CHAPTER 1

THE PROBLEM AND ITS BACKGROUND

Introduction
In the business world where firms battle for customers and strive for
victory over forces of downturns and struggles, management accounting is very
essential. It plays a vital role in the decision-making process of the management.
It combines accounting, finance and management with the leading edge
techniques needed to drive successful businesses. It is used in analyzing
information that is used in making decisions, formulating strategies that create
higher competence level of the enterprise, identifying and managing risks,
planning and budgeting. These functions by management accounting provide
improvements for the operations of a company.
One analysis undertaken by the management is the cost-volume-profit
(CVP) analysis. CVP analysis is the study of the relationship between the cost
and the sales volume of a cost object and how it affects the companys profit. It is
a necessary tool in establishing requisites of a profitable business operation.
Such requisites, as enumerated by Payongayong (2006), are operating costs,
required level of business activity, and planning and control of target profit. It
helps the management to have a view on the cost structure of an enterprise
which is very important in determining the required level of business activity. Cost
structure is relationship among the various expenses that a firm must take into
account when manufacturing a product or providing services. The cost structure
of a firm is the ratio of fixed costs and variable costs to an appropriate point of
reference, that is, sales. The objective of defining the cost structure is to

determine how much volume of sales is needed to sustain the operations fixed
and variable costs. After defining cost structure, the next step is solving for the
breakeven sales and subsequently, the required sales to achieve the
managements target profit.
Making necessary decisions within the management keeps the firms
operations profitable. It helps in carrying out strategies and policies that are used
to achieve the target operating profit of the firm effectively and efficiently. Thus,
decision making should be taken in a deeper perspective to ensure that the
companys operations are still fulfilling its objectives and leading the whole
business enterprise towards its goals.

Background of the Study

CVP analysis is a systematic method of examining the effects of changes
in an organizations volume of activity on its costs, revenue and profit. It is useful
for the management in knowing how profit is influenced by sales volume, sales
price, variable expenses and fixed expenses. A critical part of CVP analysis is the
point where total revenues equal total costs, both fixed and variable costs. Such
point is called the breakeven point (BEP), where a company will experience
neither income nor loss. CVP analysis can simplify the computation of BEP in
break-even analysis.
Mindanao Container Corporation (MCC), established in 1989 by A.
Soriano Corporation and Aboitiz & Company and years later, Grupo F. Jacinto
invested into the corporation, specializes in production and marketing of high-

quality 210-liter steel drums. MCC considers itself as the leader in the industry of
steel drums. It is a dynamic and experienced organization that has invested more
than 20 years of drumming excellence in the Philippines since 1989 and is
definitely committed in providing its clients with quality drums which are also
tailor-fitted to their needs and requests. It envisions itself to be the premier
manufacturer of quality steel drums here and abroad.
In this study, the interviewees were Ms. Macky Mendoza, Financial
Manager, and Ms. Gregoria Guillermo, the former Financial Manager of MCC.
They had a chance to answer pertinent questions that are essential for
conducting the study. These questions would help them to evaluate the
companys operations, whether they meet the standards set by the companys
management or not. Such standards are designed by the management to have a
close control on the operations of a company. These would also measure the
cost structure of the companys production of steel drums, the level of companys
volume of activity, the companys profitability and other aspects that may affect its
operations.
The researchers would be able to determine if MCCs management, in
relation to producing and marketing its products, is effective and competitive
enough to really consider itself as the leader in steel drum industry. Since
studying multiple product lines within a limited period of time will be impracticable
for the researchers, the cost structure of a particular product is the chosen object
of this study.

Theoretical Framework
Managers of profit-oriented organizations find that cost-volume-profit
analysis is the best tool to profit maximization. In having this analysis, an
understanding of cost theory is a must.
Cost theory is a classic thought in economics proposed by Adam Smith
that deals with how individuals and firms allocate resources in such a way that
keeps costs low and benefits high. It is based on the central economic concept
that getting something requires giving up something else. Cost theory contains
various measures of costs, namely fixed costs and variable costs. The former
does not vary with the quantity of goods produced while the latter changes with
the number of units being run or finished in production. Cost theory also
encompasses profit maximization which employs cost-volume-profit analysis as a
technique

(http://www.ehow.com/about_5432534_cost-theory-economics.html.

Retrieved August 28, 2013).

