RSA The Review School of Uccounitancy Mamegemerd Udrisorg, Sevrices MAS-02: COST-VOLUME-PROFIT (CVP) ANALYSIS VP analysis - 's useful for profit planning by way of 9 systematic analysis of the proft’s relationship with various costs and volume of sales Increase Decrease Decrease 1 Tncrease ix may also affect company profit LIMITATIONS and ASSUMPTIONS of CVP analysis Relevant range, time and linearliy assumptions in MAS - 01 are also assumed in CVP analysis. Unless indicated otherwise, unit selling price is constant even if sales volume changes. Inventories do not change significantly from period to period. In case of a multi-product company, sales mix is constant. Labor productivity, production technology and market conditions remain stable. ‘TERMINOLOGIES USED IN CVP ANALYSIS Contribution Margin (CM) - Is the difference between sales and variable cost. It is otherwise known 'as marginal income, profit contribution, contribution to fixed cost or incremental contribution ‘+ CM Ratio = CM + Sales = Unit CM = Unit Selling Price + CM Ratio = A.CM + A Sales NOTE: The sign ‘A’ is used to mean change or aifference. Break-Even Point (BEP) - 2 level of activity, in units (break-even volume) or in pesos (break-even ‘sales), at which total revenues equal total costs. At the break-even point, there is neither a profit nor a loss. + BEP unts = Fixed Costs + CM per unit + BEP peso sales = Fixed Costs + CM Ratio Unit Sates with Target Profit = (Fixed Costs + Profit) = CM per unit Peso Sales with Target Return on Sales = tax rate) Margin of Safety - the difference between actual sales and break-even sales. It indicates the ‘maximum amount by which sales could decline without incurring a loss, = Margin of Safety = Sales ~ Breakeven Sales + _Margin of Safety Ratio = Margin of Safety = Sales Indifference Point ~ the level of volume at which two alternatives being analyzed would yield equal amount of total costs or profits. ‘Alternative A ‘Alternative 8 J. (Unit CM x Q) ~ Fixed Cost (Unit Cm x Q) = Fixed Cost J+ Fixed Cost « (Unit VCx Q) Fixed Cost + (Unit VC x Q) ‘Sates Mix - the relative combination of quantities of sales of various products that make up the total sales of @ company. ‘Over-all BEP units = Fixed Costs + Weighted Average CM per unit COver-all BEP pes> sales = Fixed Costs = Weighted Average CM Ratio Degree of Operating Leverage (20L) - measures how a percentage change in sales will affect ‘company profits. It indicates how sensitive the company is to sales volume Increases and decreases. It is also known as operating leverage factor. TanErTbtTan Marga > PrOTR Devore Tax A % sales x DOL. = A % profit before tax Page 1 of 3 pagesRS. The Review School of Accountancy, MAS-02 COST-VOLUME-PROFIT ANALYSIS EXERCISES: COST-VOLUME-PROFIT ANALYSIS 1. May Company manufactures and seils 4 single product. The company's sales and expenses for a recent ‘month follows: Sales (1,500 units) P-37,500 : “Less: Variabie Costs Contnbution Margin Less: Fixed Costs Profit REQUIRED: 1. Determine the folowing ‘A) Unit selling price 2% 8) Unit vanable cost |> ©) Contribution margin ratic (CMR) 3>°% 2. For profit planning purposes, compute the totiowing: A) Break-even point in units foment 8) Break-even peso sales om a) Cae) What unit sales are required to earn P 6,000 profit for the month? cD #s What peso sales are required to earn an after-tax profit of P 4,800 (assuming tax rate is 20%)? Assume that May is currently selling 800 units per month and that the company president believes that sales would increase if advertising were increased by P 6,000. How many units should sales Increase to give May the same profit or tows chat itis currently earning? (NOTE: although you know that 800 units are being sold at present, you do not need this information to solve the problem.) “loo units ‘What is the margin of safety at its present sales of P 37,500? “Fs 90 May currently pays its salespeople a monthly salary of P 4,000 per month without any commission. However, the company considers a plan whereby the salespeople would receive @ 10% commission, but the monthly salary would fall to P 2,500.” What sales level will the company be indifferent between the two compensation plans? (Adapted and edited: Managerial Accounting by Louderback) ‘SOLUTION GUIDE (2).1,900 uni (3).1,400 units (5) 800 units Sales D Zoo) Less: Variable Costs Contribution Margin Less: Fixed Costs Profit (Loss) 2 ul ethly fixed cost will decrease by P 1,500 under the proposal (P 4,000 > P 2,500). 