COST VOLUME PROFIT ANALYSIS
- Systematic examination of the relationships
among costs, activity levels or volume and profit
- A useful tool in decision making activities
covering but not limited to the following areas:
 Setting selling prices
 Selecting the mix of products to sell
 Choosing among marketing strategies
 Analysing the effects of changes in cost on
profits
COST BEHAVIOR
- way cost change with change in activity level
COST BEHAVIOR PATTERNS
Fixed costs
- Cost that do not change with changing levels
of activity
- Fixed cost per unit changes in an indirect or
inverse pattern
- example: rental expense, depreciation- straight
line method
Y= a
Variable costs
- Cost that change directly and proportionately
with the level of activity
- Cost per unit is constant
- example: direct materials, direct labor
Y= bx
Mixed costs
- it has the characteristics of both variable and
fixed costs
- Example: Basic salary + incentive or
commission
Y= a+ bx
Semi variable costs
- Costs which vary directly with change in
activity level but the rate of change is not
constant
a. Cost that increase at an increasing rate
ex. electricity
b. Cost that increase at a decreasing rate
ex. Learning curve theory
Semi fixed costs/step function cost or step cost
- Like variable cost, semi-fixed costs increase
with the activity level, although not
proportionately, and like fixed costs, they
remain constant for stretches of activity level,
although not for all levels of activity
COST BEHAVIOR ASSUMPTIONS
RELEVANT RANGE ASSUMPTION
- Refers to the band of activity within which the
identified cost behaviour patterns are valid
TIME ASSUMPTION
- Cost behaviour patterns identified are true only
over a specific period of time
VARIABLE COSTING INCOME STATEMENT
Sales
Variable Cost
Contribution Margin
Fixed Cost
Profit
BREAK-EVEN ANALYSIS
Break even sales – that point of activity level where
total revenues equal total cost, therefore there is no
profit or loss
Computation:
1. Equation method or algebraic approach
Sales = Variable cost + Fixed cost + Profit
2. Contribution margin method or formula
approach
BES units =
Fixed cost
Contribution margin per unit
BESpesos =
Fixed cost
Contribution margin ratio
Variable cost ratio =
Variable cost
Sales
Contribution margin ratio =
Contribution margin
Sales
Contribution margin = Sales – Variable cost
TARGET ANALYSIS – is concerned with estimating
the level of sales required to attain a specified target
profit
Sales in units =
Fixed cost + Profit
Contribution margin per unit
Sales in peso =
Fixed cost + Profit
Contribution margin ratio
Sales in units =
Fixed cost +
Sales in peso =
Fixed cost +
Profit after tax
100% - tax rate
Contribution margin per unit
Profit after tax
100% - tax rate
Contribution margin ratio
FACTORS AFFECTING PROFIT
1.) Selling price per unit
2.) Variable cost per unit
3.) Volume or number of units
4.) Fixed cost
5.) Sales mix
Desired profit as a certain %
Sales in units =
Fixed cost
CM/u – P/u
Sales in peso =
Fixed cost
CMR – PR
3. Graphic Approach
a) Break Even Chart - highlights the CPV
relationships over a wide range of activity and
gives managers a perspective that can be
obtained in no other way. It also clearly shows
the break-even point on the graph
1. Plot the sales line
2. Plot the cost line
3. The intersection between the cost line and the
sales line is the break- even point
EX:
Activity level
Fixed cost
Variable cost
Total cost
Sales
3000 units
12,000
12,000
24,000
30,000
5000 units
12,000
20,000
32,000
50,000
UNDERLYING ASSUMPTIONS IN BREAK EVEN
ANALYSIS
1.) Costs are classified as variable or fixed
2.) Variable costs change at a linear rate
3.) Fixed costs remain unchanged over relevant
range
4.) Selling prices do not change as sales volume
changes
5.) For multi-products, the sales mix remains
constant
6. Productive efficiency does not change
7.) Inventory levels remain constant, (production =
sales)
8.) Volume is the only relevant factor affecting
revenues and costs
9.) Relevant range for which all the other underlying
assumptions and concepts are valid
b) Profit Volume Graph - focuses on
profitability. This highlights only the difference
between total sales revenues and total costs
and enables the manager to more easily
determine the operating profit/loss for various
levels of operation
OPERATING LEVERAGE
- is a principle by which management in a high
fixed industry with a relatively high contribution
margin can increase profits substantially with a
small increase in sales volume
1. Plot the profit line based on assumed activity
level
- Measure of how sensitive net income is to a
given percentage change in sales
Activity level
Total sales
Total cost
Profit
3000 units
30,000
24,000
6,000
5000 units
50,000
32,000
18,000
MARGIN OF SAFETY
- Indicates the amount by which actual or
planned sales may be reduced without
incurring a loss
Margin of safety ratio =
Margin of safety =
DOL =
Contribution margin
Net income
DOL =
Percentage change in operating
income
Percentage change in sales
Margin of safety
Actual or planned sales
Actual or planned sales
(Breakeven sales)
100%
= MSR + BESR
MSR
= 1 – BESR
BESR = 1 – MSR
PR
- The degree of operating leverage (DOL) is the
change in the operating income (EBIT) resulting
from a percentage change in sales. Here, the
unchanging fixed costs are used as a lever to
increase profits
- The greater the DOL, the greater the risk of
loss when the sales decline and the greater the
reward when sales increase.
= CMR x MSR
Percentage change
in net income =
DOL x Percentage
change in sales
DOL =
1
MSR