Accounting Workshop on Financial/Cost/Managerial 03

Accounting with Economics

CVP ANALYSIS: FIXED COST RECOVERY OR ZERO PROFIT- SINGLE

PRODUCTS (BREAKEVEN ANALYSIS);

Breakeven analysis pertains to forecasting the required level of sales in order to recover the
fixed cost inherent to the operations. At breakeven point, the organization is neither at a loss or
profit. Where:

CVP ANALYSIS: FIXED COST RECOVERY WITH PROFIT; INCLUDING EFFECT

OF TAX RATE – SINGLE PRODUCT

The method is similar to that of breakeven analysis. This pertains to forecasting the required
level of sales to cover the fixed cost as well as earning a certain amount of profit. Under this
section, CVP analysis treats profit as a fixed cost that must be recovered. However, profit must
be expressed before tax.

CVP ANALYSIS AND THE CONCEPT OF MARGIN OF SAFETY

The concept of margin of safety gives management an idea whether their projected level
of operations will result in profit or loss. Margin of Safety, therefore, is the portion of the
company’s sales that will contribute to profit while breakeven sales is the portion of the
company’s sales that will be used to recover fixed cost. Where:

CVP ANALYSIS AND THE CONCEPT OF OPERATING LEVERAGE

Operating leverage indicates how sensitive the company is to sales volume increases and
decreases, summarizing the impact of change in volume to profit without going through the
process of preparing a contribution margin income statement. In analysing operating
leverage, the mix of the company’s variable and fixed cost (or often referred to as cost
structure) should be taken into account. Where:
Accounting Workshop on Financial/Cost/Managerial 03
Accounting with Economics

CVP ANALYSIS AND THE CONCEPT OF INDIFFERENCE POINT

The concept of indifference point in CVP analysis pertains to the level of sales where
two alternatives have the same profit. Simply put, it is a point where management is
indifferent between two alternatives. Where:

CVP ANALYSIS: FIXED COST RECOVERY OR ZERO PROFIT (SIMPLY

BREAKEVEN ANALYSIS) – MULTIPLE PRODUCTS

Most organizations have multiple products with various characteristics where there is a relative
combination of sales of various products that make up the total sales of a company. Where:

CORRELATION ANALYSIS

Correlation Analysis is used to measure the strength of linear relationship between two or more
variables which can be seen by drawing a scatter diagram.

 If the points seems to be straight line, there is a high correlation

 If the points form a random pattern, there is a low correlation or no correlation at all

Coefficient of Correlation(r) on the other hand measures the relative strength of linear relationship
between two (2) variables. Its value ranges from -1.0 to + 1.0.

 If r = -1.0, there is perfect inverse linear relationship between X and Y

 If r = 0, there no linear relationship
 If r = +1.0, there is a perfect direct relationship between X and Y

Lastly, Coefficient of Determination is the proportion of the total variation in Y that is accounted for by
the regression equation, regardless of whether the relationship between X and Y is direct or inverse. It is
a measure of goodness of fit in the regression. The higher the coefficient of determination, the more
confidence one can have in the estimated cost formula.
Accounting Workshop on Financial/Cost/Managerial 03
Accounting with Economics
Exercises:

1. Correlation Analysis. BB Company is interested in the relationship between sales

(dependent variable) and occurrence of rain (independent variable). Using the proper
formula, the coefficient of correlation is computed as -0.99. What conclusion about the
sales and rain occurrence could one make?
a. An increase in sales causes an increase in rain occurrence
b. An increase in sales causes a decrease in rain occurrence
c. An increase in rain occurrence causes a decrease in sales
d. An increase in rain occurrence causes an increase in sales

2. Cost Volume Profit (CVP) Analysis (Single Product). MBC Company manufactures
and sells a single product. The company’s sales and expenses for a recent month are as
follows:
Sales (1,200 units) 30,000.00
Less: Variable Costs 12,000.00
Contribution Margin ?
Less: Fixed Costs 10,000.00
Profit ?
Compute for the following:
a. Determine the following:
i. Unit Selling Price
ii. Unit Variable Cost
iii. Contribution Margin Ratio (CMR)
iv. Break-even point in units
v. Break-even point in peso sales
vi. Unit sales required to earn P 6,000 profit for the month
vii. Peso sales required to earn an after-tax profit of P 4,800, assuming the
tax rate is 20%
b. Assume that the company is currently selling 800 units per month and that the
company president believes that sales would increase if advertising were
increase by P 6,000. How many units should sales increase to give the
company the same profit or loss that it is currently earning?
c. What is the margin of safety at its present sales of P 37,500?
d. The company currently pays its sales person a monthly salary of P 4,000 per
month without any commission. However, the company considers a plan
whereby the sales person would receive a 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?
Accounting Workshop on Financial/Cost/Managerial 03
Accounting with Economics
3. Cost Volume Profit (CVP) Analysis (Multiple Products). DEF Company produces and
sells two products, tables and chairs with the following data below:
Chairs Tables Total
Unit Sales 60 15 75
Sales 1,200.00 187.50 1,387.50
Variable Costs 1,050.00 112.50 1,162.50
Contribution Margin 150.00 75.00 225.00
Fixed Costs 90.00
Profit 135.00

Compute for the following:

a. How many units of chairs should be sold next month to break-even?
b. How many units of tables should be sold to earn a profit of P 210?

4. Operating Leverage. AF Facilities Gym has the following data for its operations during
its first year:
Sales 250,000.00
Variable Costs 100,000.00
Contribution Margin 150,000.00
Fixed Costs 120,000.00
Profit 30,000.00

Compute for the following:

a. Degree of Operating Leverage
b. If sales increases by 10%, then what is the percentage of increase in profit, ceteris
paribus?