CVP ANALYSIS
MANAGEMENT ADVISORY SERVICES
COST-VOLUME-PROFIT 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 ixed costs of a product. Elements of CVP Analysis 1. ales price !. "nit sales #. $otal otal ix ixed ed cos costs ts %. Varia ariabl ble e cos costs ts per per unit unit &. ales mi mix Assumptions of Cost-V Cost-Volume-Po!it An"l#sis An"l#sis 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. !. $otal costs can be separated into a ixed component that does not vary 'ith the output level and a component that is variable 'ith respect to the output level. #. hen represented graphically, the behavior of total revenues and total costs are linear (represented as a straight line) in relation to output level 'ithin a relevant range and time period. %. $he selling price, variable cost per unit, and ixed costs are no'n and constant. &. $he analysis either covers a single product or assumes that the sales mix, 'hen multiple products are sold, 'ill remain constant as the level of total units sold changes. *. +ll revenues and costs can be added and compared 'ithout taing into account the time value of money. $REA%-EVEN ANALYSIS $e"&-E'en $e"&-E'en Point Point that point of activity level (sales volume) 'here total revenues e-ual total costs, i.e., there is neither proit nor loss. Met(o)s of Deteminin* $e"&-e'en Point 1. -uation /ethod or algebraic approach 2. Contribution margin method or formula approach 3. 0raphic approach GRAPHS OF CVP RELATIONSHIPS $he +ost-'olume-po!it *"p( depicts the relationships among cost, volume, and proits. Pesos
$he point 'here the total revenue line and the total cost line intersect is the breaeven breaeven point. MULTIPLE-PRODU MULTIPLE-PRODUCT CT ANALSIS ANALSIS hen CVP analysis is used for a multipleproduct irm, the product is deined as a pacage of products. or example, if the sales mix is #21 for Products + and 3, the pacage 'ould consist of # units of Product + and 1 unit of Product 3. 3reaeven 3reaeven in pacages for a multipleproduct irm is then calculated as2 Break-even packages = Fixed Costs/Weighted average contribution margin / 44!
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SALES !"- the composition of total sales in terms of various products, i.e., the percentage of each product included in total sales. RE,UIRED SALES IT. DESIRED PROFIT $he breaeven formula may be expanded to compute for the re-uired sales to earn a desired amount or percentage of proit. CVP ANALYSIS AND RIS% AND UNCERTAINTY/ A#$!% &F SAFE'( - indicates the amount by 'hich actual or planned sales may be reduced 'ithout incurring a loss. 5t is the difference bet'een actual or planned sales volume and breaeven sales. &)E#A'!%$ LE*E#A$E - a measure of the extent to 'hich ixed costs are being used in an organi6ation. $he greater the ixed costs in relation to variable cost, the greater is the operating leverage available and the greater is the sensitivity of income to changes in sales. +E$#EE &F &)E#A'!%$ LE*E#A$E ,+&L - a measure of the sensitivity of proit changes to changes in sales volume. 789 measures the percentage of change in proit that results from a percentage of change in sales. +egree o. &perating Leverage ,+&L or &perating Leverage Factor ,&LF - a measure, at a given level of sales, of ho' a percentage change in sales volume 'ill affect proits. 70: 8 8P:+$5;0 9V:+0 (789) 8: 8P:+$5;0 9V:+0 +C$8: (89)
< Contribution /argin = 8perating 5ncome
> $he higher the degree of operating leverage, the greater the change in proit 'hen sales change. P:C;$+0 C?+;0 5; P:85$ < 789 x Percentage change in sales SE%S!'!*!'( A%AL(S!S -- a @'hat if@ techni-ue that examines the impact of changes on an ans'er. or example, computer spreadsheets are used to analy6e changes in prices, variable costs, and ixed costs on expected proits. Factors A..ecting )roit %. ixed cost 1. elling price per unit &. ales mix !. Variable cost per unit #. Volume or number of units
E!e"#ises$ 1. /s. 0anda sells t'o beauty products for hopeless individuals, andpaper and raser. ?istorically, the irm has sold, on the average, %44 units of andpaper and 1,!44 units of raser. 5t incurs ixed costs of P1%,%44 per period. Pertinent data about the t'o products are as follo's2 andpaper raser / 44!
