Chapter 4

Cost-Volume-Profit Analysis
Learning objectives
Upon completion of this chapter, you should be able to:
1. Know the meaning of break even point
2. Determine the break even point in number of units and in total sales
3. Determine the number of units to be sold to attain a targeted profit
4. Prepare a profit volume graph
5. Prepare a cost-volume-profit graph
6. Know the meaning and computation of contribution margin
7. Explain the impact of risk, uncertainty, and changing variables on cost-
volume-profit analysis
Cost-volume-profit (CVP) analysis
● Estimates how changes in costs (variable and fixed), sales volume, and price
affect a company’s profit.
● Managers find CVP very useful in making wise business decisions,
predicting future conditions (planning) as well as in explaining, evaluating
and acting on results (controlling).
● CVP is being used by companies to determine the break-even point.
Break-even point
● The point of zero profit (no profit, no loss).
● At BEP, total revenue equals total costs.
● BEP is not the main goal of companies.
● Knowing BEP, managers are better able to set sales goals that should result
in profits from operations rather than losses.
CVP Analysis helps managers answer several questions such as:
● The number of units to be sold to break even
● The effect of changes in the fixed cost on the break-even point
● The effect of changes in the sales price on the break-even point
CVP analysis assumptions
● The company is assumed to be operating within the relevant range of
activity specified for determining the revenue and cost information used.
● Relevant range – refers to the range of activity over which a variable cost
per unit remain constant or a fixed cost remains fixed in total.
● Revenue per unit is assumed to be constant.
● Variable cost per unit is assumed to be constant. Total VC fluctuates in
direct proportion to volume.
● Fixed cost per unit fluctuates inversely to volume. Total FC is assumed to be
constant.
● Mixed cost should be segregated as to variable and fixed cost components.
Break-even point
Contribution margin
Illustrative problem 1
● Nicolas Company produces a product that sells for P800. The variable cost
per unit is P350 for direct materials, P200 for labor, P50 for variable
overhead and P30,000 for fixed overhead. The units sold for the month is
500 units.
Required:
1. Total variable cost per unit
2. Total variable cost
3. Total fixed cost
4. Total fixed cost per unit
5. Contribution margin
6. Contribution margin per unit
7. Contribution margin ratio
8. BEP (units)
9. BEP (pesos)
Illustrative problem 1
● Nicolas Company produces a product that sells for P800. The variable cost
per unit is P350 for direct materials, P200 for labor, P50 for variable
overhead and P30,000 for fixed overhead. The units sold for the month is
500 units.

1. Total variable cost per unit

Illustrative problem 1
● Nicolas Company produces a product that sells for P800. The variable cost
per unit is P350 for direct materials, P200 for labor, P50 for variable
overhead and P30,000 for fixed overhead. The units sold for the month is
500 units.

2. Total variable cost

Illustrative problem 1
● Nicolas Company produces a product that sells for P800. The variable cost
per unit is P350 for direct materials, P200 for labor, P50 for variable
overhead and P30,000 for fixed overhead. The units sold for the month is
500 units.

3. Total fixed cost – P30,000 fixed overhead

Illustrative problem 1
● Nicolas Company produces a product that sells for P800. The variable cost
per unit is P350 for direct materials, P200 for labor, P50 for variable
overhead and P30,000 for fixed overhead. The units sold for the month is
500 units.

4. Total fixed cost per unit

Illustrative problem 1
● Nicolas Company produces a product that sells for P800. The variable cost
per unit is P350 for direct materials, P200 for labor, P50 for variable
overhead and P30,000 for fixed overhead. The units sold for the month is
500 units.

5. Contribution margin
Illustrative problem 1
● Nicolas Company produces a product that sells for P800. The variable cost
per unit is P350 for direct materials, P200 for labor, P50 for variable
overhead and P30,000 for fixed overhead. The units sold for the month is
500 units.

6. Contribution margin per unit

Illustrative problem 1
● Nicolas Company produces a product that sells for P800. The variable cost
per unit is P350 for direct materials, P200 for labor, P50 for variable
overhead and P30,000 for fixed overhead. The units sold for the month is
500 units.

7. Contribution margin ratio

Illustrative problem 1
● Nicolas Company produces a product that sells for P800. The variable cost
per unit is P350 for direct materials, P200 for labor, P50 for variable
overhead and P30,000 for fixed overhead. The units sold for the month is
500 units.

8. BEP (units)
Illustrative problem 1
● Nicolas Company produces a product that sells for P800. The variable cost
per unit is P350 for direct materials, P200 for labor, P50 for variable
overhead and P30,000 for fixed overhead. The units sold for the month is
500 units.

9. BEP (pesos)
Illustrative problem 1
● Nicolas Company produces a product that sells for P800. The variable cost
per unit is P350 for direct materials, P200 for labor, P50 for variable
overhead and P30,000 for fixed overhead. The units sold for the month is
500 units.

