Effect of Change in Variable Cost, Fixed Cost and Sales Volume on Contribution Margin and Profitability


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

Learning Objectives:

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

The following data is used to show the effect of changes in variable cost, fixed cost and sales volume on the 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. The sales manager would like to pay a sales commission of $15 per unit sold rather than paying salespersons flat salaries that now total $6,000 per month. The sales manager is confident that the change will increase monthly sales by 15% to 460 units per month. Should the change be made?

Solution:
Changing the sales staff from a salaried basis to a commission basis will affect both fixed and variable expenses. Fixed expenses will decrease by $6,000, from $35,000 to 29,000. Variable expenses will increase by $15, from $150 to $165, and the unit
contribution margin will decrease from $100 to $85.

Expected total contribution margin with sales staff on commission:
460Units × $100 Per unit $39,100
Present total contribution margin:
400 units × $100 per unit 40,000
——–
Decrease in total contribution margin $(900)
Change in fixed expenses:
Add salaries avoided if a commission is paid 6,000
——–
Increase in net operating income $5,100
======

According to this analysis, the change should be made. Again, the same answer can be obtained by preparing comparative income statements.

Present 400 units per month

Expected 460 units per month

Difference: increase (decrease) in net operating income

Total Per unit Total Per unit
Sales $100,000

$250

$115,000 $250 $15,000
Less variable expenses 60,000 150 75,900 165 (15,900)
—— —— ——- ——- ——–
Contribution margin $40,000 $100 $39,100 $85 $(900)
Less fixed expenses 35,000 ====== 29,000 ====== 6,000
——- ——- ——–
Net operating income $5,000 $10,1000 $5,100
====== ====== ======

You may also be interested in other articles from “cost volume profit relationship” chapter

  1. Contribution Margin and Basics of CVP Analysis
  2. Difference Between Gross Margin and Contribution Margin
  3. Cost Volume Profit (CVP) Relationship in Graphic Form
  4. Contribution Margin Ratio (CM Ratio)
  5. Importance of Contribution Margin
  6. Change in fixed cost and sales volume
  7. Change in variable cost and sales volume
  8. Change in fixed cost, sales price and sales volume
  9. Change in variable cost, fixed cost, and sales volume
  10. Change in regular sales price
  11. Break even point analysis (calculation of break-even point by contribution margin and equation method)
  12. Target profit analysis
  13. Margin of safety
  14. Sales Mix and Break Even with Multiple Products
  15. Cost Volume Profit (CVP) Consideration in Choosing a Cost Structure
  16. Operating Leverage and degree of operating leverage
  17. Assumptions of Cost Volume Profit (CVP) Analysis
  18. Limitations of Cost Volume Profit Analysis

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