The application of the CVP is in the assessment of the impacts of change in the fixed cost, sales volume and price to contribution margin and profitability to comprehend this application, the following example expresses the information in a practical situation.
In considering the basic data below:
The selling price is $250 and it is 100% in this case
The variable expenses takes 60% of sales revenue and is thus $150
The contribution margin is 40% of the sales margin and is thus given as $100 as is obtained as $250 - $150.
And the fixed expenses are assumed to be $35,000 per month.
On further assuming that the company’s current monthly sales are 400 units, and that the company needs to increase sales by the manager cutting the selling price by per unit price of $20. Also, the company ought to increase the advertisement budget with $15,000 monthly increase. In this case the sales manager anticipates an increase of 50%, which implies a monthly increase of up to 600 unit. Therefore, the manger is in the dilemma of whether or not to make the changes.
In the pursuit of this decision making dilemma, a further information necessary for the decision is that when unit selling price decreases by $20, the contribution margin decreases to $80 from $100.
The solution for this dilemma is obtainable from the Cost Volume Profit analysis as follows:
The anticipated total contribution margin with lower selling price: 600 units × $80 per unit will give $48,000
Present total contribution margin will be 400 units × $100 per unit 40,000
This gives an Incremental contribution margin of 8,000
Change in fixed expenses:
Subtracting the incremental advertising expenses 15,000
Therefore, the decrease in net operating income is $(7,000)
Since there the introduction of the change will result to a loss to the organization, the changes should not be made.
Another application of the cost volume profit analysis is in it capability to assess for the effects of variations in variable cost, fixed cost and sales volume and affect the contribution margin and profitability. In the pursuit of this application the following example comes in handy:
Assuming the following basic data of selling price worthy $250 and makes up 100%,
The variable expenses are $150 and makes 60%
The contribution margin simply goes to a cool $250 - $ 150 giving $100, which is 40%.
The monthly fixed expenses are $35,000.
Making an assumption that a given company has a current monthly sales of 400 units. The sales manager is faced by the need to make a change regarding the salespersons in that they be paid on commission of $15 per unit sold instead of paying for the flat salaries of $6,000 per month. According to the sales manager, the change will increase the monthly sales by 15%, which gives $460 per month. With the foregoing circumstances, the management is faced with the decision of whether to make the changes or not.
In order to come with the answer for the above situation, the following calculations are important:
It is expected that the proposed changes from salaried salespersons to commission based ones will affect the variable expenses. The decrease on fixed expenses will be $6,000, meaning that it will reduce from $35,000 to $29,000. At the same time, there will be an increase in the variable expenses from $150 to $165, while the unit contribution margin will reduce to $85 from $100.
The anticipated total contribution margin with the commission-based salespersons is
460 × 100 = 39,100
The current total contribution margin is
400 × 100 = 40,000
Reduction in total contribution margin will be 900
The change in fixed price will be 6,000
The increased net operating income will be $5,100.
Since the change will bring about the increase in net operating income, the change should be made.
In conclusion, the analysis of the cost volume profit is a fundamental tool in accounting management decision making. It has the ability to cope with the changing technology and is adaptable to the various tools of analysis.