Kelly (2010) pointed out that most inputs are xed only for a certain range
of production. Examples given were salaried workers who only work for a certain
number of hours otherwise paid with overtime premiums and fixed assets that
need additions and improvements to increase capacity. The formula for
determining breakeven sales is presented as follows:
Q =

TFC
P-AVC

In the preceding equation, Q stands for quantity to be sold, TFC stands for
total fixed costs, P stands for selling price per unit, and AVC stands for average

variable cost per unit. The denominator is the same as the unit contribution
margin.
Drury (2006) explained that CVP analysis is based on the relationship
between volume and sales revenue, costs and profit in the short run, the short
run normally being a period of one year, or less, in which the output of a firm is
restricted to that available from the current operating capacity. In the short run,
some inputs can be increased, but others cannot. Output is limited in the short
run because plant facilities cannot be expanded. It also takes time to reduce
capacity, and therefore in the short run a firm must operate on a relatively
constant stock of production resources. Furthermore, most of the costs and
prices of a firms products will have already been determined, and the major area
of uncertainty will be sales volume. Short-run profitability will therefore be most
sensitive to sales volume. CVP analysis thus highlights the effects of changes in
sales volume on the level of profits in the short run.

Conceptual Framework
The conceptual framework discussed the flow of the study to be taken.
The study used the systems approach. The system of three (3) frames is
composed of input which went through the process or operation and emerged as
the output.

INPUT
Cost Structure

Variable Cost
of Goods Sold
Fixed Production
Costs
Operating
Expenses
Level of Business
Activity
Sales
Operating
Capacity
Breakeven Sales
Degree of
Operating
Leverage
Margin of Safety
Level of Profitability

PROCESS

OUTPUT
Policy
Recommendations
for:

Triangulation:

Managing and
Reducing the
Cost of the
Companys
Product Line

Planning
Expansion to
International
Territories

Applying CVP
Analysis in Sales
Planning

Operating a
Similar Firm

Conducting
Further Studies
Related to CVP
Analysis

Structured
Interview

Document
Review

Observation

Cost Management
Practices
Management of
Variable Costs
Management of
Fixed Costs
Volume-Related
Policies

Pricing
Advertising and
Promotion

Product
Development

Feedback
Figure 1. Conceptual Paradigm
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The input contains the aspects that may affect the cost, volume and profit
levels of the product. It includes the cost structure of the product, level of
business activity, profitability, cost management practices, and volume-related
policies.
The second frame contains the methods and procedures to be undertaken
in the study to gather and analyze information by making the interview guide,
conducting interviews, reviewing pertinent documents, and observation of
relevant activities.
The third frame is the output. It contains having a general view on the
cost, volume and profit levels of the product, analysis of the firms policies
relating to cost, volume and profit, and commentaries and recommendations
about the role of cost-volume-profit analysis in formulating and implementing
business policies.
The arrows include the workflow of information in the research process.
The feedback loop connects the output to the process involved as well as to the
input. It made the system continuous.

Statement of the Problem

This research aimed to capture a general view on the cost, volume
and profit levels of manufactured steel drums. Furthermore, the study was
undertaken to provide an understanding about the application of cost-volumeprofit analysis in setting up policies regarding cost management, sales and
profitability of the said product line.

Specifically, the study endeavored to answer the following:

1 What is the cost structure of the product line broken down into
1 Variable Cost of Goods Sold;
2 Fixed Production Costs; and,
3 Operating Expenses?
2 What is the level of the product lines business activity identified by
1 Sales;
2 Operating Capacity;
3 Breakeven Sales;
4 Degree of Operating Leverage; and,
5 Margin of Safety?
3 What is the level of profitability of the product?
4 What are the cost management practices undertaken by the company with
regards to
1 Management of Variable Costs; and,
2 Management of Fixed Costs?
5 How does the company implement its volume-related policies relating to
1 Pricing;
2 Advertising and Promotion; and,
3 Product Development?

Scope and Limitations

This study was conducted to capture a general view of the cost, volume
and profit levels associated with the steel drums manufactured by MCC. The
aspect looked into were the cost structure, level of business activity, profitability,
cost management practices and volume-related policies of the chosen product
since studying multiple product lines within a short period of time is somehow
impracticable for the researchers.
The interviewees of the study were Ms. Macky Mendoza, Financial
Manager of MCC, and Ms. Gregoria Guillermo, former Financial Manager of
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Mindanao Container Corporation. The interviewees were chosen based on their

knowledge and responsibility on the topic involved in the study which is all about
the operations of the firm. The interview was conducted on September 26, 2013,
in Mindanao Container Corporations administration office, Makati City.

Significance of the Study

This study was anticipated to contribute additional information to serve the
following individuals and organizations.
Mindanao Container Corporation. This study will give the company a
general view on the cost, volume and profit levels of its product that may aid the
firms management in decision-making. It will also provide the companys
management commentaries regarding the role of CVP analysis in implementing
business practices, as well as recommendations on how the management would
improve such practices.
Prospective Investors. This study will help prospective investors to have
a general idea about the costs incurred in operating a similar firm and the
required revenues to cover these costs and their desired profit. The study will
also be useful in showing investors how to perform cost-volume-profit analysis
with respect to the specific operation discussed herein.
The Academe. This study will contribute to the academe by providing
them additional reference material available for study and other research
activities. This study may also be used for classroom instruction and teaching.

