Effect of Change in Fixed Cost, Sales Price and Sales Volume on Contribution Margin and Profitability
Effect of Change in Fixed Cost, Sales Price and Sales Volume on Contribution Margin and Profitability:
Learning Objectives:
- What is the effect of change in fixed cost, sales price and sales volume on contribution margin and profitability?
The following data is used to show the effects of changes in fixed cost, sales price and sales volume on the contribution margin and profitability.
Basic Data:
Selling price: $250 (100%)
Variable Expenses: $150 (60% of sales revenue)
Contribution Margin: $250 – $150 = $100 (40% of sales revenue)
Fixed Expenses: $35,000 per month
Suppose that a company is currently selling 400 units per month. To increase sales, the sales manager would like to cut the selling price by $20 per unit and increase the advertising budget by $15,000 per month. The sales manager argues that if these two steps are taken, units sales will increase by 50% to 600 units per month. Should the changes be made?
A decrease of $20 per unit in the selling price will cause unit contribution margin to decrease from $ 100 to $80.
Solution:
|
According to this analysis, the change should not be made. The same solution can be obtained by preparing comparative income statement as follows:
Present 400 Units per Month |
Expected 600 Units per Month |
||||
Total |
Per Unit |
Total |
Per Unit |
Difference | |
Sales | $100,000 | $250 | $138,000 | $230 | $38,000 |
Less variable expenses | 60,000 | 150 | 90,000 | 150 | 30,000 |
———— | ———— | ———— | ———— | ———— | |
Contribution margin | 40,000 | 100 | 48,000 | 80 | 8,000 |
Less fixed expenses | 35,000 | ====== | 50,000* | ====== | 15,000 |
———— | ———— | ———— | |||
Net operating income (loss) | $5,000 | $(2,000) | $(7,000) | ||
*35,000 + Additional monthly advertising budget of $15,000. |
Notice that the effect on net operating income is the same as that obtained by the incremental analysis above.
You may also be interested in other relevant articles:
- Contribution Margin and Basics of CVP Analysis
- Difference Between Gross Margin and Contribution Margin
- Cost volume profit (CVP) relationship in graphic form
- Contribution margin ratio (CM ratio)
- Importance of the contribution margin
- CVP consideration in choosing a cost structure
- Operating leverage–degree of operating leverage
- Assumptions of CVP analysis
- Break even point analysis
- Target profit analysis
- Margin of safety
- Sales mix and break even with multiple products
- Limitations of Cost Volume Profit Analysis
Difficulties Encountered in Process Costing Procedures:
Learning objectives of this article:
What are the difficulties or Limitations in a process costing procedure?
Certain difficulties likely to be encountered in actual practice should be mentioned with regard to process cost accounting procedures:
The determination of production quantities and their stage of completion presents problem. Every computation is influenced by these figures. Since the data generally come to the cost department from operating personnel often working under circumstances that make a precise count difficult, a certain amount of double counts and unreliable estimates are bound to exist. Yet, the data submitted from the basis for the determination of inventory costs.
Materials cost computations frequently require careful analysis In the illustrations materials are generally considered to the the cost of first department. In certain industries, materials costs are not even entered on production reports. When materials prices are influenced by fluctuating market quotations, the materials cost may be recorded in a separate report designed to facilitate management decisions in relation to the materials market.
The discussion of lost units by shrinkage, spoilage, or evaporation indicates that the time when the loss occurs influences the final cost calculation. Different assumptions concerning the loss would result in departmental unit costs, which, in turn effect inventory costs, the cost of units transferred, and the completed unit cost. Another consideration involves the possibility of treating cost attributable to avoidable loss as an expense of the current period. Industries using process cost procedures are generally of the multiple product type. Joint processing cost must be allocated the the products resulting from the processes. Weighted unit averages or other bases are used to prorate the joint cost to the several products. If units manufactured are used as a basis for cost allocation, Additional clerical expenses are necessary if the labor hour or machine hour basis is used for charging overhead to work in process. Management must decide whether economy and low operational cost are compatible with increased information based on additional cost computations and procedures.
It should be noted that some companies use both process costing and job order costing procedures for various purposes in different departments. This is particularly true when a parallel or selective cost flow format is required. Each system or method employed by a company must be based on reliable production and performance data which, when combined with output, budget, or standard cost data, will provide the foundation for effective cost control and analysis.
Present 400 Units per Month |
Expected 600 Units per Month |
||||
Total |
Per Unit |
Total |
Per Unit |
Difference | |
Sales | $100,000 | $250 | $138,000 | $230 | $38,000 |
Less variable expenses | 60,000 | 150 | 90,000 | 150 | 30,000 |
———— | ———— | ———— | ———— | ———— | |
Contribution margin | 40,000 | 100 | 48,000 | 80 | 8,000 |
Less fixed expenses | 35,000 | ====== | 50,000* | ====== | 15,000 |
———— | ———— | ———— | |||
Net operating income (loss) | $5,000 | $(2,000) | $(7,000) | ||
*35,000 + Additional monthly advertising budget of $15,000. |
Other Related Accounting Articles:
- Effect of Change in Variable Cost, Fixed Cost and Sales Volume on Contribution Margin and Profitability
- Effect of Change in Variable Cost and Sales Volume on Contribution Margin and Profitability
- Effect of Change in Regular Sales Price on Contribution Margin and Profitability
- Effect of Change in Fixed Cost and Sales Volume on Contribution Margin and Profitability
- Contribution Margin and Basics of Cost Volume Profit (CVP) Analysis
- Cost Volume Profit (CVP) Formulas
- Importance of Contribution Margin – Advantages of Cost Volume Profit (CVP) Analysis
- Cost Volume Profit (CVP) Relationship in Graphic Form
- Operating Leverage and Degree of Operating Leverage (DOL)
- Limitations of Cost-Volume-Profit (CVP) Analysis
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