Cost-Volume- Profit Analysis

CVP analysis, sometimes termed break even analysis is an application of marginal costing and
seeks to study the relationship between costs, volume and profit at differing activity levels and can be a
useful guide for short term planning and decision making. It is a technique used to measure the effect on
profit as a result of changes in volume of activities, cost and prices. It also facilitates planning in the sense
that CVP analysis could assist to predict future cost levels and sales as related to a range of level of
activity. It demonstrates how the profit will be affected as a result of changes in any of the variables that
make up the profit function. Its use requires the separation of the total cost function into their variable and
fixed portion, as required in the application of marginal costing principles.

The objectives of CVP analysis is to provide solution to the under-mentioned questions:

a )How many units must an organization produce and sell in order to be able to absorb the total
cost of production or what is the break-even point in units?
b )What is the total turnover required by an organization in order to equate the total cost of
production or what is the break-even point in sales value?
c) What will be the turn over required by an organization for the purpose of achieving a pre-
determined level of profit.
d) Under a pre-determined amount of profit, how many units must an organization produce and sell
in order to achieve the desired profit target?
Basic Assumptions of C-V-P Analysis
a) All costs can be resolved into fixed and variable elements.
b) Semi-variable cost can be segregated into both the variable and its fixed components
c) Selling price per unit is constant.
d) Variable cost per unit is constant.
e) Total fixed cost remain unchanged regardless of output. F
f) Only one product is involved and in case of a multi-product organization, there is a constant
sales mix. G
g) The only factor affecting costs and revenues is volume h
h) Over the activity range being considered costs and revenues behave in a linear fashion i)Risk
and uncertainty are non-existent j)
i) There is a relevant range.
Limitations of the basic assumptions The basic assumptions of CVP have the following deficiencies:
a. It might be difficult to separate some costs into their fixed and variable cost portion. b)
b. The selling price per unit is assumed to be constant, this is not realistic because of possibility of
discounts
c. Variable cost per unit is assumed to be constant. This is not realistic because quantity discount
could result in decrease in material cost and labour cost per unit could fall whenever the
learning curve theory becomes applicable.
d. Fixed cost is assumed to remain unchanged. This is not true because in reality, fixed cost
moves in a step like manner.
e. It is assumed that production is equal to sale, hence no closing stock. This assumption looks
unrealistic because a business is a going concern and invariably stocks are carried from one
period to the other.
Basic terminologies in C-V-P-A a)
a. Break-even: Break even explains a situation where a company is making neither profit nor
loss. A company that makes neither profit nor loss is said to be breaking even. B
b. Contribution: this is the difference between sales revenue and variable cost or the addition of
fixed cost and profit.
c. Contribution margin ratio (CMR): This is also known as contribution to sales ratio (C/S ratio)
or Profit volume ratio. It is designed to measure the level of contribution derivable froma
specified amount.
d. )Margin of Safety: This indicates the extent to which sales may decrease before loss begin
to set in.
2Formulas involved in CVP Analysis
a. Break-even point (in units)=Fixed costs Contribution/unit
b. )C/s ratio=Contribution/unitx100 Sales price per unit
c. C/s ratio when selling price or sales value is omitted=FC + Profit Contribution + Variable
cost
d. C/s ratio when net profit is presented at different levels of activity=change in profit Change
in sales value
e. Break-even point (N Sales)=Fixed costORBreak even point in unit x Selling price. C.M.R
f)Level of sales to result in target profit (in units)=Fixed costs +Target profits
Contribution/unit
f. Note:The target profit is always profit before tax and not profit after tax. Howeverif profit after
tax is given the following formula should be used to convert it to profit before tax.
Profit before tax =Profit after tax 1 -tax rate g
 g. Level of sales to result in target profit (N sales) =(Fixed cost + Profit) x Sales price/unit
Contribution/unit
h. Margin of safety in unit =Budgeted/Actual sales unit-B.E.P in unit.
i. Margin of safety in sales value =Budgeted/Actual sales value-B.E.P in sales value.
j. Margin of safety in percentage=expected/ Actual sales-B.E.P sales Expected/Actual sales
Note that C/s + V/s = 1.Where V/S is variable cost to sales.
C-V-P-A in a multi- product firm A firm is said to be a multi-product firm if it produces more than a
product. In this situation, the B.E.P of a particular product line will not represent the B.E.P of the entire
organization. This is due to the fact that individual product is expected to operate under different cost
structure, marketing strategy and also different market all together.
Steps involved in ascertaining B.E.P in a multi- product firm
1) Identify the total fixed cost of the entire organization irrespective of the number of product lines.
2) Compute the contribution margin ratio for the entire organization using either the total value method
or the weighted average method.
3) Use the information obtained in one and two above to determine the break even in sales value for
the entire organization irrespective of the number of product.
4) Determine the individual sales proportion as a percentage of the total sales value
5) )Apply the individual product sales percentage obtained above to the total B.E.P in sales value
obtained in (3) above.
6) )In order to identify the individual product B.E.P in unit, divide the individual product B.E.P in sales
value by their corresponding selling prices.
Break even Chart This is another way of presenting management with information about the effect on
revenue and profit at different levels of activity. It is an elementary form of profit volume graph.
Steps involved in construction of breakeven chart 1)
1. Select a scale for sales on x axis
2. Select a scale for cost and revenue on y axis.
3. Draw the fixed cost line parallel to the x axis.
4. Draw the variable cost line starting from y axis where you have the fixed cost to give total cost.
5. Draw the sales line starting from the point of origin (0) to end at maximum sales.

