Effect of Change in Variable Cost and Sales Volume on Contribution
Margin and Profitability:
Learning Objectives:
-
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. |
