10/11/2022

Cost Volume Profit

Analysis
Module 3

Intended Learning Outcomes

• Explain the uses, assumptions, and limitations of CVP analysis and
factors affecting profit
• Apply the breakeven point formula in computing the target profit
• Apply the breakeven point formula in computing the sales mix

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Introduction
• Cost Volume Profit (CVP) Analysis is the key factor in planning and
controlling, and undoubtedly, the best tool to profit maximization.
• CVP Analysis is the study of the effects of volume of output on
revenues, expenses, and net income.
• It is an analytical technique for studying the relationship between
fixed costs, variable costs, sales volume, and profits.
• Managers must classify costs as to fixed costs and variable costs in
planning their activities or production.
• Knowing the cost function, the break-even point can be determined.

Cost-Volume-Profit Analysis
• Is a systematic examination of relationships among costs, activity
levels or volume, and profit

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Traditional Income Statement

Classify the cost elements as to cost

behavior

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Combined Similar Cost

Variable Costing Income Statement/

Marginal Income Statement/ Direct
Costing Income Statement

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Breakeven Point in CVP Analysis

• Breakeven point is the point at which total sales will just cover total
costs – that it will only break even – no profit, no loss.
Sales = Cost
• Breakeven analysis shows the magnitude of the firm’s profits or losses
if sales exceed or fall below the breakeven point.
• A sufficient volume of sales must be anticipated and achieved so that
fixed and variable costs are covered, otherwise the firm will incur
losses.
• Interest charge is disregarded in the analysis because this is a finance
cost, not an operating cost.

Breakeven Point in CVP Analysis

Why is the Breakeven point (BEP) in CVP analysis important in the
planning process?
BECAUSE…
CVP relationship can be greatly influenced by the proportion of the
firm’s investment in assets which are fixed.
Any changes in the ratio of fixed to variable assets (costs) should be
determined and set when financial plans are being prepared.
RELEVANT Range – a range where all the cost elements are valid.

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Breakeven Point in CVP Analysis

TAKE NOTE:
In the discussion of CVP analysis, it is assumed that mixed costs have
been segregated already into their variable and fixed components
using the different cost segregation techniques.
Therefore, VC = actual VC + VC component of a mixed cost.
Therefore, FC = actual FC + FC component of a mixed cost.
Since Interest charge/finance charge is not considered in computing
the BEP, thus, the BEP in this topic is the BEP before interest charges.
Focuses more on the operating plan rather than a financial plan
which focuses on capital structure.

Breakeven Analysis helps

management to determine:
1. The number of unit sales required to break-even
2. The peso amount of revenues needed to achieve a specified profit
level
3. The effect on profits if selling price, fixed cost, and variable cost
changes
4. The required selling price that is needed to cover projected fixed
cost charges.

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CVP Terms
• Breakeven point - the point were there is no profit, no loss. The point
where total sales are equal to total costs.

• Contribution margin (CM) – excess of sales over all variable costs or sales
less all variable costs.

• Contribution margin ratio – CM divided by total sales

• Contribution margin per unit – selling price per unit less all variable cost
per unit

• Margin of safety – the excess of actual or budgeted sales over breakeven

sales. It is the amount by which sales could be decrease before losses may
occur.

CVP Terms
• Margin of Safety ratio – margin of safety divided by the actual or
budgeted sales, or could be derived also by dividing the profit ratio by
the contribution margin ratio.
• MofS ratio = MofS / Actual or Budgeted Sales
• MofS ratio = profit ratio / CM ratio

• Relevant range – limit within which the volume of activity can vary
where sales and costs relationship remains valid.

• Sales mix – the relative combination of products that compose a

company’s total sales. This is applicable only in multiple product line
companies

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CVP Equation
Sales – Variable Cost = Contribution Margin – Total Fixed Costs = Profit
Expanded formula:
Sales Selling Price x Sales volume P xx
Less: Variable Cost Variable Cost per unit x Sales (xx)
volume
Contribution CM per unit x Sales volume P xx
Margin
Less: Total Fixed (xx)
Cost
Profit P xx

Underlying Assumptions about CVP

analysis:
• Relevant Range – CVP Analysis is valid only within the company’s
relevant range of activity. If an activity was made beyond this point
the relationships of fixed cost, volume, and variable costs may vary.

• Cost behavior identified – costs are classified as to fixed and variable

only, no more mixed cost, as the mixed cost was assumed to have
been segregated already using any cost segregation method.

• Linearity – the selling price and the unit variable cost are constant
over all sales volumes within the company’s relevant range of activity.

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Underlying Assumptions about CVP

analysis:
• Sales and production volume are equal – if sales and production are
not equal, some amount of variable and fixed costs is treated as
assets (inventories) rather than expenses. If inventories remain fairly
stable between adjacent time periods, there will be no significant
effect on the CVP analysis. Thus, CVP assumes no beginning, no
ending inventory.
• Activity measures – the only cost driver is the volume of units
produced.
• Constant sales mix – in multiple product lines, the sales mix is
assumed to be constant throughout the year.

