# Effect of Change in Fixed Cost, Sales Price and Sales Volume on Contribution Margin and Profitability:

Learning Objectives:

1. 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:

 Expected total contribution margin with lower selling price: 600 units  × \$80 per unit \$48,000 Present total contribution margin: 400 units × \$100 per unit 40,000 ———— Incremental contribution margin 8,000 Change in fixed expenses: Less incremental advertising expenses 15,000 ———— Reduction in net operating income \$(7,000) ======

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.

# Difficulties Encountered in Process Costing Procedures:

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.