 USES, ASSUMPTIONS AND LIMITATIONS OF CVP ANALYSIS

COST VOLUME PROFIT (CVP) ANALYSIS- a systematic examination of the relationships
among revenues, costs, activity levels or volume, end profit.
 BREAK-EVEN POINT (BEP)- that point of activity level (sales volume, pesos) where total
revenues equal total costs, i.e., there is neither profit nor loss.

ASSUMPTIONS AND LIMITATIONS UNDERLYING BREAK-EVEN ANALYSIS:

The reliability of CVP lies in the assumptions it makes, the following are the limitations and assumptions
of CVP Analysis:
1. All costs are classifiable as either fixed or variable.
2. Fixed costs remain constant within the relevant range.
3. The behavior of total revenues and total costs will be linear over the relevant range.
4. In case of multiple product companies, the selling prices, costs, and proportion of units (sales mix) sold
will not change.
5. There is no significant change in the inventory level during the period under review.

1.2.2.2 FACTORS AFFECTING PROFIT

Profit will change es long as any of the factors needed to compute for total revenues or total cost will
change. These are:
1. Selling price per unit
2. Variable cost per unit
3. Volume or number of units
4. Fixed cost
5. Sales mix
Sensitivity analysis is very important in determining factors thet Wii' significantly affect profits. The
ultimate goal is to manipulate the factors that will lead to improved overall company profitability.

1.2.2.3 Breakeven point in unit sales and peso sales

l. METHODS OF COMPUTING BREAK-EVEN POINT:
1. Equation methods or algebraic approach
This approach uses an algebraic equation to determine the point where there is neither profits nor
losses. That is Total Revenue (TR) is equal to Total Cost (TC). Usually the following equations are used

Let:
X = sales units at break-even point
SPU = Selling price per unit
VCU = Variable cost per unit
FC = Total Fixed Cost
Where
TR = SPU x X
TC = FC + (VCIJ x X)
Therefor BEP
TR=TC

ILLUSTRATION
Latin Company sells several products. Information of average revenue and costs is as follows.
Selling price per unit P20.00
Variable costs per unit:
Direct material P4.00
Direct manufacturing labor P1.60
 Manufacturing overhead P0.40
Selling costs P2.00
Annual fixed costs P96,000
Compute for the break-even point in units and in pesos
2. Graphical approach
Total Revenues and Total Cost are presented in a graph where Y axis is in Pesos and X axis in
units. The point wherein the TR and TC will intersect is the Break-Even Point. The graph is celled Cost-
Volume Profit graph
3. Contribution margin method or formula approach
This approach premises the concept that the contribution margin at BEP is equal to the
Total Fixed Cost. A. BEP Pesos
= Total fixed costs / Contribution Margin Ratio
= Total Sales Pesos - MOS pesos
B. BEP Units
= Total Fixed costs / Contribution margin per unit
= Total Sales Units - MOS units

C. Contribution Margin per Unit (CMU)

= Selling Price per Unit - Variable Cost per Unit
= Total Contribution Margin / Total Sales Units
= Fixed Cost / BE? Units
= Profit / Margin of Safety Units
= Change in Fixed Cost / Change in BEP Units
D. Contribution Margin Ratio (CMR)
= CMU / SPU
= Total Contribution Margin / Total Sales Pesos
= Fixed Cost / BEP Pesos
= Profit / Margin of Safety Pesos
= Change in Fixed Cost / Change in BEP Pesos
= 1 - VCR
= NPR / MSR

E. Fixed Cost
= Total Contribution Margin - Profit
= Total Cost - Total Variable Cost
= BEP Units x CMU
= BEP Pesos x CMR
F. Variable Cost Ratio (VCR)
= Variable Cost per Unit / Selling Price per Unit
= Total Variable Cost / Total Sales Pesos
= 1 - CMR
Bloom Company reported the following:
Revenues P4,500
Variable manufacturing costs P 900
ILLUSTRATION
Variable nonmanufacturing costs P 810
Fixed manufacturing costs P 630
Fixed nonmanufacturing costs P 545

Required:
a. Compute contribution margin.
b. Compute contribution margin percentage.
c. Compute for the variable cost ratio
d. Compute for the BEPP
Nokia Cellular sells phones for P100. The unit variable cost per phone is P50 plus a selling
commission of 10%. Fixed manufacturing costs total PI ,250 per month, while fixed selling and
administrative costs total P2,500
Required:
a. What is the contribution margin per phone?
b. What is the breakeven point in phones?
1.2,2.4 REQUIRED SELLING PRICE, UNIT SALES AND PESO SALES TO ACHIEVE A TARGET
PROFIT
A. Total Sales Pesos or Amount of sales to earn a desired profit
= Total fixed costs + Desired profit before tax / CMR
= Total fixed cost + Desired
profit after tax
(1 - tax rate)