Profit Volume graph This is a development of the break- even chart and portrays the relationship of profit
to volume or output. It uses the same basic data as break even chart.
Steps involved in the construction of profit volume graph

a) Select a scale for sales on x axis.

b) Select a scale for fixed cost and profit on y axis
c) Divide the graph into two (2) areas, ne representing profit and the other representing loss.
d) On y axis, the area above the sales line represents profit and the area below the sales line represents
fixed cost.
e) Plot the required points for fixed cost and profit and draw a line to connect both of them.

QUESTIONS Question 1 The data below relates to a particular manufacturing company: YearTotal sales
(N)Total cost (N) 139,00034,800 243,00037,600 Required, determine: a)Total fixed cost. b)Profit volume
ratio c)Break-even point. d)The margin of safety for year 1 and 2. Question 2 Chin chun Limited
manufactured a single product with a sales of N500,000 per unit. The following also relate to the
organization: Raw materials 20kg @ N5,000/kgN100,000 Direct labour2 hours @ N75,000 per
hourN150,000 Variable overheads2 hours @ N25,000 per hourN50,000 Fixed costs are N30,000,000 per
annum. You are required to: a)Calculate the number of units to sell in order to break even. b)Sales at B.E.P
c)C/s ratio d)Number of units to be sold to achieve a profit of N40,000,000. Question 3 ABC Ltd
manufactures one product only which it sells at N20 per unit. Existing plant have a maximum capacity of
20,000 units at which level net profit is N1.50 per unit and the profit volume ratio is 20%. New plant is to be
purchased having a maximum capacity of 30,000 units per annum but which will result in fixed cost being
increased by N15,000 per annum. The variable cost will be reduced by N4 per unit and to achieve
increased sales, the selling price is to be reduced by N4/unit. You are required to: a)Explain what you
understand by the terms profit volume ratio and margin of safety. b)Calculate the revised PV ratio as a
result of the purchase of new plant. c)Calculate the number of units which will be required to be produced
using new plant to give a 50% increase in profit compared with maximum production using old plants
d)Calculate the margin of safety if the actual level of sales is 25,000 units assuming the new plant is
purchased. Question 4 Ayomide Ltd makes a single product with a sales price per unit of N10 and a
marginal cost per unit of N6, fixed costs are N60,000. Calculate. a)Number of units to break-even.
b)Contribution ratio
4c)Sales in Naira at break-even point. d)What number of units will need to be sold to achieve a profit of
N20,000 per annum. e)As (d) above but, assuming the profit is PAT and the tax rate is 40%. Question 5
Me and You company makes a single product with a sales price per unit of N20 and a marginal cost per unit
of N12 while fixed cost total up to N120,000 per annum. You are required to calculate the following:
a)Number of units to break-even. b)Sales in Naira at break-even point. c)Contribution to sales ratio d)What
number of units will need to be sold to achieve a profit of N40,000 per annum? e)What level of sales will
achieve a profit of N40,000 per annum. f)If the tax rate is 40% how many units will need to be sold to make
a profit after tax of N40,000 per annum. g)Because of increasing costs, the marginal cost is expected to
rise to N13 per unit and fixed costs to N140,000 per annum. If the selling price cannot be increased what
will be the number of units required to maintain a profit of N40,000 per annum? (ignore tax) Question 6
Infinite supplies Nig Ltd tentative budget forproduct OLIVA for 2012 is as follows: NN Sales (2,500 units @
N40/unit)100,000 Manufacturing cost of goods sold: Direct labour15,000 Direct materials14,000 Variable
factory overhead10,000 Fixed factory overhead5,00044,000 Gross Profit56,000 Selling Expenses:
Variable6,000 Fixed10,000 Administrative expenses: Variable5,000 Fixed10,00031,000 Operating
income25,000 Required: a)How many units of product OLIVA would have to be sold to break-even?
b)What would be the operating income if projected sales increased by 30%. Question 7 Draw a break-even
chart from the following figures. SalesProfit NN Year 16,400,000160,000 Year 27,000,000400,000 Predict
