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IE 300
WRITTEN REPORT
COST VOLUME PROFIT RELATIONSHIPS
GROUP 6
De La Cruz, Jeraldene C.
Ramos, Cheska Mae R.
Regidor, Jhane Valerie ES.
Sanchez, Julets Keah T.
Bagting, Shendy L.
CEIT 06 601A
Prices of products
Volume or level of activity within the relevant range
Variable cost per unit
Total fixed cost
Mix of products sold
If the above items are known, the following relationships may be established
Contribution margin
Contribution margin ration
Example:
Dale own a company that manufactures bowling balls. These are the following
information on the unit pricing and variable cost for each unit of Bowling ball that she
produce and sell:
P10
P1
P2
P3
P6
Unit Selling Price Variable cost per unit = Contribution Margin per unit
P10 P6 = P4
Contribution Margin per unit - This is the excess of unit selling price over variable cost per unit
and the amount each unit sold contributes toward.
1. Covering fixed cost
2. Providing operating profit
In the example,
P10 P6 = P4
- This is means that for each unit we produce and sell, we are left with P4 toward our
profit.
P4 is how much Bowling ball contributes to our margin (Profit).
P10000
6000
P 4000
P 10,000,000
(6,000,000)
4,000,000
(2,500,000)
P 1, 500,000
The analysis above shows that if She sells each unit for P10, and the variable cost per unit is P6
and the total annual fixed cost are P2,500,000, if she sell 1 million units this year her net income
will be P1,500,000
What if this year Dale produce and sell 625,000 units and our total fixed costs for the year
are P2, 500,000?
Sales Revenue (625,000 X P10)
Variable Cost (625, 000 X P6)
= Contribution Margin
Total Fixed Cost
NET INCOME
P 6,250,000
(3,750,000)
2,500,000
(2,500,000)
0
The analysis above shows that if our company sells each unit for P10, the variable
cost per unit is P6 and the total annual fixed costs are P2,500,000, if she sell 625,000 units
this year our net income will be 0.
This is known as the break-even point and it tells us how much we need to sell just to
cover our cost
Break even point is the level of sales volume where total revenues and the total expenses are
equal, that is, there is either profit or loss. This point can be determined using CVP analysis. Breakeven point can be computed as follows:
1.
2.
3.
B. Weighted CM Ratio
=
Total weighted CM Ratio
Total weighted Sales
Break-even Analysis
The Income Statement for one of Manhattan Companys product shows:
Sales (100 units at P100 a unit).............................................. P10, 000
Cost of goods sold:
Direct Labor...............................
P1, 500
Direct materials used.................
1, 400
Variable factory overhead.......... 1, 000
Fixed factory overhead................
500
4,400
Gross profit.............................................................................
P 5, 600
Marketing expenses
Variable.....................................
P 600
Fixed.........................................
1,000
Administrative expenses
Variable....................................
500
Fixed........................................
1,000
3,100
Operating income.................................................................... P 2, 500
Required:
1.
Compute the break-even point in units
2.
If sales increase by 25%, how much will be the operating income?
3.
Compute the new break-even point in pesos if fixed factory overhead will
increase by
P1, 700.
Solution: Manhattan Company
(1) Break-even point = P500+P1, 000+P1000
P50
= 50 units
(2) Current Net Income
Add: Incremental Contribution
Margin (25 units x P50)
Operating Income
P2, 500
1,250
P3, 750
Required:
1.
The break-even point in units and in pesos.
2.
The number of units that must be sold to earn an income of P60, 000 before
income tax.
3.
The number of units that must be sold to earn an after-tax income of P90, 000.
Income tax rate is 40%
4.
The number of units required to break even if there is a 10% increase in wages
and salaries. Labor cost constitutes 50% of variable costs and 20% of fixed costs.
Solution:
(1)
BEP
BEP
= P792, 000
P6
= 132,000 units
= P792, 000
30%
= P2, 640,000
(2)
Desired net income
Add: Fixed costs
Contribution margin
Divided by: contribution margin unit
Total number of units
(3)
Desired net income after tax
Desired net income before tax
(P90, 000+ 60%)
Add: Fixed costs
Contribution margin
Divided by: contribution margin/unit
Total number of units
(4)
BEP
=
=
P60, 000
792,000
942,000
P6
157,000
P 90,000
P 150,000
792,000
P 942,000
P6
P157, 000
P20.00
P7.00
7.70
P 5.30
14.70
A
60%
40%
24%
(2)
BEP (P) = Fixed costs
Weighted CMR
= P150, 000
30%
= P500, 000
(3)
Desired net income
Add: Total Fixed costs
(P150, 000 x 130%)
Contribution margin
Divided by: Weighted CMR
Sales necessary to generate
desired net income
P 9,000
195,000
P204, 000
30%
P 680,000
B
40%
15%
+
6%
= 30%
Under the graphical approach, sales revenue, variable costs and fixed costs are
plotted on the vertical axis while volume is plotted on the horizontal axis.