7 Unit variable cost increases by P 2.50 (10% of P 25) Based on cost function bx" Costs (old) = Costs (new) 1,500 = 2.5x x X= 600 units - 15,000 + 10 X = 13,500 + 2. PROVING: Contribution margin ratio x margin of safety ratio = net profit ratio Where: Contribution margin ratio = Cantnibution margin + Sales Margin of safety ratio = Margin of safety = Sales Net profit ratio = Profit + Sales : 3, Dave's break-even sales are P 528,000. The variabe cost rato is 60% while the profi rato is 8%. REQUIRED: Determine the foliowing Fixed Costs sales Profit catety Margin of Safet Margin of Safety Ratio Page 2 of 3 pages ©ReSQ- The Review School of lecourctancy MAS-02 COST-VOLUME-PROFIT ANALYSIS 4 Mahjong Company produces and sells two products, tables and chairs. Following is next month's income budget: Chairs Tables Total Unit sales ‘e0u 15u 75u Sales P 1,200.00 P 187.50 1,387.50 Variable Costs 4,050.00 11250 _1,162.50 Contribution Margin ~P'150,00 P7500 P'225.00 Fixed Costs 20.00 Profit 35,00 REQUIRED: 1. How many units of chairs should be sold next month to break-even? 2. How many units of tables should be Soli to earn a profit of P 210? (Adopted: Monagerial Accounting by Garrison, et.al.) SOLUTION GUIDE Chairs Tables Contribution Margin (CM) per unit P 2.50 P5.00 _Sales Mix (4:1 > 80%:20% 80% 20% Weighted Average CM per unit: 5. Ms. Rita has recently opened the UBE Fitness Gym being offered exclusively for malnourished millennials. The income statement for its first year of operations follows: Sales 250,000 Variable Costs _(100,000) Contribution Margin —P 150,000 Fixed Costs 120,000) Profit 30,000 Ms. Rita is unhappy about the results of his gym’s first year of operations. She observed that despite the high contribution margin, profit was still low because of the high fixed costs. She concludes that an increase in sales would not yield a satisfactory increase in profit REQUIRED: 1. Explain to Ms. Rita that his conclusion 1s not night by computing the operating leverage factor. 2. Ifsales increase by 10%, then how many percent would profit increase, ceteris paribus? (NOTE: determine the percentage A in profit by using the operating leverage factor.) (Adapted: Managerial Accounting by Garrison, et.al.) WRAP-UP EXERCISES (TRUE OR FALSE: MULTIPLE-CHOICE) 1. At the break-even point, total contribution margin is a. Zero Equal to total costs b. Equal to total fixed costs __Equal to total variable costs 2. Which of the following does NOT affect a company’s break-even point? 2. Total fixed costs Unit selling price b. Unit variable cost 4d. Number of units sold 3. An increase in the income tax rate ‘a. Raises the break-even point b. Lowers the break-even point Increases sales required to earn a particular after-tax profit d. Decreases sales required to earn a particular after-tax profit 4, Acompany with a negative margin of safety also has a (an) ‘2. Operating loss Sales above its break-even point b. Operating profit d._ Sales equal to its break-even point 5. Under CVP analysis, which of the following is NOT assumed to be constant? ‘2. Unit variable cost Sales mix b._Unit selling price Unit fixed cost 6. Operating leverage measures how sensitive the profits to changes in 2. Selling price c. Fixed costs b._ Sales volume 3. Variable costs 7. Operating leverage factor = ’2. Gross margin + profit after tax & Contribution margin + profit after tax b. Gross margin + profit before tax d. Contribution margin = profit before tax 8. If inventones are expected to change, the type of costing that provides the best information for breakeven analysis 15 '2. Job-order costing Joint costing b. Variable costing 4 Absorption costing Page 301 3 pages S )