Gross profit is the difference between the cost of goods sold and sales.
Since the adherence of the actual to the budgeted or standard gross profit figure is highly desirable, a careful analysis of unexpected changes in gross profit is useful to a company's management. These changes are the result of one or a combination of the following.
Changes in sales prices of the products.
Changes in volume sold.
a. Changes in number of physical units sold.
b. Changes in the types of products sold, often called the product mix or sales mix.
Changes in cost elements, i.e., materials, labor, and overhead costs.
Procedures for analyzing gross profit:
The determination of the various causes for an increase or decrease in gross profit is similar to the computation of standard cost variances, although gross profit analysis is often possible without the use of standard costs or budgets. In such a case, prices and costs of the previous year, or any year selected as the basis for the comparison, serve as the basis for the calculation of the variances. When standard costs and budgetary methods are employed, however, a greater degree of accuracy and more effective results are achieved.
Gross Profit Analysis Based on the Previous Years Figures
Gross Profit Analysis Based on Budgets and Standard costs
Discussion Questions and Answers about Gross Profit Analysis
Gross Profit Analysis Solved Problems
Gross Profit Analysis Case Study
Uses of Gross Profit Analysis:
The gross profit analysis based on budgets and standards costs depicts the weak spots in the year's performance. Management becomes able to outline the remedies that should correct the situation. The planned gross profit is the responsibility of the marketing as well as the manufacturing department. The gross profit analysis brings together these two major functional areas of the firm and points to the need for further study by both of these department. The marketing department must explain the changes in the sales prices, the shift in the sales mix, and the decrease in units sold, while the production department must account for the increase in cost. To be of real value, the cost price variance should be further analyzed to determine variances for materials, labor, and factory overhead.
Gross Profit Analysis Based on the Previous Year's Figures:
As the basis for illustrating the gross profit analysis using the previous year's figures, the following gross profit section of a company's operating statements for 19A and 19B are presented.
19A
19B
Changes
Sales (net)
Cost of goods sold
Gross profit
$120,000
$100,000
----------
$20,000
=======
$140,000
$110,000
---------
$30,000
=======
+$20,000
+$10,000
----------
+$10,000
=======
In comparison with 19A, sales in 19B increased $20,000 and costs increased $10,000, resulting in increase in gross profit of $10,000.
Additional data taken from various records indicate that the sales and the cost of goods sold figure can be broken down as follows:
19A Sales
19A Cost of goods sold
Product Quantity Unit Price Total Unit Cost Total
X 8,000 Units $5.00 $40,000 $4.000 $32,000
Y 7,000 Units $4.00 $28,000 $3.500 $24,500
Z 20,000 Units $2.60 $52,000 $2.175 $43,500
---------- ----------
$1,20,000 $1,00,000
======= =======
19B Sales
19B Cost of goods sold
Product Quantity Unit Price Total Unit Cost Total
X 10,000 Units $6.60 $66,000 $4.00 $40,000
Y 4,000 Units $3.50 $14,000 2.50 $14,000
Z 20,000 Units $3.00 $60,000 2.80 $56,000
-------- -------
140,000 110,000
====== =====
In analyzing the gross profit of the company, the sales and cost of 19A are accepted as the basis (or standard) for all comparisons. A sales price variance and a sales volume variance are computed first., followed by the computation of a cost price variance and a cost volume variance. The sales volume variance and cost volume variance are analyzed further as a third step, which result in the computation of a sales mix variance and a final sales volume variance.
Calculation of sales price and sales volume variance:
The sales price and sales mix variances from the above data are calculated as follows:
Actual 19B sales $140,000
Actual 19B sales at 19A price:
X: 10,000 units @ $5.00 $50,000
Y: 4,000 units @ $4.00 $16,000
Z: 20,000 units @ $2.60 $52,000
------- $118,000
-------
Favorable sales price variance $22,000
=======
Actual 19B sales at 19A price $118,000
Total 19A sales (used as standard) $120,000
------
Unfavorable sales volume variance $2,000
======
Calculation of Cost Price and Cost Volume Variance:
The cost price and and cost volume variances are calculated as follows.