Uses of CVP Analysis

1. It will provide management with cost and profit data for profit
planning, policy formulation, and decision making

2. It will provide data in determining the optimal level and mix of

output to be produced with available resources

3. It will help the management to pre-determine the required volume

of production and sales to achieve the desired profit.

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Methods in Computing Breakeven

Point
1. Equation method or algebraic approach
2. Contribution margin method or formula approach
3. Graphic approach

1. Equation method or algebraic

approach

Sales = Variable Costs + Fixed Costs + Profit

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Problem Solving
Bagets Company produces and sells rubber balls. The variable costs to
produce and sell one unit of rubber ball amount to P4.00, while the
total fixed manufacturing, selling, and administrative costs per period
are P12,000. The rubber balls are sold at P10.00 per unit.

Required:
Determine the break-even sales in units and in pesos.

Solution:
Sales = Variable Costs + Fixed Costs + Profit
• Sales = Units x Selling Price Per unit
• Variable Costs = Units x Variable Cost per unit
• Let x = the number of units to be sold to break even, where at
breakeven point, profit = 0

P10x = P4x + P12,000 + 0

P10x – P4x = P12,000 + 0
P6x = P12,000 + 0
x = P12,000 + 0 / P6
x = 2,000 units [or P20,000 (2,000 units x P10 per unit)]

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2. Breakeven Point (BEP) Formula

• Single Product Line
• Equation Approach
BEP = Sales – Variable costs – Fixed Costs

• Contribution Margin Approach

BEP in units = Total Fixed Costs / CM per unit

BEP in peso = Total Fixed Costs / CM Ratio

Problem Solving
Bagets Company produces and sells rubber balls. The variable costs to
produce and sell one unit of rubber ball amount to P4.00, while the
total fixed manufacturing, selling, and administrative costs per period
are P12,000. The rubber balls are sold at P10.00 per unit.

Required:
Determine the break-even sales in units and in pesos.

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Solution:
Breakeven Sales in Units = Fixed Cost / Contribution Margin per unit
BES in Units = P12,000 / (P10 – P4)
BES in Units = 2,000 units

Breakeven Sales in Peso = Fixed Cost / Contribution Margin Ratio

BES in Peso = P12,000 / (P6/P10)
BES in Peso = P20,000

Breakeven Point (BEP) Formula

Desired sales if net income is before income tax

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Problem Solving
Bagets Company produces and sells rubber balls. The variable costs to
produce and sell one unit of rubber ball amount to P4.00, while the
total fixed manufacturing, selling and administrative costs per period
are P12,000. The rubber balls are sold at P10.00 per unit.

Assume that Bagets Company wants to know the required sales volume
in units and in pesos to earn a desired profit of P6,000.

Solution
Sales in Units = Fixed Cost + Profits / CM per unit
= P12,000 + P6,000 / P6
= 3,000 units

Sales in Pesos = Fixed Cost + Profits / CM Ratio

= P12,000 + P6,000 / 60%
= P30,000

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Breakeven Point (BEP) Formula

Desired sales if net income is after income tax

Problem Solving
Bagets Company produces and sells rubber balls. The variable costs to
produce and sell one unit of rubber ball amount to P4.00, while the
total fixed manufacturing, selling, and administrative costs per period
are P12,000. The rubber balls are sold at P10.00 per unit.

Required:
Assume that Bagets Company pays the corporate income tax rate of
P35%. What should sales volume be (in units and in pesos) to earn an
after-tax profit of P1,950?

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Solution:

= P12,000 + P1,950/(100%-35%) / P6
= 2,500 units

= P12,000 + P1,950/(100%-35%) / 60%

= P25,000

3. Graphic Approach
• The sales and cost lines are drawn on a chart, called a breakeven
chart.

• At least two activity levels are assumed, and the corresponding sales
and costs are calculated, considering the unit sales price, unit variable
costs, and the amount of fixed costs.

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3. Graphic Approach
• At the breakeven point, the total sales and total cost lines intersect
which simply means that at this point, the total sales and total costs
are equal, indicating zero profits.

• Shows useful data for planning purposes, like sales, costs, profits, and
loss possibilities at various activity levels.

Problem Solving
Bagets Company produces and sells rubber balls. The variable costs to
produce and sell one unit of rubber ball amount to P4.00, while the
total fixed manufacturing, selling, and administrative costs per period
are P12,000. The rubber balls are sold at P10.00 per unit.

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Solution:

Advantages of Using Graphical

Approach
1. It is easier for most managers to understand and visualize financial
information presented graphically than those presented in
computational or scheduler formats.
2. With the use of charts, a wider range of activities can be presented
with much more information without necessarily experiencing
information overload.
3. Complex analyses or cases are made easier or simpler to solve and
understand with the use of graphs.

