COST VOLUME PROFIT ANALYSIS (CVP)

(ABSORPTION AND VARIABLE COSTING)

I.

Definition
A. The analysis of the relationship among the three elements, i.e. cost,
volume and profit.
B. The study of how cost and volume affect profit, how volume affects cost
and how cost affects volume.

II.

Cost Behaviour
A. The way cost responds to changes in activity level.
B. Level of activity is measured in terms of units. Some examples are units
produced, hours worked, kilometers traveled and machine hours used.

III.

Terms
A. Variable Cost
1. A cost that changes in direct proportion to level of activity (cost
driver).
2. If the level of activity increases, the total variable costs will also
increase by the same percentage.
3. Variable cost per unit remains the same whether the level of activity
increases or decreases.
B. Fixed Cost
1.
A cost that is unchanged in total as volume changes within the relevant
range of activity.
2.
Relevant range the range within which the total fixed cost do not
change.
3.
Fixed cost per unit changes in direct proportion to level of activity, i.e.
when volume increases, fixed cost per unit decreases, and vice versa.
C. Mixed Cost
A cost that has a mixture of fixed cost and variable cost.
D. Absorption Costing
1. All costs are absorbed into production and thus operating statements
do not distinguish between fixed and variable costs.
2. Inventories are carried at total cost of manufacturing, meaning the
inventories contain both fixed and variable elements of
manufacturing costs.
3. Absorption cost is also known as product cost, which consists of
direct materials, direct labour and manufacturing overhead (fixed
and variable).
4. Unsold inventories at the end of the fiscal year, will carry the fixed
cost that is associated with the unsold units, to the next fiscal year.

E. Variable/Marginal Costing
1. This costing method assigns only the variable manufacturing
overhead to products.
2. Fixed costs, whether manufacturing or non-manufacturing, are
treated as period costs and written off as an expense each period.
3. Inventories are valued at variable costs only, i.e. direct materials,
direct labour and variable manufacturing overhead.
IV.

Graphical Presentation of Absorption and Variable Costing

Absorption Costing
Cost
Manufacturing Cost

Material

Labour

Non-Manufacturing cost
Overhead

Work in progress ------->Finished Goods------>Stmt. of Comprehensive Income

Variable Costing
Cost
Manufacturing Cost
Material

Labour

Non-Manufacturing cost
Overhead
VOH
FOH

Work in progress ------->Finished Goods------>Stmt. Of Comprehensive Income

V.

Example
The company produces frozen yogurt in five-gallon containers. The following are
the price and standard variable costs per container.
Sales price
Direct material
Direct Labour
Variable Overhead

RM15
RM 5
RM 2
RM 3

Budgeted Fixed overhead in 2015 was RM300,000. Actual production was

150,000 five-gallon containers of which 125,000 were sold. The company
incurred the following sales and administrative expenses.
Fixed
Variable
1.
2.
VI.

RM50,000 for the year

RM 1 per container sold

Compute the standard product cost per container under a) absorption

costing and b) variable costing.
Prepare the Statement of Comprehensive Income using (a) and (b).

Format of the Statement of Comprehensive Income

A. Absorption Costing (Conventional)
Sales
Less: Cost of Goods Sold
Beginning Inventory
Add: Cost of goods manufactured
Good available for sales
Less: Ending Inventory
Gross Profit
Less: Operating expense
Variable Sales and administration
Fixed Sales and administration expenses
NET PROFIT

xx
xx
xx
xx
(xx)
xx
xx

(xx)
xx
(xx)
xx

B. Variable Costing (Contribution margin)

Sales
Less: Variable Cost
Beginning Inventory
Add: Cost of goods manufactured
Cost of goods available for sale
Less: Ending Inventory
Variable Cost of Goods Sold
Add: Variable Sales and administration
Total variable cost
Contribution Margin
Less: Fixed Cost
Fixed factory overhead
Fixed Sales & Administration Expenses
NET PROFIT
VII.

xx
xx
xx
xx
(xx)
xx
xx
(xx)
xx
xx
xx

(xx)
xx

Breakeven Analysis
A business is said to breakeven when there is neither profit nor loss. This means
that costs are equal to revenue or revenue minus costs is equal to zero.
Cost = Revenue

or

Revenue Costs = 0

A. Breakeven Quantity
1. Breakeven quantity is the quantity of goods that the business must sell
in order to meet the total costs of production without earning any
profit or incurring any loss.
2. The formula to determine the quantity to be sold to breakeven is as
follows:
BEQty = Total Fixed Costs
CM/unit
where
CM/unit = SP/unit TVC/unit
BE breakeven
CM contribution margin
SP selling price
TVC total variable cost
B. Breakeven Sales
1. Breakeven sales are the amount of sales that the business must achieve
to meet the total costs of production without earning any profit or
incurring any loss.