CMR
= BEP Pesos + MOS Pesos
B. Total Sales Units or Number of units to be sold to earn a desired profit
= Total fixed costs + Desired profit
before tax / CMU = Total
fixed cost + Desired profit after tax
(1 - tax rate)

CMU
= BEP Units + MOS Units
ILLUSTRATION
Genetics Company, a producer of specialty vaccines, has asked you to complete several calculations
based upon the following information:
Income tax rate 30%
Selling price per unit P6.60
Variable cost per unit P5.28
Total fixed costs P46,200.00
Required:
a. What is the breakeven point in units?
b. What sales volume in Pesos is needed to earn an after-tax net income of P 13,028.40?
c. How many units must be sold to earn an after-tax net income of PI 8,480?
1.2.2.5 SENSITIVITY ANALYSIS (INCLUDING INDIFFERENCE POINT IN UNIT SALES AND PESO
SALES)
Sensitivity analysis is very important in determining factors that will significantly affect profits.
Sensitivity is measured using the following equation:
Sensitivity = % change in output / % change in input
ILLUSTRATION
Jennie Kim Company sells figurines for P25.00 each The manufacturing cost, all variable, is
PIO per figurine The company is planning on renting an exhibition booth for both display and selling
purposes at the annual crafts end art convention The convention coordinator allows three options for
each participating company. They are:
1. paying a fixed booth fee of P5,010, or
2. paying an P4,000 fee plus 10% of revenue made at the convention, or
3. paying 20% of revenue made at the convention.

Required:
a. Compute the breakeven sales in figurines of each option.
b. Which option should Jenny Kim Company choose, assuming sales are expected to be 800 figurines?
1.2.2.6 USE OF SALES MIX IN MULTI-PRODUCT COMPANIES
The proportion of two or more products sold is referred to as the sales mix. In addition to the assumptions
used for CVP analysis, the following assumptions are applied for calculating the break-even threshold for
sales mix
1. The proportion of sales mix must be predetermined.
2. The sales mix must not change within the relevant time period
These are used to compute the sales mix break-even point.
A. Mix BEP Pesos
= Total fixed costs / Composite CMR
B. Mix BEP Units
= Total fixed costs / Composite CMU
C. Composite CMR
= (CMR a X Mix Ratio a) + (CMR b X Mix Ratio b) + (CMR X Mix Ratio..)*
D. Composite CMU
= (CMU e X Mix Ratio a) + (CMU b X Mix Ratio b) + (CMU nth.. X Mix Ratio nth..)*

* Mix Ratio is determined by dividing the total sales units or pesos of a single product by the
total sales units or pesos of all products combined.
ILLUSTRATION
 Anne-8 Manufacturing Company produces two products, X and Y. The following
information is presented for both products:

X Y
Selling price per unit P30 P20
Variable cost per unit 20 5

Total fixed costs are

P292,500.
Required:
a. Calculate the contribution margin for each product.
b. Calculate breakeven point in units of both X and Y if the sales mix is 3 units of X for every unit of Y.
c. Calculate breakeven point in P of both X and Y if the sales mix is 3 units of X for every unit of Y.
d. Calculate breakeven volume in total pesos if the sales mix is 2 units of X for every 3 units of Y.

Mason Enterprises has prepared the following budget for the month
of July:
Selling Price Variable Cost Unit
Per Unit Per Unit Sales
Product A P10.00 P4.00 15,000
Product B 15.00 8.00 20,000
Product C 18.00 9.00 5,000

Assuming the total fixed costs will be P 165 000 and the mix remains constant, how many units
are needed to breakeven? How much is the BEP in pesos?

With a desired profit of P33,000, how much is the desired sales in units and in pesos for the three
products and in total.

Zel Gray Company provided the following information pertaining to its three products:
A B C
Selling price/ unit P20.00 P8.00 P20.00
Variable cost/ unit 15.00 6.00 12.00

Sales mix in pesos are 50%, 10%, and 40% respectively. Fixed cost amounted to P155,000

