CVP ANALYSIS MANAGEMENT ADVISORY SERVICES

COST-VOLUME-PROFIT ANALYSIS (CVP analysis) examines the behavior of total revenues, total
costs, and operating income as changes occur in the output level, selling price, variable cost
per unit, or fixed costs of a product.

Elements of CVP Analysis

1. Sales price
2. Unit sales
3. Total fixed costs
4. Variable costs per unit
5. Sales mix

Assumptions of Cost-Volume-Profit Analysis

1. Changes in the level of revenues and costs arise only because of changes in the number of
product (or service) units produced and sold.
2. Total costs can be separated into a fixed component that does not vary with the output level
and a component that is variable with respect to the output level.
3. When represented graphically, the behavior of total revenues and total costs are linear
(represented as a straight line) in relation to output level within a relevant range and time
period.
4. The selling price, variable cost per unit, and fixed costs are known and constant.
5. The analysis either covers a single product or assumes that the sales mix, when multiple
products are sold, will remain constant as the level of total units sold changes.
6. All revenues and costs can be added and compared without taking into account the time
value of money.

BREAK-EVEN ANALYSIS
Break-Even Point - that point of activity level (sales volume) where total revenues equal total
costs, i.e., there is neither profit nor loss.

Methods of Determining Break-even Point

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

GRAPHS OF CVP RELATIONSHIPS

The cost-volume-profit graph depicts the relationships among cost, volume, and profits.

Pesos

The point where the total revenue line and the total cost line intersect is the break-even point.

MULTIPLE-PRODUCT ANALYSIS
When CVP analysis is used for a multiple-product firm, the product is defined as a package
of products. For example, if the sales mix is 3:1 for Products A and B, the package would consist of 3
units of Product A and 1 unit of Product B.

Break-even in packages for a multiple-product firm is then calculated as:

Break-even packages = Fixed Costs/Weighted average contribution margin

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SALES MIX- the composition of total sales in terms of various products, i.e., the percentage of each
product included in total sales.

REQUIRED SALES WITH DESIRED PROFIT

The break-even formula may be expanded to compute for the required sales to earn a desired
amount or percentage of profit.

CVP ANALYSIS AND RISK AND UNCERTAINTY:

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.

OPERATING LEVERAGE - a measure of the extent to which fixed costs are being used in an
organization. The greater the fixed costs in relation to variable cost, the greater is the
operating leverage available and the greater is the sensitivity of income to changes in sales.

DEGREE OF OPERATING LEVERAGE (DOL) - a measure of the sensitivity of profit changes to changes
in sales volume. DOL measures the percentage of change in profit that results from a percentage of
change in sales.
Degree of Operating Leverage (DOL) or Operating Leverage Factor (OLF) - a measure, at a
given level of sales, of how a percentage change in sales volume will affect profits.

DEGREE OF OPERATING LEVERAGE (DOL)

OR = Contribution Margin / Operating Income
OPERATING LEVERAGE FACTOR (OLF)

> The higher the degree of operating leverage, the greater the change in profit when sales change.

PERCENTAGE CHANGE IN PROFIT = DOL x Percentage change in sales

SENSITIVITY ANALYSIS -- a "what if" technique that examines the impact of changes on an answer.
For example, computer spreadsheets are used to analyze changes in prices, variable costs,
and fixed costs on expected profits.
Factors Affecting Profit
1. Selling price per unit 4. Fixed cost
2. Variable cost per unit 5. Sales mix
3. Volume or number of units

Exercises:
1. Ms. Ganda sells two beauty products for hopeless individuals, Sandpaper and Eraser. Historically, the
firm has sold, on the average, 400 units of Sandpaper and 1,200 units of Eraser. It incurs fixed costs of
P14,400 per period. Pertinent data about the two products are as follows:
Sandpaper Eraser

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 Selling price P20 P10
Contribution margin per unit 6 4

REQUIRED:
1. How much revenue is needed to break-even? How many units of Sandpaper and Eraser does
it represent?
2. How much, revenue is needed to earn pre-tax profit of P10,800?
3. How much revenue is needed to earn an after-tax profit of P15,680? (Ms.Ganda pays
corporate income taxes)
4. If the company earns the revenue determined in (2), but in doing so, sells 2 units of
Sandpaper for each Eraser, what would the pre-tax profit or loss be?

2. Hellopo Company manufactures and sells a telephone answering machine. The company’s
contribution format income statement for the most recent year is given below:
Total Per Unit Percent of
Sales
Sales (20,000 units) P900,000 P45.00 100%
Less variable expenses 675.000 33.75 ?%
Contribution margin P 225,000 P11.25 ?%
Less fixed expenses 180.000
Net income P 45.000
Management is anxious to improve the company's profit performance and has asked for several
items of information.