The break-even point is the point where the total sales revenue line intersects the
total.
EXAMPLE
The company has annual fixed cost of $40, a unit selling price of $10, and a unit variable
cost of $6. Total sales 200 units.
PROFIT-VOLUME CHART
This chart focuses more directly on how profits vary with changes in volume. Profits are
plotted on the vertical axis while units of output are shown on the horizontal axis.
150,000
100,000
PROFIT LINE
50,000
0
-50,000
10,0
00
B
E
P
20,000 30,000
40,000 50,000 60,000
VOLUME (UNITS)
37,500
COMMENT
1. The analysis is valid for a limited range of 1. Failure to observe this limits would the
values the relevant and limited period working with unrealistic data.
of time.
2. Semi variable costs present a problem that
can be solved by segregating fixed and
2. All cost can be categorized as fixed or
variable portion.
variable.
a.
Variable
costs
change
proportionately with volume within the
relevant volume
Range.
b. Fixed costs are constant within the
relevant volume range.
3. Revenue change proportionately with 3. Price is constant for all volumes within the
volumes with selling price remaining constant. relevant change.
4. Data should be adjusted for any shifts in
4. There is a constant product mix.
product mix.
5. There are other factors affecting costs and
5. Changes in volume alone are responsible
revenues, but they are lessened if narrow time
for changes in costs and revenues
and volume limits are applied.
6. There is no significant change in inventories 6. Data should be adjusted if inventories
(i.e. in physical units, sales volume equals change markedly
production volume.
7. Operation leverage questions can be dealt 7. This should be supported with capital
with in the CVP framework.
budgeting approaches that consider the time
value of money.
8. The analysis is deterministic and 8. Uncertainly and probabilities approach
appropriate data can be found.
can be introduced. This will change decisions
in some cases.
REQUIRED:
(a) Prepare a break-even graph for the company.
(b) From the graph, how many units must be sold to break-even?
(c) What is the margin of safety in units?
Break-even Graph
Revenue and Cost (P)
B. Break-even sales
7,500 units
C. Margin of Safety
10,000 7, 500
2,500 units
Profit Volume Graph is the graphic that shows the relationship between a company's
earning (or losses) and its sales.
The Solimansing Company had the following revenue and cost data when 2,000 units
were sold:
Selling price per unit
Variable cost per unit
Fixed cost per unit
REQUIRED:
(A) Prepare a profit-volume graph for the company.
(B) Determine the break-even point from the graph.
(C) From the graph, determine how many must be sold to generate a net income of
P30,000.
Cost-volume-profit (CVP) analysis is used to determine how changes in costs and volume
affect a company's operating income and net income. In performing this analysis, there
are several assumptions made, including:
Woodstock is preparing its budget for the coming year and has made the
following projections about cost increases: materials 5%, labor 8% and all other costs
(including fixed), 6%. Production capacity is 200,000 units.
The President has been offered various proposals by the division manager as follows:
a. Maintain the present volume and sales price.
b. Produce and sell at capacity and reduce the unit price to P28
c. Raise the units price to P32, spend an extra P300, 000 on advertising and
produce and sell 180,000 units.
Required: Recommend action, based on quantification of alternatives
Margin of Safety
- measures the potential effect of the risk that sales will short of planned levels.
Margin of safety
Actual or Planned Sales
Fixed
P 14.00
P 12.00
Selling cost
2.50
5.50
General cost
0.25
7.00
Manufacturing cost
= P 875,000
P 8.75
= 100,000 units
50
P 50.00
P 14.00
Selling
2.50
General
0.25
Contribution margin/unit
P 33.25
24.50
Net Income/unit
2. a.
Margin of Safety
16.75
P 8.75
b.
= P 1, 315, 789
P 5,000,000
= 26%
Operating Leverage
- is the ratio of the contribution margin to profit
Operating Leverage =
Contribution Margin
Profit or Net Operating Income
The sales and cost data(s) are for two companies in the transportation industry:
Company A
Amount
Company B
Percent of Sales Amount
Percent of
Sales
Sales
P100,000
Variables cost
60,000
Contribution Margin
P 40,000
Fixed cost
30,000
Net Income
P 10,000
100%
60
40%
P100,000
30,000
P 70,000
100%
30
70%
60,000
P 10,000
Required:
1. Calculate the operating leverage for each company. If sales increase, which company
benefits more? How do you know?
2. Assumes sales rise 10 percent in the next year. Calculate the percentage increase in
profit for each company. Are the results what you expected?
Solution:
1. Operating leverage =
contribution margin
Net income
2.
Company A
Amount
Sales
Percent of Sales
P110, 000
Variables cost
Contribution Margin
Fixed cost
Net Income
Company B
100%
66,000
60
P 44,000
40%
30,000
33,000
P 77,000
P 17,000
14 10 =40%
10
Bs change in profit =
P110, 000
60,000
P 14,000
As change in profit =
Amount
17 10 = 70%
10
Percent of Sales
100%
30
70%