2. The formula to determine the amount of sales to breakeven is as

follows:
BESales
= Total Fixed Costs
CM ratio
where
CM ratio =

CM/unit
SP/unit

3. The breakeven in sales can also be determined as follows:

BESales
VIII.

BEQty

SP/unit

Others
A business can also determine the amount of sales that it should achieve or the
quantity of goods that it should sell in order to earn a specific amount of net
profit.
A. To determine the amount of sales that must be achieved in order to get a
specific amount of net income, the following formula can be used:
Sales =

TFC + NI
CM ratio

where TFC total fixed costs

NI net income

Example:
If TFC = RM100,000, CM ratio = 0.5 and target NI = RM30,000, then
Sales =
=

100,000 + 30,000
0.5
RM260,000

B. To determine the quantity of goods that must be sold to achieve a specific

amount of net income, the following formula can be used:
Quantity

= TFC + NI
CM/unit

Example:
If TFC = RM100,000, CM/unit = RM2/unit and target NI = RM30,000,
then
Quantity to be sold
=

100,000 + 30,000
2
65,000 units

Matching
Fill in the blanks with the appropriate term.
1.

The costing method that assigns all manufacturing costs to products is called
_______________________.

2.

_________________________ is the sales level at which operating income is

zero.

3.

_______________________ does not change in total despite changes in volume.

4.

When a cost is part variable and part fixed, it is known as _________________.

5.

A scope of activity in which a specific relationship exists between cost and

volume is referred to as ______________________________.

6.

____________________________ is the costing method that assigns only

variable manufacturing costs to products.

7.

To determine ___________________________, it is calculated as the excess of

the sale price over the variable expense per unit.

8.

Total __________________________ changes in direct proportion to changes in

volume.

9.

Absorption costing income statement is also known as _________________

income statement.

10.

Variable costing income statement is also known as ________________________

income statement.

Terms
Absorption costing
Variable costing
Contribution margin
Conventional
Fixed cost
Variable cost

Mixed cost
Relevant range
Breakeven point
Breakeven sales
Breakeven quantity
Margin of safety

True or False
1. Mixed costs are part variable and part fixed.
2. Fixed cost per unit remains constant as production levels change.
3. If a unit sells for RM11.40 and has a variable cost of RM3.80, its contribution margin
ratio is RM15.20.
4. Contribution margin appears on a conventional statement of comprehensive income after
cost of goods sold.
5. Contribution margin is defined as sales revenue less fixed expenses.
6. If all other factors are constant, an increase in fixed costs will increase the breakeven
point.
7. Fixed costs divided by the contribution margin ratio would yield the ringgit amount of
breakeven sales.
8. The breakeven point is the minimum number of units a company must sell to earn a net
profit.
9. To determine the target sales in units, total fixed expenses plus the target operating
income are divided by contribution margin per unit.
10. When a company produces more units than it sells, absorption costing income will
exceed variable costing income.

Multiple Choice Questions

1.

When comparing each statement of comprehensive income under absorption and variable
costing, the net income will be different when:
A.
B.
C.
D.

2.

The number of units sold is the same as the number of units produced.
The number of units produced is more than the number of units sold.
The number of units sold is more than the number of units produced for the year.
Cannot be determined since additional information is needed.

Breakeven is when:
A.
B.
C.
D.

3.

Revenue less expenses equals zero.

Net income is zero.
Revenue is equal to costs.
All of the above.

If total fixed expenses is RM250,000 and contribution margin per unit is RM30, how many
units must the business sell if it wants a net income of RM50,000?
A.
B.
C.
D.
4.

8,333 units
6,666 units
10,000 units
Not enough information to determine the answer.

Which of the following statements concerning the statement of comprehensive income

under variable costing is true?
A. It has the same format as the statement of comprehensive income under
absorption costing.
B. It separates all costs into variable and fixed.
C. It shows gross profit after cost of goods sold.
D. It is prepared for external users of financial statements.

5.

Which of the following is a characteristic of a variable cost?

A.
B.
C.
D.

6.

Variable costs are fixed per unit and variable in total.