Students. This study will allow students to have knowledge about the
application of cost-volume-profit analysis in the real business world.
Other Researchers. This study will be an effective tool and reference for
the researchers who would intend to make any further relevant study particularly
the actual application of cost-volume-profit analysis.

Definition of Terms
For better understanding and interpretation of this study, operational
definitions of important terms are provided hereunder.
Advertising and Promotion. This refers to a volume-related policy that
covers all advertising expenses, such as promotions, signs, window dressings,
catalogues, and the like.
Breakeven Analysis. This refers to a technique under financial
management that is utilized to determine breakeven sales.
Breakeven Sales. This refers to the revenue from sales necessary to
cover costs and prevent a firm from operating at a loss.
Consolidating. This refers to combining related data to capture a general
view of a particular subject.
Cost. This refers to the cost structure of a particular product or service.
Cost Management Practices. This refers to the policies and actions
implemented by the firm to manage variable and fixed costs.
Cost Object. This refers to a product or a service offered by a firm for
which costs accumulate.

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Cost Structure. This refers to the general composition of the products

total cost which includes variable cost of goods sold, fixed production costs, and
operating expenses.
Cost-Volume-Profit Analysis. This is a technique employed by managers
to study the relationships among cost, volume, and profit levels of a particular
product, service, or project that includes principles about changes in cost and
volume levels and how these changes affect the level of profitability of a
particular cost object.
Cost-Volume Formula. Depiction of total cost in algebraic form (i.e. total
cost = fixed costs + variable cost per unit multiplied by the number of units sold).
Degree of Operating Leverage. It is a measure, at a given level of sales,
of how a percentage change in sales volume will affect profits. The degree of
operating leverage is computed by dividing contribution margin by net income.
Depreciation. This refers to the wear and tear of fixed assets used in
production and administration of business affairs.
Direct Labor. This is comprised by the basic pay received by workers
directly involved in the cost object plus 13th month pay.
Distribution Expenses. These are expenses incurred for transferring the
companys product from plant to customers.
Document Review. Thorough analysis of relevant documents, such as
financial statements, general information sheets, purchase order documents and
the like, provided by the company itself and by the Securities and Exchange
Commission (SEC) in order to be assured that the processes undertaken by the

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company that were observed by the researchers are properly recorded and
documented.
Fixed Production Costs. These are the costs incurred in producing or
rendering a service that remain constant regardless of volume.
General View. This refers to a perspective of existing owners of the firm,
or the companys representatives, that can be used as a projection of a possible
owners view on cost, volume and profit related to a particular business venture.
Interview Guide. An instrument used by the researchers to guide them in
gathering information during the interview.
Level of Business Activity. This refers to the level of sales, operating
capacity, breakeven sales, degree of operating leverage, and margin of safety
related to the product studied.
Level of Profitability. This refers to the overall profitability of the product
defined by operating income and return on investment.
Levels. These are the quantities or relative amounts of sales, variable
costs, fixed costs, and earnings before interest and taxes of a particular product
or service.
Margin of safety. It is the excess of budgeted (or actual) sales over the
break-even volume of sales.
Mindanao Container Corporation (MCC). This is the company chosen
by the researchers in conducting their study.
Observation Sheet. This is a sheet that lists a number of processes that
the company undertakes during its operations that were observed by the

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researchers, as well as the findings and the sub-problems that were being solved
through observation.
Operating Capacity. This refers to the amount of production capacity that
can be made available in the short-term
Operating Expenses. This is equal to general administrative expenses
plus distribution and marketing and selling expenses.
Particular Product or Service. This refers to the cost object chosen by
the researchers to be the subject of the study.
Product Development. This refers to improving an existing product or
developing new kinds of products.
Product Line. This refers to marketing a group of related products
marketed by the same company
Profit. This refers to earnings before interest and taxes.
Profitability. This refers to the status of operating income earned in
selling a product or service.
Raw Materials. These include the direct and indirect materials used to
produce a product.
Sales. This refers to the quantity of units or amount sold by the company
within a specified period.
Saturated Market. This refers to the type of market where supply is
greater than the demand for the product. This is the type of market wherein the
company operates.

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Scrap Materials. These are parts of materials that are no longer needed
in production and therefore disposed.
Scrap Value. This refers to the fair market value or selling price of scrap
materials.
The Company. This refers to Mindanao Container Corporation.
Triangulation. This is the process undertaken by the researchers in order
for them to gather relevant information in conducting the study and corroborating
the same to come up with their conclusions.
Variable Cost of Goods Sold. This refers to the variable production costs
associated with a product.
Variable Overhead. This includes overhead costs that vary as to volume
of sales.
Volume. This is the level of sales or revenues of a particular product or
service.
Volume-Related Policies. This refers to the policies implemented by the
firm to increase sales such as pricing, advertising and promotion, and product
development.

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