Effect of Change in Fixed Cost and Sales Volume on Contribution Margin and Profitability
Effect of Change in Fixed Cost and Sales Volume on Contribution Margin and Profitability:
Learning Objectives:
- What is the effect of change in fixed costs and sales volume on contribution margin and profitability?
The following data is used to show how changes in fixed costs and sales volume can effect company’s contribution margin and profitability.
Basic Data:
Selling price: $250 (100%)
Variable Expenses: $150 (60%)
Contribution Margin: $250 – $150 = $100 (40%)
Fixed Expenses: $35,000 per month
Suppose that a company is currently selling 400 units per month (monthly sales of $100,000).The sales manager feels that a $10,000 increase in the advertising budget would increase monthly sales by $30,000 to a total of 520 units. Should the advertising budget be increased? The following table shows the effect of the proposed change in the monthly advertising budget.
Current Sales |
Sales with additional advertising budget |
Difference |
Percent of sales | |
Sales | $100,000 | $130,000 | $30,000 | 100% |
Less variable expenses | $60,000 | $78,000 | $18,000 | 60% |
——— | ——— | ——— | ——— | |
Contribution margin | 40,000 | 52,000 | 12,000 | 40% |
Less fixed expenses | 35,000 | 45,000 | 10,000 | ====== |
——— | ——— | ——— | ||
Net operating income | $5,000 | $7,000 | $2,000 | |
====== | ====== | ====== |
Assuming no other factors need to be considered, the increase in the advertising budget should be approved since it would lead to an increase in net operating income of $2,000. There are two shorter ways to present this solution. The first alternate solution follows:
Alternative Solution 1:
Expected total contribution margin: | |
$130,000 × 40% CM ratio | $52,000 |
Present total contribution margin: | |
$100,000 × 40% CM ratio | 40,000 |
——— | |
Incremental contribution margin | 12,000 |
Less incremental advertising expenses | 10,000 |
——— | |
Increased net operating income | $2,000 |
======= |
Since in this case the fixed costs and the sales volume change, the solution can be presented in an even shorter format.
Alternative Solution 2:
Incremental contribution margin: | |
$30,000 × 40% Contribution Margin ratio | $12,000 |
Less incremental advertising expenses | 10,000 |
——— | |
Increased net operating income | $2,000 |
Notice that this approach does not depend on knowing of previous sales. Also notice that it is unnecessary under either shorter approach to prepare an income statement. Both of the solutions above involve an incremental analysis. They consider only those items of revenue, cost, and volume that will change if the new program is implemented. Although in each case a new income statement could have been prepared, the incremental approach is simpler and more direct and focuses attention on the specific items involved in the decision.
You may also be interested in other articles from “cost volume profit relationship” chapter
- 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 Contribution Margin
- Change in fixed cost and sales volume
- Change in variable cost and sales volume
- Change in fixed cost, sales price and sales volume
- Change in variable cost, fixed cost, and sales volume
- Change in regular sales price
- Break even point analysis (calculation of break-even point by contribution margin and equation method)
- Target profit analysis
- Margin of safety
- Sales Mix and Break Even with Multiple Products
- Cost Volume Profit (CVP) Consideration in Choosing a Cost Structure
- Operating Leverage and degree of operating leverage
- Assumptions of Cost Volume Profit (CVP) Analysis
- Limitations of Cost Volume Profit Analysis
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
- Importance of Contribution Margin – Advantages of Cost Volume Profit (CVP) Analysis
- Effect of Change in Fixed Cost, Sales Price and Sales Volume on Contribution Margin and Profitability
- Limitations of Cost-Volume-Profit (CVP) Analysis
- Cost Volume Profit Relationship – (CVP Analysis)
- Operating Leverage and Degree of Operating Leverage (DOL)
- Cost Volume Profit (CVP) Consideration in Choosing a Cost Structure
- Difference Between Gross Margin and Contribution Margin
Recommended Books !
Or
Download E accounting book in MS-word format for just 20 $ - Click here to Download