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elling price Contribution margin per unit
P!4 *
P14 %
RE,UIRED/ 1. ?o' much revenue is needed to breaevenA ?o' many units of andpaper and raser does it representA !. ?o' much, revenue is needed to earn pretax proit of P14,B44A #. ?o' much revenue is needed to earn an aftertax proit of P1&,*B4A (/s.0anda pays corporate income taxes) %. 5f the company earns the revenue determined in (!), but in doing so, sells ! units of andpaper for each raser, 'hat 'ould the pretax proit or loss beA !. ?ellopo Company manufactures and sells a telephone ans'ering machine. $he companys contribution format income statement for the most recent year is given belo'2 'ota0 )er 1nit )ercent o. Sa0es ales (!4,444 units) 9ess variable expenses
PD44,444 *F&.444
P%&.44 ##.F&
144E AE
Contribution margin P !!&,444 P11.!& AE 9ess ixed expenses 1B4.444 ;et income P %&.444 /anagement is anxious to improve the companyGs proit performance and has ased for several items of information. RE,UIRED/ 1. Compute the companyGs C/ ratio and variable expense ratio. !. Compute the companyGs breaeven point in both units and sales pesos. #. +ssume that sales increase by P#44,444 next year. 5f cost behavior patterns remain unchanged, by ho' much 'ould the companyGs net income increaseA "se the C/ ratio to determine your ans'er. %. :efer to original data. a. +ssume that next year, management 'ants the company to earn a minimum proit of P*F,&44, ?o' many units 'ill have to be sold to meet this target proit igureA b. ?o' much should peso sales be to earn proit after tax of P%!,444A +ssume that the company pays income tax at the rate of #4E. c. Compute the peso sales volume re-uired to earn proit of 14E of such sales volume. d. ?o' many units must be sold to earn proit of P!.!& per unitA &. :efer to the original data. Compute the companyGs margin of safety in units, pesos, and percentage form. *. +ns'er the follo'ing -uestions2 a. Compute the companyGs degree of operating leverage at the present level of sales. b. +ssume that through a more intense effort by the sales staff, the companyGs sales increase by 14E next year. 3y 'hat percentage 'ould you expect net income to increaseA "se the operating leverage concept to obtain your ans'er. c. Verify your ans'er to (b) by preparing a ne' income statement sho'ing an 14E increase in sales.
#. 7acers Company, a 'holesaler of Heans, had the follo'ing income statement2 ales (%4,444 pairs at P#&) 1,%44,444 Cost of sales B44,444 0ross margin *44,444 elling expenses #&4,444
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+dministrative expenses 1D4,444 &%4,444 5ncome *4,444 /r. 7acers informs you that the only variables costs are cost of sales and P! per unit selling costs. +ll administrative expenses are ixed. 5n planning for the coming year, /r. 7acers expects his selling price to remain constant, 'ith unit volume increasing by !4E. ?e also forecasts the follo'ing changes in costs and is concerned about ho' they 'ill affect proitability. Variable costs2 Cost of goods sold up P1.&4 per unit elling costs up P4.14 per unit ixed costs2 elling costs up P%4,444 +dministrative costs up P#4,444 RE,UIRED/ 1. Compute the expected income for the coming year, assuming that all forecasts are met. !. 7etermine the number of units the 7acers 'ill have to sell in the coming year to earn the same proit as the current year. #. /r. 7acers is disturbed at the results of re-uirements 1 and !. ?e ass you ho' much he must raise his selling price to earn P*4,444 selling %B,444 units. %. +llen Cosmetics maes t'o facial creams, +llergyfree and Cleansa'ay. 7ata are as follo's2 +llergyfree Cleansa'ay Price per Har P1B P!% Variable cost per Har D * /onthly ixed costs are P1B4,444 :I"5:72 01 5f the sales mix in pesos is *4Efor +llergyfree and %4E for Cleansa'ay, 'hat is the 'eighted contribution margin percentageA hat peso sales are needed to earn a proit of P*4,444 per monthA +t that level, ho' many units of each product, and total units 'ill the company sell2 31 5f the sales mix is &4E for each product in units, 'hat is the 'eighted average unit contribution marginA hat units sales are needed to earn P*4,444 per monthA hy is this number of units different from the ans'er you found in re-uirement 1A hat are the total peso sales and 'hy is this igure different from your ans'er to re-uirement 1A 41 uppose that the company is operating at the level of sales that you calculated in re-uirement 1, earning a P*4,444 monthly proit $he sales manager believes that it is possible to persuade customers to s'itch to Cleansa'ay from +llergyfree by increasing advertising expenses. ?e thins that PB,444 additional monthly advertising 'ould change the mix to %4E for +llergyfree and *4E for Cleansa'ay. $otal peso sales 'ill not change, only the mix. hat effect 'ould the campaign have on proitA &. amsonette sells one of its products, a piece of softsided luggage, for P*,444. Variable cost per unit is P#,%44, and monthly ixed costs are P* million. + combination of changes in the 'ay amsonette produces and sells this product could reduce variable cost per unit to P!,B44 but increase monthly ixed cost by P%.