REQUIRED:
1. Compute the company's CM ratio and variable expense ratio.
2. Compute the company's break-even point in both units and sales pesos.
3. Assume that sales increase by P300,000 next year. If cost behavior patterns remain
unchanged, by how much would the company's net income increase? Use the CM ratio to
determine your answer.
4. Refer to original data.
a. Assume that next year, management wants the company to earn a
minimum profit of P67,500, How many units will have to be sold to
meet this target profit figure?
b. How much should peso sales be to earn profit after tax of P42,000? Assume that the
company pays income tax at the rate of 30%.
c. Compute the peso sales volume required to earn profit of 10% of such sales volume.
d. How many units must be sold to earn profit of P2.25 per unit?
5. Refer to the original data. Compute the company's margin of safety in units, pesos, and
percentage form.
6. Answer the following questions:
a. Compute the company's degree of operating leverage at the present level of sales.
b. Assume that through a more intense effort by the sales staff, the company's sales increase by
10% next year. By what percentage would you expect net income to increase? Use the
operating leverage concept to obtain your answer.
c. Verify your answer to (b) by preparing a new income statement showing an 10% increase in
sales.

3. Dackers Company, a wholesaler of jeans, had the following income statement:

Sales (40,000 pairs at P35) 1,400,000
Cost of sales 800,000
Gross margin 600,000
Selling expenses 350,000

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 Administrative expenses 190,000 540,000
Income 60,000
Mr. Dackers informs you that the only variables costs are cost of sales and P2 per unit selling
costs. All administrative expenses are fixed. In planning for the coming year, Mr. Dackers expects
his selling price to remain constant, with unit volume increasing by 20%. He also forecasts the
following changes in costs and is concerned about how they will affect profitability.
Variable costs:
Cost of goods sold up P1.50 per unit
Selling costs up P0.10 per unit
Fixed costs:
Selling costs up P40,000
Administrative costs up P30,000

REQUIRED:
1. Compute the expected income for the coming year, assuming that all forecasts are met.
2. Determine the number of units the Dackers will have to sell in the coming year to earn the same
profit as the current year.
3. Mr. Dackers is disturbed at the results of requirements 1 and 2. He asks you how much he must
raise his selling price to earn P60,000 selling 48,000 units.

4. Allen Cosmetics makes two facial creams, Allergy-free and Cleansaway. Data are as follows:
Allergy-free Cleansaway
Price per jar P18 P24
Variable cost per jar 9 6
Monthly fixed costs are P180,000

REQUIRED:
1. If the sales mix in pesos is 60%-for Allergy-free and 40% for Cleansaway, what is the
weighted contribution margin percentage? What peso sales are needed to earn a profit of
P60,000 per month? At that level, how many units of each product, and total units will the
company sell?
2. If the sales mix is 50% for each product in units, what is the weighted average unit
contribution margin? What units sales are needed to earn P60,000 per month? Why is this
number of units different from the answer you found in requirement 1? What are the total
peso sales and why is this figure different from your answer to requirement 1?
3. Suppose that the company is operating at the level of sales that you calculated in
requirement 1, earning a P60,000 monthly profit The sales manager believes that it is
possible to persuade customers to switch to Cleansaway from Allergy-free by increasing
advertising expenses. He thinks that P8,000 additional monthly advertising would change
the mix to 40% for Allergy-free and 60% for Cleansaway. Total peso sales will not change,
only the mix. What effect would the campaign have on profit?

5. Samsonette sells one of its products, a piece of soft-sided luggage, for P6,000. Variable cost per
unit is P3,400, and monthly fixed costs are P6 million. A combination of changes in the way
Samsonette produces and sells this product could reduce variable cost per unit to P2,800 but
increase monthly fixed cost by P4.4 million.

REQUIRED:
1. Determine the monthly break-even points under the two available alternatives.
2. Determine the indifference point of the two alternatives

6. Hay! Co. produces a single product. Sales have been very erratic, with irregular monthly
operating results. The company’s income statement for the most recent month is given below:
Sales (15,000 units) P 450,000
Less variable expenses 315,000
Contribution Margin 135,000
Less fixed expenses 150,000

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 Net Loss P (15.000)

REQUIRED:
1. Compute the company’s CM ratio and its break-even point in both units and pesos.
2. The sales manager feels that a P20,000 increase in the monthly advertising budget,
combined with an intensified effort by the sales staff, will result in a P100,000 increase in
monthly sales, if the sales manager is right, what will be the effect on the company’s
monthly net income or loss?
3. The president is convinced that a 10% reduction in the selling price, combined with a
P50,000 increase in the monthly advertising budget, will cause unit sales to double. What
will the new income statement look like if these changes are adopted?
4. Refer to the original data. The company’s advertising agency thinks that a new package for
the company’s product would help sales. The new package being proposed would increase
packaging costs by P3 per unit. Assuming no other changes in cost behavior, how many units
would have to be sold each month to earn a profit of P9,000?
5. Refer to the original data. By automating certain operations, the company could slash its
variable expenses to half. However, fixed costs would increase to P250,000 per month.
a. Compute the new CM ratio and the new break-even point in both units and pesos.
b. Assume that the company expects to sell 20,000 units next month. Prepare two income
statements, one assuming that operations are not automated and one showing that they
are.
c. Would you recommend that the company automate its operations? Explain.

