Cost-Volume-Profit (CVP) Analysis

(Study Notes CPA SPLE BATCH 2)

1.0 Relationship Between Cost, Volume (Activity), & Profit:

Production Level Total Variable
Total Fixed Costs Net Income*
(Activity) Costs
Increase Increase Constant Decrease
Decrease Decrease Constant Increase

*Disregarding effect of Production Level on Sales.

Sales Level Total Variable Total Fixed
Total Sales Net Income
(Activity) Costs Costs
Increase Increase Increase Constant Increase
Decrease Decrease Decrease Constant Decrease

2.0 Contribution Format Income Statement

2.1 An income statement that will be an aid in predicting the result of operation
2.2 Classify cost according to its behavior rather that its function
2.3 Format:
Sales xx
Variable Costs xx
Contribution Margin xx
Fixed Costs (xx)
Operating Income xx
2.4 Contribution Margin:
2.4.1 How much a unit of product would be able to contribute in covering fixed costs
and generating net income
2.4.2 Can be expressed on a Per Unit, in total, or Ratio basis.

3.0 The Break-Even Point

3.1
3.2 The level of activity wherein No Income was Earned or No Loss was Incurred by the entity.
3.3 Total Revenue = Total Costs (Variable + Fixed)
3.4 Act as the threshold of the firm’s sales.
3.5 Methods:

3.5.1 Graphical Approach;

 3.5.1.1 Point A – Revenue Line
3.5.1.2 Point B – y intercept (fixed cost line)
3.5.1.3 Point C – Total Cost Line
3.5.2 Equation Approach (Sales – VC – FC = Profit; where profit = 0);
3.5.3 Contribution Approach

4.0 Target Profit

4.1 The amount of before tax net income being desired by the firm in a particular operating
period.
4.2 Objective: What is the level of sales to achieve it?
4.3 Methods:
4.3.1 Equation Approach (Sales – VC – FC = Target Profit)
4.3.2 Contribution Approach
5.0 Margin of Safety
5.1 The amount that acts as an allowance, by which the firm’s total sales can decreased without
incurring any loss.
5.2 Methods:
5.2.1 As an amount: (Budgeted/Actual Sales less BES)
5.2.2 As a percentage of sales
6.0 Degree of Operating Leverage
6.1 Measures how sensitive the firm’s net income
6.2 It tells how “fixed cost-dependent” the firm is.
6.3 It is the number of times net income will change as compared to the changes in total sales.
6.4 Computation:
7.0 Using CVP in a Multiple Product Environment
7.1 Determine the CM/unit of each product
7.2 Determine the sales mix and the weighted CM:
7.2.1 Using total sales – the weighted CM will be based on the CM ratio
7.2.2 Using unit sales – the weighted CM will be based on the CM per unit
7.3 Determine of BES depending on the weighted CM.
8.0 Assumptions Used in CVP Analysis
8.1 Selling Price, Total Fixed Costs, Variable Cost per unit, and Sales Mix are constant
8.2 Operations are within the relevant range
Cost-Volume-Profit (CVP) Analysis (Practice Problem)