9. BEP (pesos)
Illustrative problem 1
● If a statement is prepared for the break-even sales, it will appear as:

● At break-even sales, contribution margin equals total fixed costs. Any

excess of contribution margin over fixed costs is net income.
Illustrative problem 1
● The statement of comprehensive income that is based on the separation of
costs into fixed and variable is called the Contribution Margin Statement
which is used under direct costing or variable costing.
● The Contribution Margin Statement for the Nicolas Company, assuming
sales of 500 units will appear as:
Margin of safety
● Margin of safety is the units sold or revenue earned above the BEP volume.
● In simple words, it represents the number of units or amount of sales
revenue that the company can absorb before incurring loss.
Margin of safety
● Using the Illustrative Problem 1:

● MEANING: Sales may decrease by P280,000 before the company will break-
even. Beyond P280,000, the company will incur a loss.
Margin of safety
● Using the Illustrative Problem 1:

● MEANING: Sales may decrease by 350 units before the company will break-
even. Beyond 350 units, the company will incur a loss.
Margin of safety
● Using the Illustrative Problem 1:

● MEANING: Sales may decrease by 70% before the company will break-
even. Beyond 70%, the company will incur a loss.
CVP analysis in a multiproduct company
● Simply convert the multiple product problem to a single product problem.
● The key to this conversion is to identify the expected sales mix, in units, of
the products being produced and marketed.
● The sales mix is the combination of products being marketed by the
company.
● The sales mix is measured in terms of units sold.
Illustrative problem 2
● Selina Company produces three products A, B, and C with the following
characteristics:

● Total fixed costs are P1,800,000. Assume that sales mix will be the same at all sales
level.

Required:
1. Compute for the break-even point in total units.
2. Compute for the units A, B, and C must sell at break-even point.
3. Compute for the total contribution margin if the company expects profit of
Illustrative problem 2
1. Compute for the break-even point in total units.

● In computing for the composite break-even point (average break-even

point of the products), we need to compute first for the weighted-average
contribution margin based on the sales mix (percentage of expected sales
per product to the total expected sales of all the products).
Illustrative problem 2
1. Compute for the break-even point in total units.
Illustrative problem 2
1. Compute for the break-even point in total units.

Alternatively, to compute for the weighted-average contribution margin

(WACM)
Illustrative problem 2
1. Compute for the break-even point in total units.

Use the computed WACM to the BEP (units) formula.

Illustrative problem 2
2. Compute for the units A, B, and C must sell at break-even point.

● Use the sales mix percentage and multiply to the answer in number 1.
Illustrative problem 2
2. Compute for the units A, B, and C must sell at break-even point.

● To check:
Illustrative problem 2
3. Compute for the total contribution margin if the company expects profit of
P350,000.
Sales and units with desired profit
● Most companies would not want to break-even only, the main objective is
to earn profit.
● CVP gives us a way to determine how many units must be sold, or how
much sales revenue must be earned to earn a particular net income.
Illustrative problem 3
The Gilas Company is trying to do CVP analysis with the following information
for the month of August.

Required:
1. Sales (units and amount) to break even.
2. Sales if the company desires a profit of P120,000.
Illustrative problem 3
1. Sales (units and amount) to break even
Illustrative problem 3
1. Sales (units and amount) to break even
Illustrative problem 3
2. Sales if the company desires a profit of P120,000.
Illustrative problem 3
2. Sales if the company desires a profit of P120,000.

To check:
● The break-even point is affected by the three factors: selling price, variable
cost, and volume of sales. Any changes in any of these will definitely change
the break-even point.
● There will be a decrease in BEP if total fixed cost decrease or unit
contribution margin increase.
● BEP will increase if there is an increase in fixed cost or a decrease in unit (or
percentage) contribution margin.
Illustrative 4 - Effect of change in sales
price
● Nicolas Company produces a product that sells for P800 per unit. the
variable cost is P600 per unit. The units sold for the month is 500 units.
Assuming variable cost is still P600 and fixed cost remain at P30,000. The
selling price this time increased to P850 per unit.

Required:
1. Compute for BEP
2. Compare with Illustrative 1
Illustrative 4 - Effect of change in sales
price
1. Compute for BEP
Illustrative 4 - Effect of change in sales
price
2. Compare with Illustrative 1

BEP in Problem 1 is 150 units and the new selling price in BEP decreased to
120 units because of the increase in the contribution margin.
Illustrative 5 - Effect of change in fixed
cost
● Same data in Problem 1 for Nicolas Company. The change is the amount of
fixed cost that increased to P150,000. Selling price is still P800 and variable
cost is P600.

Required:
1. Compute for BEP
2. Compare with Illustrative 1
Illustrative 5 - Effect of change in fixed
cost
1. Compute for BEP
Illustrative 5 - Effect of change in fixed
cost
2. Compare with Illustrative 1

With the increase in fixed cost to P50,000, the new BEP increased to 250 units.
As we increase the fixed cost, BEP also increased.
Illustrative 6 – Changes in variable cost
per
● Sameunit
data in Problem 1 for Nicolas Company but the change now is on the
variable cost per unit. The selling price is still P800 per unit. Fixed cost is
P30,000 but variable cost is P650 per unit.

Required:
1. Compute for BEP
2. Compare with Illustrative 1
Illustrative 6 – Changes in variable cost
per unitfor BEP
1. Compute
Illustrative 6 – Changes in variable cost
per unitwith Illustrative 1
2. Compare

The BEP increased to 200 units as compared to 150 BEP in Problem 1 because
of the decrease in contribution margin (due to increase in variable cost).
● So we can conclude that BEP will increase if total fixed cost increase.
● BEP will decrease if total fixed cost decrease.
● If selling price increase, BEP will decrease because each unit will be able to
contribute more to the recovery of the fixed cost.
● An increase in selling price will result to increase in contribution margin and
decrease in BEP.
Operating leverage
● It is the use of fixed cost to get higher percentage changes in profit as sales
changes.
● It is concerned with the relative mix of fixed cost and variable cost in an
organization.
● As variable cost is decreased, the CM increases, making the contribution of
each unit to the recovery of the fixed cost increase.
● Companies with lower variable costs by increasing the proportion to fixed
cost will benefit with greater increases in profit as sales increase.
● On the other hand, companies with a higher operating leverage will
experience greater reduction in profit as sales decrease.
Operating leverage

The greater the degree of operating leverage, the more that changes in sales
will affect operating income.
END

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