7. Relax Company and Recline Company both make rocking chairs'. They have the same
production capacity, but Relax is more automated than Recline. At an output of 1,000 chairs per
year, the two companies have the following costs:
Relax Recline
Fixed costs P400,000 P200,000
Variable costs at P100 per chair 100,000
Variable costs at P300 per chair 300,000
Total cost P500,000 P500,000
Assuming that both companies sell chairs for P700 each and that there are no other costs or
expenses for the two firms,
a. Which company will lose the least money if production and sales fall to 500 chairs per
year?
b. How much would each company lose at production and sales level of 500 chairs per
year?
c. How much would each company make at production and sales levels of 2,000 chairs per
year?

8. Great Wali Ski Company recently expanded its manufacturing capacity, which will allow it to
produce up to 15,000 pairs of cross-country bike of the mountaineering mode or the touring
model. The Sales Department assures management that it can sell between 9,000 pairs and
13,000 pairs of either product this year. Because the models are very similar, Great Wall will
produce only one of the two models.
The following information was compiled by the Accounting Department.
Per-Unit (Pair) Data
Mountaineering Touring
Selling price P88.00 P80.00
Variable costs 52.80 52.80
Fixed costs will total P369,600 if the mountaineering model is produced but will be only
P316,800 if the touring model is produced. Great Wall Ski is subject to a 40 percent income tax

REQUIRED:
a. Compute the contribution margin for each product line.
b. If Great Wall desires an after-tax net income of P22,080, how many pairs of touring
skis will the company have to sell?
c. How much would the variable cost per unit of the touring model have to change
before it had the same break-even point in units as the mountaineering model?

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 d. Suppose the variable cost per unit of touring skis decreases by 10 percent, and the
total fixed cost of touring skis increases by 10 percent. Compute the new break-even
point.
e. Suppose management decided to produce both products. If the two models are sold in
equal proportions, and total fixed costs amounting to P343,200, what is the firm's
break-even point in units?
f. Suppose that Great Wall decided to produce only one model of ski. What is the total
sales revenue at which Great Wall would make the same profit or loss regardless of
the ski model it decided to produce?
g. If the Great Wall sales department could guarantee the annual sale of 12,000 pairs of
either model, which model would the company produce and why?

9. The accountant of Sirus Company is trying to prepare comparative income statements for the first
two months of the year 2012. However, he obtained only the following information:
January February
Sales P500,000 -
Contribution margin ratio 40% 36%
Break-even sales ratio 70% 76%
Changes in the given ratio are due to the decrease in sales price and fixed costs.

REQUIRED:
1. Prepare the comparative income statements.
2. Compute the break-even point for February.

10. Snape Company has fixed expenses of P50,000, a contribution margin ratio of 40% and a margin
of safety ratio of 20% for a quarter's operations.

REQUIRED: Compute the company's profit for the quarter.

11. Following are data taken from the most recent income statement of Whitney Company:
Sales (45,000 units at P10 per unit) P450,000
Less cost of goods sold:
Direct Materials 90,000
Direct Labor 78,300
Manufacturing overhead 98,500 266,800
Gross margin 183,200
Less operating expenses:
Selling expenses
Variable:
Sales commissions P27,000
Shipping 5,400 32,400
Fixed (advertising, salaries) 120,000
Administrative:
Variable (billing and other) 1,800
Fixed (salaries and other) 48,000 202,200
Net operating loss P(19,000)
All variable expenses in the company van/ in terms of unit sold, except for sales commissions
which are based on peso sales. Variable manufacturing overhead is P0.30 per unit. There were
no beginning or ending inventories. Whitney Company's plant has a capacity of 75,000 units per
year.
The company has been at a loss for several years. Management is studying several possible
courses of action to determine what should be done to make next year profitable.

