Introducing income taxes into cost-volume-profit analysis
a. raises the break-even point.
b. lowers the break-even point.
c. increases unit sales needed to earn a particular target profit.
d. decreases the contribution margin percentage
⚠️ First: What happens when income tax is introduced into
CVP (Cost-Volume-Profit) analysis?
CVP typically looks at:
Break-even sales = Fixed Costs / Contribution Margin per unit
But when we add income taxes, we must adjust target profit — not
contribution margin.
� Let's go through the options:
a. Raises the break-even point

❌ Incorrect: Break-even point is where Net Income = 0 → and tax
on 0 = 0, so taxes don’t affect break-even.
b. Lowers the break-even point

❌ Incorrect: For the same reason above.
c. Increases unit sales needed to earn a particular target profit

✅ This is actually TRUE — because after-tax profit needs more
before-tax profit to reach the same net.
Example: Want ₱100,000 after tax, and tax rate is 25%?
You need ₱133,333 before tax → more units must be sold.

But despite being true, this is not the best choice for this
question.
✅ d. Decreases the contribution margin percentage

✔️ This is the best answer only if the question means:
"Effective CM% after tax" — that is, the portion of contribution margin
that actually results in net income.
Here's how:


Normally, CM% = (Selling Price – Variable Cost) / Selling Price
Taxes don't change this formula, but they reduce the portion of
CM that goes to profit.
So effectively:


Before tax, 100% of CM contributes to net income.
After tax, only (1 – tax rate) × CM goes to profit.
Example: With 25% tax rate, only 75% of CM contributes to net income
→ So "effective CM%" is lower
� Bottom Line:



If the question is asking about reported/net income impact,
then D makes sense in context.
If it were strictly about basic CM formula, then D would
be incorrect.
But in CVP analysis with taxes, effective CM for profit planning is
reduced → hence, D is correct based on that interpretation.
✅ Correct answer: c. Increases unit sales
needed to earn a particular target profit
Why?
When income taxes are introduced in CVP, the target net income (after
tax) must be grossed up to a higher pre-tax income to cover the taxes.
Formula Comparison:
� Without Taxes:
To get a target profit:
Required Sales=Fixed Costs+Target ProfitContribution Margin per unitRequir
ed Sales=Contribution Margin per unitFixed Costs+Target Profit
✅ With Taxes:
To get the same after-tax profit:
Required Sales=Fixed Costs+Target Profit1−Tax RateCM per unitRequired Sa
les=CM per unitFixed Costs+1−Tax RateTarget Profit
So if you want ₱100,000 after tax and the tax rate is 25%:
Pre-tax profit needed=100,0001−0.25=133,333.33Pretax profit needed=1−0.25100,000=133,333.33
→ You need to sell more units to reach that profit.
✅ Hence, c is the most directly correct answer.
❌ Why D. Decreases the contribution margin
percentage is incorrect:
Contribution Margin Percentage is:
Selling Price – Variable CostSelling PriceSelling PriceSelling Price – Variable C
ost
➡️ This does not change when you introduce taxes — because CM% is
based only on selling price and variable cost, which are pre-tax
figures.
Taxes are applied after CM, on profit — they don’t affect CM%.
� Summary:
A. Raises break-even point
Effect when income tax is
introduced
❌ No change — tax on ₱0 = ₱0
B. Lowers break-even point
❌ Same as above
C. Increases unit sales
needed for a target profit
✅ More sales needed to achieve
same after-tax profit
❌ CM% is unaffected by taxes
Option
D. Decreases CM%
Correct?
❌
❌
✅
❌