Variable costs do not change in total over the relevant range.
Variable costs do not vary in total with production and sales.
All of the above are characteristics of variable costs.

The following statements are all true except:

A. Mixed costs are part variable and part fixed.
B. Holding all other factors constant, if fixed expenses increase by 25%, the
breakeven point stays the same.
C. When a company produces more units than it sells, absorption costing income
will exceed variable costing income.
D. The breakeven quantity is the minimum number of units a company must sell to
meet its total expenses.

7.

Variable costs per unit will:

A.
B.
C.
D.

8.

Contribution margin is equal to:

A.
B.
C.
D.

9.

remain the same as production levels change

increase as production decreases
decrease as production increases
decrease as production decreases

fixed expenses plus variable expenses

fixed expenses minus variable expenses
sales revenue minus variable expenses
sales revenue minus fixed expenses

If the sale price per unit is RM75, variable expenses per unit are RM40, target operating
income is RM22,000, and total fixed expenses are RM16,500, the total number of units that
must be sold to reach the target operating income is:
A.
B.
C.
D.

1,100
963
629
513

10. All of the following costs are examples of variable costs except:
A.
B.
C.
D.

direct materials
sales commissions
salary of plant manager
delivery costs

11. Which of the following is a fixed cost?

A.
B.
C.
D.

direct materials
units-of-production depreciation
sales commissions
straight-line depreciation

12. Which of the following is a characteristic of a statement of comprehensive income under

contribution margin?
A. Contribution margin is identified as the difference between sales revenue and total
expenses.
B. The amount of gross margin is shown.
C. Variable and fixed expenses are combined into total expenses.
D. When variable costs are less than sales revenue, there is a positive contribution
margin.

13. Sales below the breakeven point indicate a ________ whereas sales above the breakeven
point indicate a __________.
A.
B.
C.
D.

loss, loss
loss, income
income, loss
income, income

14. If total fixed costs decrease while the sale price per unit and variable costs per unit remain
constant, the:
A.
B.
C.
D.

contribution margin increases

contribution margin decreases
breakeven point decreases
breakeven point increases

15. If the sale price per unit is RM68.50, the variable expense per unit is RM45, and total fixed
expenses are RM1,325,400, the breakeven sales in ringgit is:
A.
B.
C.
D.

RM 634,500
RM2,538,000
RM1,931,700
RM3,863,400

16. Given breakeven sales in units of 45,700 and a unit contribution margin of RM6, the total
number of units that must be sold to reach a target operating income of RM25,200 is:
A.
B.
C.
D.

1,813
49,900
45,700
4,200

17. Which of the following will decrease the breakeven point assuming no other changes in the
cost-volume-profit relationship?
A.
B.
C.
D.

an increase in the sale price per unit

an increase in the variable costs per unit
an increase in total fixed costs
a decrease in the sale price per unit

18. On a CVP graph, the intersection of the sales line and the total cost line is known as the:
A.
B.
C.
D.

breakeven point
margin of safety point
unit contribution margin
total cost point

19. A decrease in inventory will cause:

A. the same operating income under both a variable costing and absorption costing
statement of comprehensive income.
B. a lower operating income under a variable costing statement of comprehensive
income.
C. a higher operating income under a variable costing statement of comprehensive
income.
D. a higher operating income under an absorption costing statement of
comprehensive income.
20. If production exceeds units sold:
A. a higher operating income will result under a variable costing statement of
comprehensive income.
B. a lower operating income will result under an absorption costing statement of
comprehensive income.
C. the same operating income will result under both a variable costing and
absorption costing statement of comprehensive income.
D. a higher operating income will result under an absorption costing statement of
comprehensive income.

Essay
1. What are the characteristics of fixed costs and variable costs?
2. List the advantages of preparing a contribution margin statement of comprehensive
income.
3. When the number of units produced is different from the number of units sold, the net
operating income shown in statement of comprehensive income under both absorption
and variable costing will be different. Is this true? If so, why? If not, why not?

Problems
Question 1
Fill in the blanks using one of the following:

Stays the same

Decreases

Increases
a.
b.
c.
d.
e.
f.
g.
h.

As the number of units increases, the variable cost per unit ____________.
As the number of units decreases, the variable cost per unit ___________.
As the number of units increases, the fixed cost per unit ______________.
As the number of units decreases, the fixed cost per unit _____________.
As the number of units increases, the total variable cost ______________.
As the number of units decreases, the total variable cost ______________.
As the number of units increases, the total fixed cost _________________.
As the number of units decreases, the total fixed cost ________________.