% million. RE,UIRED/ 1. 7etermine the monthly breaeven points under the t'o available alternatives. !. 7etermine the indifference point of the t'o alternatives
*. ?ayJ Co. produces a single product. ales have been very erratic, 'ith irregular monthly operating results. $he companys income statement for the most recent month is given belo'2 ales (1&,444 units) P %&4,444 9ess variable expenses #1&,444 Contribution /argin 1#&,444 9ess ixed expenses 1&4,444
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;et 9oss
P
(1&.444)
RE,UIRED/ 1. Compute the companys C/ ratio and its breaeven point in both units and pesos. !. $he sales manager feels that a P!4,444 increase in the monthly advertising budget, combined 'ith an intensiied effort by the sales staff, 'ill result in a P144,444 increase in monthly sales, if the sales manager is right, 'hat 'ill be the effect on the companys monthly net income or lossA #. $he president is convinced that a 14E reduction in the selling price, combined 'ith a P&4,444 increase in the monthly advertising budget, 'ill cause unit sales to double. hat 'ill the ne' income statement loo lie if these changes are adoptedA %. :efer to the original data. $he companys advertising agency thins that a ne' pacage for the companys product 'ould help sales. $he ne' pacage being proposed 'ould increase pacaging costs by P# per unit. +ssuming no other changes in cost behavior, ho' many units 'ould have to be sold each month to earn a proit of PD,444A &. :efer to the original data. 3y automating certain operations, the company could slash its variable expenses to half. ?o'ever, ixed costs 'ould increase to P!&4,444 per month. a. Compute the ne' C/ ratio and the ne' breaeven point in both units and pesos. b. +ssume that the company expects to sell !4,444 units next month. Prepare t'o income statements, one assuming that operations are not automated and one sho'ing that they are. c. ould you recommend that the company automate its operationsA xplain. F. :elax Company and :ecline Company both mae rocing chairsG. $hey have the same production capacity, but :elax is more automated than :ecline. +t an output of 1,444 chairs per year, the t'o companies have the follo'ing costs2 :elax :ecline ixed costs P%44,444 P!44,444 Variable costs at P144 per chair 144,444 Variable costs at P#44 per chair #44,444 $otal cost P&44,444 P&44,444 +ssuming that both companies sell chairs for PF44 each and that there are no other costs or expenses for the t'o irms, a. hich company 'ill lose the least money if production and sales fall to &44 chairs per yearA b. ?o' much 'ould each company lose at production and sales level of &44 chairs per yearA c. ?o' much 'ould each company mae at production and sales levels of !,444 chairs per yearA B. 0reat ali i Company recently expanded its manufacturing capacity, 'hich 'ill allo' it to produce up to 1&,444 pairs of crosscountry bie of the mountaineering mode or the touring model. $he ales 7epartment assures management that it can sell bet'een D,444 pairs and 1#,444 pairs of either product this year. 3ecause the models are very similar, 0reat all 'ill produce only one of the t'o models. $he follo'ing information 'as compiled by the +ccounting 7epartment. Per"nit (Pair) 7ata /ountaineering $ouring elling price PBB.44 PB4.44 Variable costs &!.B4 &!.B4 ixed costs 'ill total P#*D,*44 if the mountaineering model is produced but 'ill be only P#1*,B44 if the touring model is produced. 0reat all i is subHect to a %4 percent income tax
RE,UIRED/ a. Compute the contribution margin for each product line. b. 5f 0reat all desires an aftertax net income of P!!,4B4, ho' many pairs of touring sis 'ill the company have to sellA c. ?o' much 'ould the variable cost per unit of the touring model have to change before it had the same breaeven point in units as the mountaineering modelA / 44!