Actual 19B cost of goods sold $110,000
Actual 19B sales at 19A cost:
X: 10,000 units @ $4.000 $40,000
Y: 4,000 units @ $3.500 $14,000
Z: 20,000 units @ $2.175 $43,500
--------- $97,500
---------
Unfavorable cost price variance $12,500
========
Actual 19B sales at 19A cost $97,500
Cost of goods sold in 19Aused as standard $100,000
---------
Favorable cost volume variance $2,500
========
The result of the preceding computations might explain the reason for the $10,000 increase in gross profit.
Favorable sales price variance $22,000
Favorable volume variance (net) consisting of:
Favorable cost volume variance $2,500
Less unfavorable sales volume variance $2,000
--------
Net favorable volume variance $500
--------
$22,500
Less unfavorable cost price variance $12,500
-------
Increase in gross profit 10,000
=====
Calculation of the sales mix and final sales volume variance:
The net $500 favorable volume variance is a composite of the sales volume and cost volume variance. It should be further analyzed to determine the more significant sales mix and final sales volume variances. To accomplish this analysis, one additional figure must be determined―the average gross profit realized on the units sold in the base (or standard) year. The computations is:
Total gross profit ÷ Total number of units sold
= $20,000 ÷ 35,000
= $0.5714
The $0.5714 average gross profit per unit sold in 19A is multiplied by the total number of units sold in 19B (34,000 units). The resulting $19,427 is the total gross profit that would have been achieved in 19B if all units had been sold at 19A's average gross profit per unit.
The sales mix and final sales volume variance can now be calculated:
Actual 19B sales at 19A sales price $118,000
Actual 19B sales at 19A cost $ 97,500
-------------
Difference $20,500
19B sales at 19A average gross profit $19,427
---------
Favorable sales mix variance $ 1,073
======
19B sales at 19A average gross profit $19,427
Total 19A sales (used as standard) $120,000
Cost of goods sold in 19A (used as standard) 100,000
--------- 20,000
---------
Unfavorable final sales volume variance $573
======
Recapitulations of Variances:
The variances identified in the preceding calculations are summarized below:
Gains
Losses
Gain due to increased sales price $22,000
Loss due to increased cost $12,500
Gain due to shift in sales mix $1073
Loss due to decrease in units sold
$573
--------- ---------
Total $23073 $13073
Less $13073
---------
Net increase in gross profit
$10,000
=======
Gross Profit Analysis Based on Budgets and Standard Costs:
As the basis for illustrating the analysis of gross profit using budgets and standard costs, three financial statements for a company are presented:
The budgeted income statement prepared at the beginning of the period
The actual income statement prepared at the end of the period.
An income statement prepared at the end of the period on the basis of actual sales at budgeted sales prices and at standard costs.