Question 2
Suppose you were recently hired as an accounts assistant at Optical Cable Corporation. Your
boss, Bob Kancil, hands you the following information from Novembers operations and asks
you to compute gross profit and contribution margin.
Sales revenue
Sales commissions
Variable manufacturing cost of goods sold
Fixed marketing expense
Research and development (fixed)
Fixed manufacturing cost of goods sold
Delivery expense (variable)

RM 120,000
2,500
50,000
12,000
3,000
20,000
5,000

Question 3
The Notime Company manufactures and sells fine watches. The following data cover the latest
year of operations:
2015
Selling price

RM

Sales in units

140
25,000

Fixed manufacturing overhead costs

RM 320,000

Fixed marketing and administrative costs

RM 490,000

Standard variable costs per unit

Direct materials

RM 10.00

Direct manufacturing labour

RM 29.00

Variable manufacturing overhead

RM 15.00

Variable marketing and administrative

RM 31.00

REQUIRED:
A. Prepare a conventional statement of comprehensive income and contribution margin
statement of comprehensive income for the information above.
B. Notime Company marketing vice president believes a new sales promotion that costs RM
250,000 would increase sales to 35,000 units. Should the company go ahead with the
promotion? Give your reasons.
(CM and Conventional, Net Income: RM565,000)

Question 4
Fast Noodles Company gathered the following information for the year ended 31 December
2015:
Fast Noodles Company
Statement of Comprehensive Income for the year ended 31 December 2015
Sales revenue
Cost of goods sold
Gross margin
Operating expenses:
Marketing expenses
Administrative expenses
Total operating expenses
Operating income

RM 650,000
455,000
195,000
RM 52,000
73,000
125,000
RM 70,000

Total fixed manufacturing expenses amounted to $210,000. Marketing expenses were 25%
variable and 75% fixed. Administrative expenses were 80% fixed and 20% variable.
REQUIRED:
A. Prepare a contribution margin statement of comprehensive income.
B. Fast Noodles marketing manager believes a new sales promotion that cost RM10,000
would increase sales to RM700,000. Should the company go ahead with the promotion?
(Net income: RM70,000; Yes)

Question 5
The 2015 data that follow pertain to the Ehsan star Company, manufacturer of a single product:
RM
Sale price per unit
120.00
Variable manufacturing cost per unit
95.00
Variable operating cost per unit
15.00
Fixed manufacturing cost
500,000
Fixed operating cost
250,000
Units produced
Units sold

100,000
90,000

REQUIRED:
A. Prepare both conventional (absorption costing) and contribution margin (variable costing)
statement of comprehensive income for Ehsan Star Company.
B. Which statement shows the higher operating income? Why?
C. Ehsans marketing vice-president believes that a sales promotion that costs RM75,000
would increase sales to 100,000 units. Should the company go ahead with the promotion?
Give your reason.
D. How many units must the company sell to breakeven? Show your workings.
(NET INCOME=RM200,000, RM150,000, BEP=75,000)
Question 6
The DVD Company manufactures compact discs. Each disc sells for RM3.50 with unit variable
manufacturing expenses of RM1.50. For the year ended 31 December 2015, total fixed
manufacturing expenses were RM325,000 and 500,000 discs were produced and 430,000 discs
were sold. Marketing expenses amounted to RM40,000 in fixed expenses plus 10% of sales.
Administrative expenses included RM17,500 in fixed expenses and variable expenses equal to
6% of sales.
REQUIRED:
A. Prepare a conventional statement of comprehensive income for the year ended 31
December 2015.
B. Prepare a contribution margin statement of comprehensive income for the year ended 31
December 2015.
C. How many units must be sold to breakeven? How much is the breakeven in sales?
(Net Income= RM282,200, RM236,700, BEP=265,625, RM929,687.50)

Question 7
Rahmat Signatures imprints T-shirts with company logos. Rahmat has fixed expenses of
RM585,000 per year plus variable expenses of RM4.20 per T-shirt. Each T-shirt sells for
RM12.00.
REQUIRED:
A. Use the statement of comprehensive income equation approach to compute the number of
T-shirts Rahmat must sell each year to break even.
B. Use the contribution margin ratio CVP formula to compute the ringgit sales Rahmat
needs to earn RM32,500 in operating income.
C. Prepare Rahmats contribution margin statement of comprehensive income for 2015 for
sales of 70,000 T-shirts.