Compute the break-even point in units for the three products respectively

1.22207 CONCEPTS OF MARGIN OF SAFETY AND DEGREE OF OPERATING

LEVERAGE MARGIN OF SAFETY
indicates the amount by which actual or planned sales may be reduced without incurring a loss. It
is the difference between actual or planned sales volume and break-even sales.
A. Margin of Safety Pesos (MSP)
= Total Sales Pesos - BEP Pesos
 = Profit / CMR
B. Margin of Safety Units (MSU)
= Total Sales Units - BEP Units
= Profit / CMU
C. Margin of Safety Ratio (MSR) = MSP / Total Sales Pesos
= MSU / Total Sales Units
= NPR / CMR
D. Profit
= Total Revenues - Total Cost
= Total Contribution Margin - Fixed Cost
= MSU x CMU
= MSP x CMR
= Total Revenues x NPR
E. Net Profit Ratio (NPR) or Rate of Return on Sales (ROS)
= Earnings Before Interest and Taxes or Operating Income / Total Sales Pesos
= MSR x CMR

ILLUSTRATION
Tropics, Inc., sells juicer machines for P 30. The unit variable cost per lamp is P22. Fixed costs total
P9,600 Required:
a. What is the contribution margin per lamp?
b. What is the breakeven point in lamps?
c. How many lamps must be sold to earn a pretax income of P8,000?
d. What is the margin of safety-P, assuming 1 ,500 lamps are sold?
e. What is the margin of safety-units, assuming 1,500 lamps are sold?
f. What is the margin of safety ratio?
PROFIT-VOLUME GRAPH
A profit-volume (PV) chert is a graph that depicts a company's profitability (or losses) in relation
to its sales volume. The Y-axis (vertical axis) represents profits or (losses), while the X-axis represents
sales volume (quantity or units) (the horizontal axis).
DEGREE OF OPERATING LEVERAGE (DOL)

The degree of operating leverage (DOL) is a financial ratio that measures the sensitivity of a
company's operating income to its sales. This financial metric shows how a change in the company's sales
will affect its operating income.
DOL is computed as
= Total Contribution Margin / Operating Profit, if one year of operations is presented
 = Percentage Change in Profit / Percentage Change in Sales., if at least two-year comparative
information is provided.
ILLUSTRATION
Delphi Company has developed e new product that will be marketed for the first time during the
next fiscal year. Although the Marketing Department estimates that 35,000 units could be sold at P36
per unit, Delphi's management has allocated only enough manufacturing capacity to produce a
maximum of 25,000 units of the new product annually. The fixed expenses associated with the new
product are budgeted at P450,000 for the year. The variable expenses of the new product are P 16 per
unit Required:
a. How many units of the new product must Delphi sell during the next fiscal year in order to break
even?
b What is the profit Delphi would earn on the new product if all of the manufacturing capacity
allocated by management is used and the product is sold for P36 per unit?
c. What is the degree of operating leverage for the new product if 25,000 units are sold for P36 per
unit?
d. The Marketing Department would like more manufacturing capacity to be devoted to the new
product. What would be the percentage increase in net operating income for the new product if
its unit sales could be expanded by 10% without any increase in fixed expenses and without
any change in the unit selling price and unit variable expense?
e. Delphi's management has stipulated that the new product must earn a profit of at least P 125,000
in the next fiscal year. What unit selling price would achieve this target profit if all of the
manufacturing capacity allocated by management is used and all of the output can be sold at
that selling price?

1.2.2.8 DIFFERENT SCENARIOS USING CVP ANALYSIS (INDIFFERENCE POINT, STEP FIXED,
MULTIPLE DRIVERS)
The Cost Indifference Point
A cost indifference point is the point at which total cost (fixed and variable) of two alternatives
under consideration is the same. Cost indifference point will occur at a point where:
Total Cost of alternative A Total Cost alternative B
Cost Indifference Point = Differential Fixed Cost / Differential variable cost per unit

Example:
Alternative A • Fixed cost P12,000 Variable Cost P3.50/u
Alternative B . Fixed Cost P36,000 Variable Cost P2.00/u
Compute for the cost indifference point.

Scenario Analysis/ Multiple Drivers

Scenario analysis and sensitivity analysis are analytical methods to help investors determine the
amount of risk and their potential benefits. The difference between the two is that sensitivity analysis
examines the effect of changing a single variable at a time. Scenario analysis assesses the effect of
changing ell of the variables at the same time.
Benefits of Scenario Analysis
 More proactive risk management by assessing the impact of potential situations
 Better decision-making as a result of investigating the benefits and risks of various options.
 A methodical approach to analyzing the future may help companies to find opportunities or
risks they may have otherwise overlooked
STEP FIXED COST- A step fixed cost is a cost that does not change within certain high and low thresholds
of activity, but which will change when these thresholds are breached. A threshold breach can result in one
of two conditions in regard to a step fixed cost, 1. Activity declines; 2 Activity increases.
STEP VARIABLE COST- A step variable cost is a cost that generally varies with the level of activity, but
which tends to be incurred at certain discrete points and involve large changes in amounts when such a
point is reached.