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d. uppose the variable cost per unit of touring sis decreases by 14 percent, and the total ixed cost of touring sis increases by 14 percent. Compute the ne' breaeven point. e. uppose management decided to produce both products. 5f the t'o models are sold in e-ual proportions, and total ixed costs amounting to P#%#,!44, 'hat is the irmGs breaeven point in unitsA f. uppose that 0reat all decided to produce only one model of si. hat is the total sales revenue at 'hich 0reat all 'ould mae the same proit or loss regardless of the si model it decided to produceA g. 5f the 0reat all sales department could guarantee the annual sale of 1!,444 pairs of either model, 'hich model 'ould the company produce and 'hyA D. The accountant of Sirus Company is trying to prepare comparave income statements for the rst two months of the year 2012. However, he obtaine on!y the fo!!owing informaon"
ales Contribution margin ratio
2anuar3 P&44,444
Februar3
%4E
#*E
3reaeven sales ratio F4E F*E Changes in the given ratio are due to the decrease in sales price and ixed costs. RE,UIRED/ 1. Prepare the comparative income statements. !. Compute the breaeven point for ebruary. 14. nape Company has ixed expenses of P&4,444, a contribution margin ratio of %4E and a margin of safety ratio of !4E for a -uarterGs operations. RE,UIRED4 Compute the companyGs proit for the -uarter. 11. ollo'ing are data taen from the most recent income statement of hitney Company2 ales (%&,444 units at P14 per unit) P%&4,444 9ess cost of goods sold2 7irect /aterials D4,444 7irect 9abor FB,#44 /anufacturing overhead DB,&44 !**,B44 0ross margin 1B#,!44 9ess operating expenses2 elling expenses Variable2 ales commissions P!F,444 hipping &,%44 #!,%44 ixed (advertising, salaries) 1!4,444 +dministrative2 Variable (billing and other) 1,B44 ixed (salaries and other) %B,444 !4!,!44 ;et operating loss P(1D,444) +ll variable expenses in the company van= in terms of unit sold, except for sales commissions 'hich are based on peso sales. Variable manufacturing overhead is P4.#4 per unit. $here 'ere no beginning or ending inventories. hitney CompanyGs plant has a capacity of F&,444 units per year. $he company has been at a loss for several years. /anagement is studying several possible courses of action to determine 'hat should be done to mae next year proitable. RE,UIRED/ 1. $he president is considering t'o proposals prepared by his staff2 a. or next year, the vice president 'ould lie to reduce the unit selling price by !4E. he is certain that this 'ould ill the plant to capacity. b. or next year, the sales manager 'ould lie to reduce the unit selling price by !4E, increase the sales commission to DE of sales, and increase advertising by P144,444. 3ased on mareting studies, he is conident this 'ould increase unit sales by one
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third. Compute the amounts of income, one under the vice presidentGs proposal and the other one under the sales managerGs proposal. !. :efer to the original data. $he president believes it 'ould be a mistae to change the unit selling price. 5nstead, he 'ants to use less costly ra' materials, thereby reducing unit costs by P4.F4. ?o' many units 'ould have to be sold next year to earn a target proit of P#4,!44A #. :efer to the original data. hitney CompanyGs board of directors believes that the companyGs problem lies in inade-uate promotion. 3y ho' much can advertising be increased and still allo' the company to earn a target proit of %.&E on sale of *4,444 unitsA %. :efer to the original data. $he company has been approached by an overseas distributor 'ho 'ants to purchase D,&44 units on a special price basis. $here 'ould be no sales commission on the units. ?o'ever, shipping costs 'ould be increased by &4E and variable administrative cost 'ould be reduced by !&E. 5n addition, a P&,F44 special insurance fee 'ould have to be paid by hitney Company to protect the goods in transit. hat unit price 'ould have to be -uoted on the D,&44 units by hitney Company to allo' the company to earn a proit of P1%,!&4 on total operationsA :egular business 'ould not be affected by this special order. 