REQUIRED:
1. The president is considering two proposals prepared by his staff:
a. For next year, the vice president would like to reduce the unit selling price by 20%.
She is certain that this would fill the plant to capacity.
b. For next year, the sales manager would like to reduce the unit selling price by 20%,
increase the sales commission to 9% of sales, and increase advertising by P100,000.
Based on marketing studies, he is confident this would increase unit sales by one-

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 third. Compute the amounts of income, one under the vice president's proposal and
the other one under the sales manager's proposal.
2. Refer to the original data. The president believes it would be a mistake to change the unit
selling price. Instead, he wants to use less costly raw materials, thereby reducing unit costs
by P0.70. How many units would have to be sold next year to earn a target profit of
P30,200?
3. Refer to the original data. Whitney Company's board of directors believes that the
company's problem lies in inadequate promotion. By how much can advertising be
increased and still allow the company to earn a target profit of 4.5% on sale of 60,000
units?
4. Refer to the original data. The company has been approached by an overseas distributor
who wants to purchase 9,500 units on a special price basis. There would be no sales
commission on the units. However, shipping costs would be increased by 50% and variable
administrative cost would be reduced by 25%. In addition, a P5,700 special insurance fee
would have to be paid by Whitney Company to protect the goods in transit. What unit price
would have to be quoted on the 9,500 units by Whitney Company to allow the company to
earn a profit of P14,250 on total operations? Regular business would not be affected by this
special order.

12. Pittman Company is a small but growing manufacturer of telecommunications equipment. The
company has no sales force of its own; rather, it relies completely on independent sales agents
to market its products. These agents are paid a commission of 15% of selling price for all items
sold.
Barbara Cruz, Pittman's controller, has just prepared the company's budgeted income
statement for next year. The statement shows the following:
Sales P16,000,000
Manufacturing costs: Variable P7,200,000
Fixed overhead 2,340,000 9,540,000
Gross margin 6,460,000
Commissions to agents 2,400,000
Fixed marketing costs 120,000*
Fixed administrative costs 1,800,000 4,320,000
Net operating income 2,140,000
Less fixed interest cost 540,000
Income before income taxes 1,600,000
Less income taxes (30%) 480,000
Net income P 1,120,000
*Primarily depreciation on storage facilities.
As Barbara handed the statement to Karl Vega, Pittman's president, she commented, "I went
ahead and used the agents 15% commission rate in completing these statements, but we've just
learned that they refuse to handle our products next year unless we increase the commission
rate to 20%."
"That's the last straw," Karl replied angrily. "Those agents have been demanding more and
more, and this time they've gone too far. How can they possibly defend a 20% commission
rate?"
"They claim that after paying for advertising, travel, and the other costs of promotion, there's
nothing left over for profit," replied Barbara.
"I say it's just plain robbery," retorted Karl." And I also say it's time we dumped those guys and
got our own sales force. Can you get your people to work up some cost figures for us to look at?"
"We've already worked hem up," said Karl. Several companies we know about pay a 7.5%
commission to their own salespeople, along with a small salary. Of course, we would have to
handle all promotion costs, too. We figure our fixed costs would increase by P2,400,000 per
year, but that would be more than offset by the P3,200,000 (20% x P16,000,000) that we would
avoid on agents' commissions."
The breakdown of the P2,400,000 cost follows:
Salaries:
Sales Manager P 100,000
Salesperson 600,000
Travel and entertainment 400,000
Advertising 1,300,000
Total P2,400,000

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 "Super," replied Karl. "And I noticed that the P2,400,000 is just what we're paying the agents
under the old 15% commission rate."
It's even better than that," explained Barbara, "We can actually save P75,000 a year because
that's what we're having to pay the auditing firm now to check out the agent's reports. So our
overall administrative costs would be less."
Pull all of these numbers together and we'll show them to the executive committee tomorrow,"
said Karl. "With the approval of the committee, we can move on the matter immediately."

REQUIRED:
1. Compute Pittman Company's break-even point in peso sales for next year assuming;
a. That the agent's commission rate remain unchanged at 15%.
b. That the agents' commission rate is increased to 20%
c. That the company employs its own sales force
2. Assume that Pittman Company decides to continue selling through agents and pays the 20%
commission rate. Determine the volume of sales that would be required to generate the
same net income as contained in the budgeted income statement for next year.
3. Determine the volume of sales at which net income would be equal regardless of whether
Pittman Company sells through agents (at a 20% commission rate) or employs its own sales
force.
4. Compute the degree of leverage that the company would expect to have on December 31 at
the end of next year assuming:
a. That the agents' commission rate remains unchanged at 15%.
b. That the agents' commission rate is increased to 20%.
c. That the company employs its own sales force.

13. Pomfrey Company has annual fixed costs of P90,000, In the year 2011, sales increased by
P112,500 from the 2010 level of P337,500. Profit for the year 2011 was P67,500 higher than in
2010.

REQUIRED:
1. If there is no need to expand the company's capacity, how much should profit be in the year
2012 if the budgeted sales volume is R675,000?
2. What is the company's break-even point?

14. Moris Company's break-even sales would increase from P300,000 to P400,000 if fixed costs
would go up by P40,000.

REQUIRED:
Assuming no change In the selling price and variable costs per unit, compute the company's
1. variable cost ratio
2. fixed cost before and after the increase of P40,000.

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