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:

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.

You may also be interested in other relevant articles:


Managerial Accounting Articles

■	Business and Quality Improvement Programs
■	Cost Terms, Concepts and Classification
■	Job Order Costing system
■	Process Costing System
■	Process Costing System - Addition of Materials and Beginning Inventory
■	Controlling and Costing Materials
■	Materials and Inventory Cost Control
■	By Products and Joint Products Costing
■	Cost-Volume-Profit-Relationship
■	Variable Costing System
■	Activity Based Costing System
■	Budgeting and Planning
■	Standard Costing and Variance Analysis
■	Gross Profit Analysis
■	Linear Programming Technique
■	Segment Reporting and Transfer Pricing
■	Capital Budgeting Decisions
■	Service Department Costing
■	Cash Flow statement
■	Financial statement Analysis
■	Pricing Products and Services
■	Managerial Accounting Terms and Definitions
■	Managerial / Cost Accounting Formulas

Financial Accounting Articles

■	Bookkeeping and Bookkeeping Terms
■	Accounting Principles and Accounting Equation
■	Journal
■	Ledger
■	Accounting For Bills of Exchange
■	Subdivision of Journal
■	Final Accounts
■	Capital and Revenue Items
■	Single Entry System/Accounting From Incomplete Records
■	Accounting For Non-Trading Concerns
■	Accounting for Consignment / Consignment Accounts
■	Accounting for Joint Ventures
■	Accounting for Depreciation

Articles By International Authors

■	Accounting Articles


Advertisements