1!. Pittman Company is a small but gro'ing manufacturer of telecommunications e-uipment. $he company has no sales force of its o'nK rather, it relies completely on independent sales agents to maret its products. $hese agents are paid a commission of 1&E of selling price for all items sold. 3arbara Cru6, PittmanGs controller, has Hust prepared the companyGs budgeted income statement for next year. $he statement sho's the follo'ing2 ales P1*,444,444 /anufacturing costs2 Variable PF,!44,444 ixed overhead !,#%4,444 D,&%4,444 0ross margin *,%*4,444 Commissions to agents !,%44,444 ixed mareting costs 1!4,444L ixed administrative costs 1,B44,444 %,#!4,444 ;et operating income !,1%4,444 9ess ixed interest cost &%4,444 5ncome before income taxes 1,*44,444 9ess income taxes (#4E) %B4,444 ;et income P 1,1!4,444 LPrimarily depreciation on storage facilities. +s 3arbara handed the statement to Marl Vega, PittmanGs president, she commented, @5 'ent ahead and used the agents 1&E commission rate in completing these statements, but 'eGve Hust learned that they refuse to handle our products next year unless 'e increase the commission rate to !4E.@ @$hatGs the last stra',@ Marl replied angrily. @$hose agents have been demanding more and more, and this time theyGve gone too far. ?o' can they possibly defend a !4E commission rateA@ @$hey claim that after paying for advertising, travel, and the other costs of promotion, thereGs nothing left over for proit,@ replied 3arbara. @5 say itGs Hust plain robbery,@ retorted Marl.@ +nd 5 also say itGs time 'e dumped those guys and got our o'n sales force. Can you get your people to 'or up some cost igures for us to loo atA@ @eGve already 'ored hem up,@ said Marl. everal companies 'e no' about pay a F.&E commission to their o'n salespeople, along 'ith a small salary. 8f course, 'e 'ould have to handle all promotion costs, too. e igure our ixed costs 'ould increase by P!,%44,444 per year, but that 'ould be more than offset by the P#,!44,444 (!4E x P1*,444,444) that 'e 'ould avoid on agentsG commissions.@ $he breado'n of the P!,%44,444 cost follo's2 alaries2 ales /anager P 144,444 alesperson *44,444 $ravel and entertainment %44,444 +dvertising 1,#44,444 $otal P!,%44,444 / 44!
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@uper,@ replied Marl. @+nd 5 noticed that the P!,%44,444 is Hust 'hat 'eGre paying the agents under the old 1&E commission rate.@ 5tGs even better than that,@ explained 3arbara, @e can actually save PF&,444 a year because thatGs 'hat 'eGre having to pay the auditing irm no' to chec out the agentGs reports. o our overall administrative costs 'ould be less.@ Pull all of these numbers together and 'eGll sho' them to the executive committee tomorro',@ said Marl. @ith the approval of the committee, 'e can move on the matter immediately.@ RE,UIRED/ 1. Compute Pittman CompanyGs breaeven point in peso sales for next year assumingK a. $hat the agentGs commission rate remain unchanged at 1& E. b. $hat the agentsG commission rate is increased to !4E c. $hat the company employs its o'n sales force !. +ssume that Pittman Company decides to continue selling through agents and pays the !4E commission rate. 7etermine the volume of sales that 'ould be re-uired to generate the same net income as contained in the budgeted income statement for next year. #. 7etermine the volume of sales at 'hich net income 'ould be e-ual regardless of 'hether Pittman Company sells through agents (at a !4E commission rate) or employs its o'n sales force. %. Compute the degree of leverage that the company 'ould expect to have on 7ecember #1 at the end of next year assuming2 a. $hat the agentsG commission rate remains unchanged at 1&E. b. $hat the agentsG commission rate is increased to !4E. c. $hat the company employs its o'n sales force. 1#. Pomfrey Company has annual ixed costs of PD4,444, 5n the year !411, sales increased by P11!,&44 from the !414 level of P##F,&44. Proit for the year !411 'as P*F,&44 higher than in !414. RE,UIRED/ 1. 5f there is no need to expand the companyGs capacity, ho' much should proit be in the year !41! if the budgeted sales volume is :*F&,444A !. hat is the companyGs breaeven pointA 1%. /oris CompanyGs breaeven sales 'ould increase from P#44,444 to P%44,444 if ixed costs 'ould go up by P%4,444. RE,UIRED/ +ssuming no change 5n the selling price and variable costs per unit, compute the companyGs 1. variable cost ratio !. ixed cost before and after the increase of P%4,444.
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