# Effect of Change in Variable Cost and Sales Volume on Contribution Margin and Profitability:

Learning Objectives:

1. What is the effect of change in variable cost and sales volume on contribution margin and profitability.

The following data is used to show the effects of changes in variable cost and sales volume on the company’s contribution margin and profitability.

Basic Data:
Selling price————-\$250
Variable Expenses—\$150  (60% of sales)
Contribution Margin—\$250 – \$150 = \$100 (40% of sales)
Fixed Expenses: \$35,000 per month

Suppose that a company is currently selling 400 units per month. Management is considering the use of higher-quality components, which would increase variable costs (and there by reduce the contribution margin) by \$10 per unit. However the sales manager predicts that the higher overall quality would increase sales to 480 units per month. Should the higher quality components be used?

The \$10 increase in variable costs will decrease the unit contribution margin  by \$10-from \$100 down to \$90.

Solution:

 Expected total contribution margin with higher-quality components: 480 units  ×  \$90 per unit \$43,200 Present total contribution margin: 400 units × \$100 per unit 40,000 ———– Increase in total contribution margin \$3,200 =======

According to this analysis, the higher-quality components should be used. Since fixed costs will not change, the \$3,200 increase in contribution margin shown above should result in a \$3,200 increase in net operating income.