Statement 1:
Income Statement (Budgeted)
Product Units Sales Cost Gross Profit
Unit price Amount Unit cost Amount Per unit Amount
A 6,000 $15.00 $90,000 $12.00 $72,000 $3.00 $18,000
B 3,500 $12.00 $42,000 $10.00 $35,000 $2.00 $7,000
C 1,000 $10.00 $10,000 $8.75 $8,750 $1.25 $1,250
------- ------- -------- ------- ------- ------- --------
10,500 $13.52* $142,000 $11.02* $115,750 $2.50* $26,250
===== ===== ===== ===== ===== ===== =====
*Weighted average
Statement 2:
Income Statement (Actual)
Product Units Sales Cost Gross Profit
Unit price Amount Unit cost Amount Per unit Amount
A 5,112 $16.00 $81,792 $13.98 $71,466 $2.02 $10,326
B 4,208 $12.00 $50,496 $9.72 $40,902 $2.28 $9,594
C 1,105 $9.00 $9,945 $8.83 $9,757 $0.17 $188
------- ------- -------- ------- ------- ------- --------
10,425 $13.64* $142,233 $11.71* $122,125 $1.93* $20,108
===== ===== ===== ===== ===== ===== =====
*Weighted average
Statement 3:
Income Statement (Actual units at budgeted prices and costs)
Product Units Sales Cost Gross Profit
Unit price Amount Unit cost Amount Per unit Amount
A 5,112 $15.00 $76,680 $12.00 $61,344 $3.00 $15,338
B 4,208 $12.00 $50,496 $10.00 $42,080 $2.00 $8,416
C 1,105 $10.00 $11,050 $8.75 $9,669 $1.25 $1,381
------- ------- -------- ------- ------- ------- --------
10,425 $13.26* $138,226 $10.85* $113,093 $2.41* $25,133
===== ===== ===== ===== ===== ===== =====
*Weighted average
According to statement 1, the company expected a gross profit of $26,250, based on an estimated production of 10,500 units and an average gross profit of $2.50 per unit. As shown in statement 2, the company actually made a gross profit of only $20,108, or $1.93 per unit. Statement 3 Indicates that the average gross profit for the actual units sold would have been $2.41 per unit if the budgeted sales price and costs per unit had been achieved.
The $6,142 difference between the budgeted gross profit and the actual gross profit is the result of changes in sales price, sales volume, sales mix, and costs. For example, on the basis of the budget, A is the most profitable product and C is the least profitable per unit. Due to variations in sales price and cost, B is actually the most profitable while C is the least profitable per unit. The dollar effect of such changes is shown by the calculation of the sales price, sales volume, cost price, cost volume, sales mix and final sales volume variances.
Calculation of sales price variance and sales volume variance:
Using the figures from the statements above, the sales price variance and sales volume variance for the company are calculated as follows:
Actual sales $142,233
Actual sales at budgeted price $138,226
-----------
Favorable sales price variance $4,007
=======
Actual sales at budgeted price $138,226
Budgeted sales 142,000
------------
Unfavorable sales volume variance $3,774
========
Calculation of Cost Price Variance and Cost Volume Variance:
Using the figures from the statements above, the cost price variance and cost volume variance for the company are calculated as follows:
Cost of goods sold - Actual $122,125
Budgeted cost of actual units sold $113,093
-----------
Unfavorable cost price variance $9,032
=======
Budgeted cost of actual units sold $113,093
Budgeted cost of budgeted units sold 115,570
------------
Favorable cost volume variance $2,657
========
Calculation of the Sales Mix and Final Sales Volume Variance:
In the above calculation two volume variances appear:
Unfavorable sales volume variance $3,774
Favorable cost volume variance $2,657
--------
Net unfavorable volume variance $1,117
=====
The net volume variance should be further analyzed to determine the sales mix and final sales volume variance. These variances are computed as follows:
Actual sales at budgeted prices $138,266.00
Budgeted cost of actual units sold 113,093.00
--------------
Difference $25,133.00
Budgeted gross profit of actual units sold
10,425 actual units × $2.50 budgeted gross profit per unit $26062.50
---------------
Unfavorable sales mix variance $929.50
=======
Budgeted gross profit of actual units sold $26062.50
Budgeted sales $142,000
Budgeted cost of budgeted units sold $115,750
------------- 26,250.00
---------------
Unfavorable final sales volume variance $187.50
========
Check:
Unfavorable sales mix variance $929.50
Unfavorable final sales volume variance 187.50
-----------
Net unfavorable volume variance 1,117.00
======
Recapitulation of Variances:
Gains Losses
Gain due to increased sales prices $4,007
Loss due to increased cost $9,032.00
Loss due to shift in sales mix 929.50
Loss due to decrease in units sold 187.50
---------------
Total $10,149.00
Less 4,007.00
---------------
Net decrease in gross profit $6,142.00
=======
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