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Margin of Safety
• The difference between actual or planned sales volume and
breakeven sales

• Indicates the amount by which actual or planned sales may be

reduced without incurring a loss

Margin of Safety Formula

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Problem Solving
Bagets Company produces and sells rubber balls. The variable costs to
produce and sell one unit of rubber ball amount to P4.00, while the
total fixed manufacturing, selling, and administrative costs per period
are P12,000. The rubber balls are sold at P10.00 per unit.

Required:
Assume that Bagets Company has budgeted sales of 5,000 units or
P50,000 for the next period. Compute for the Margin of Safety (in units,
in peso, and in ratio)

Solution
Margin of Safety in Pesos = Planned Sales – Breakeven sales
= P50,000 – P20,000
= P30,000

Margin of Safety in Units = 5,000 units – 2,000 units

= 3,000 units

Margin of Safety Ratio = Margin of Safety/Planned Sales

= P30,000/P50,000 or 3,000units/5,000 units
= 0.60 or 60%

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Breakeven Point for Multiple Product

Line
• In a multiple product lines, the company has to pre-determine the
sales mix where such sales mix will be considered as one package
(composite unit) as in a single product line.

• Fixed costs cannot usually be identified with the specific products the
company produces and sells.

• Each product has its own sales price and variable cost and
contribution margin

Procedure
1. Determine the sales mix or set the planned sales mix.
2. Determine the CM for each product.
3. Determine the Weighted CM per unit by multiplying the number of units
in the mix for each product and each corresponding CM per unit.
4. Get the sum of the Weighted CM per unit to get the Total Weighted CM
and considers that as the single CM per unit.
5. Determine the Combined units by dividing the Total Fixed costs by the
Total Weight CM.
6. Multiply the Combined units derived from step 5 with the number of
each product in the mix.

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Problem Solving
Assume that the company produces 2 types of products, A and B,
which are using the same facilities. The company plans to produce 2
units of A and 3 units of B. Product A has a contribution margin of P8
per unit while B has P5. The company’s fixed cost is P465,000. The
selling price for is P15 and P12 for A and B, respectively.

Required: Determine the break-even point in units and in pesos.

Solution
Products Sales Mix CM per Weighted Combined Breakeven
Unit CM per Units points in
Unit (P465,000 units
/ P31)
‘b ‘c ‘d (b x c) e ‘f (b x e)
A 2 P8 P16 15,000 30,000
B 3 P5 P15 15,000 45,000
Total weighted CM P31 Total Sales 75,000

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Solution
Products Breakeven Selling Price Breakeven
points in units points in pesos
A 30,000 P15 P450,000
B 45,000 P12 P540,000
Total P990,000

Alternative Solution 1
1. Determine the combined contribution margin ratio

Products Sales Mix Selling Combined

Price per Sales Price
Unit
‘b ‘c ‘d (b x c)
A 2 P15 P30
B 3 P12 P36
Total P66

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Alternative Solution 1
Combined Contribution Margin Ratio (CRM) =

Combined Contribution Margin Ratio (CRM) =

Combined Contribution Margin Ratio (CRM) = 46.97%

Alternative Solution 1
2. Compute the Mixed Breakeven Sales in Pesos.

Mixed Breakeven Sales in Pesos =

,
Mixed Breakeven Sales in Pesos =
. %

Mixed Breakeven Sales in Pesos = P990,000

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Alternative Solution 1
3. Determine the number of sales to breakeven/

Mixed Breakeven Sales in Units =

,
Mixed Breakeven Sales in Units =

Mixed Breakeven Sales in Units = 15,000 units

Alternative Solution 1
4. Determine the individual breakeven point in units and in pesos.
Product BES (Units) BES (P)
(Sales Mix x Mixed Breakeven Sales in Units) A 30,000 450,000.00
B 45,000 540,000.00
To Check: BES (Pesos)
BES (Units) Product A Product B Total
Sales 15 12
Product A (2x15,000units) 30,000 450,000.00 450,000.00
Product B (3x15,000units) 45,000 540,000.00 540,000.00
Total 990,000.00
x CMR 46.969696969%
Mixed Contribution Margin 465,000.00
Less: Total Fixed Cost 465,000.00
Net Profit/Net Loss (0.00)

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Alternative Solution 2
1. Determine the average contribution margin per mix.

A B Total
Unit CM P8 P5
Sales Mix Ratio 40%* 60%**
Average CM P3.20 P3 P6.2

• *2units/5units = 40%
• **3units/5units = 60%

Alternative Solution 2
2. Determine the mixed break-even sales in units.
Mixed Breakeven Sales in Units =

,
Mixed Breakeven Sales in Units =
.

Mixed Breakeven Sales in Units = 75,000 units

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Alternative Solution 2
3. Determine the individual Breakeven points in units and in pesos

Products Mixed BEP Sales Mix BEP in Selling BEP in

(units) Ratio Units Price Pesos
A 75,000 40% 30,000 P15 P450,000
B 75,000 60% 45,000 P12 P540,000
Total 75,000 P990,000

Limitations of Breakeven Analysis

• The total revenue function is based on the assumption that the price
per unit is constant regardless of the volume of sales and production.

• Variable cost is not constant at all output level.

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