the variable cost, contribution, fixed cost and profit associated with N10 sales volume and set your
prediction in the form of a profit statement. Question 8 In a firm, a detailed budget of costs and sales at
various levels had been prepared but due to the computer operator's negligence, most of the information
was destroyed. The following are the data that could be rescued: Sales level (unit)6,0008,000 NN
5Material cost18,00024,000 Labour cost15,00019,000 Overhead cost11,70014,700 The selling price is
N8.00 per unit at all levels. You are required to compute: a)The fixed element, if any, of each component
cost. b)The breakeven point in units and values. Question 9 You are required to prepare to the board of
directors of ALI Ltd a break even chart based on the following information Activity level
(unit)5,00010,00015,00020,000 Fixed costN60,000N60,000N60,000N60,000 Selling price is N10 each and
variable cost is N5 per unit. Required: a)Determine the breakeven point in unit and sales value. b)Margin
of safety in unit and naira value. Question 10 Oyo Limited had the following results in the year 2012 N
Sales200,000 Total variable cost120,000 Fixed cost50,000 Profit30,000 Required: Draw the profit volume
graph using the above data. Question 11 A company manufactures and sells two products x and y. the
forecast data for a year are: Product xproduct y Sales (units)80,00020,000 Sales price per unitN12N8
Variable cost per unitN8N3 Annual fixed costs are estimated at N273,000. What is the break even point in
sales value with the current sales mix. Question 12 Indomie Ltd manufactures and sells two products A and
B, annual sales are expected to be in the ratio 1:3. Total annual sales are planned to be N420,000, product
A has a contribution to sales ratio of 40%, whereas that of product B is 50%. Annual fixed costs are
estimated to be N120,000. Find the budgeted break even sales value (to the nearest N1000) Illustration 13
For the forth coming year, the management accountant of Action Times Ltd has projected that sales and
contributions will have the following patterns: ProductsSalesSelling priceContributionCMR NNN
A180,0001854,0000.3 B42,00021(4,200)-0.1 C90,00045-- D168,0004267,2000.4 E120,0003060,0000.5
Required: determine the number of units of each product to be sold in order to earn a profit after tax of
N116,400 assuming the total fixed cost is N120,000 and tax rate is 20%.
6Question 14 Coca-Cola Ltd manufactures and sells four types of products under the brand names Ace,
Utility, Luxury and supreme. The sales mix in value comprises: BrandPercentage Ace 33 1/3 Utility41 2/3
Luxury16 2/3 Supreme8 1/3 100 The total budgeted sales (100%) are N600,000 per month. The variable
costs are: Ace60% of selling price Utility68% of selling price Luxury80% of selling price Supreme40% of
selling price a.The fixed costs are N159,000 per month. Calculate the break-even point for the products
on an overall basis. b.It is proposed to change the sales mix as follows with the total sales per month
remaining at N600,000 BrandPercentage Ace25 Utility40 Luxury30 Supreme5 Assuming that this
proposal is implemented, calculate the new break-even point. Question 15 Ariyo Ltd produces an electric
multi-purpose tol which sells for N10.50k. sales amounting to N4.2 million represents 80% capacity of the
factory and this is regarded as the normal level of activity with costs as follows: Prime cost per unitN4.50k
Factory indirect costsN220,000 (including variable cost of N60,000) Selling costsN170,000 (including
variable cost of N80,000) Distribution costsN100,000 (including variable cost of N60,000) Administration
costsN720,000 Local promotional commission payable averages 7.5% of sales value. You are required
to: (a)Calculate the break-even level (b)Prepare statements showing sales income, costs and profit: (i)At
the normal level of activity (ii)If unit selling price is reduced by 5% thereby increasing sales volume by
12.5% of the normal activity level (iii)If unit selling price is reduced by 10% thereby increasing sales
volume by 25% of the normal activity level. (c)Calculate the contribution margin ratio at the three levels of
the activity referred to in (b) above (d)Calculate the quantity to be sold under the price arrangements
referred to in b(iii) in order that the profit may be the same as in b(ii).
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