CVP, Sales Mix & Absorption Costing

Base Net Income Scenario

The base scenario is 5,000 units sold at a selling price of $65, resulting in a net income of $40,000.

Option 1: Increase Selling Price

Raising the selling price by 10% to $71.50 increases the contribution margin by $6.50 per unit, resulting in a net income of $72,500.

Option 2: Reduce Variable Costs

Reducing variable costs to 58% of sales improves the contribution margin, but results in a lower net income than Option 1.

Option 3: Reduce Fixed Costs

Reducing fixed costs by $15,000 (to $60,000) results in a net income of $87,500.

Key Insight on CVP Analysis

Once contribution margin relationships are understood, full income statements are unnecessary to compare alternatives.

Weighted Average Contribution Margin

Required when selling multiple products to calculate total break-even across the product mix.

Lawnmower Contribution Margin

$30

Weed Whacker Contribution Margin

$20

Chainsaw Contribution Margin

$40

Fixed Costs for Multiple Products

$4.2M

Sales Mix Impact on Product Ranking

Raw contribution margin favors chainsaws, but weighting by sales mix changes the ranking.

Constrained Resource Analysis

Maximize contribution margin per machine hour.

Product A Contribution Margin per Hour

$3/hr

Product B Contribution Margin per Hour

$2/hr

Product C Contribution Margin per Hour

$1.50/hr

Optimal Production Sequence

Build all of A first, then B, then C with remaining hours.

Degree of Operating Leverage (DOL)

Contribution margin / net operating income

Manual System DOL and Margin of Safety

DOL 1.5, margin of safety 67% (sales can drop 67% before a loss)

Computerized System DOL and Margin of Safety

DOL 4.5, margin of safety 22%

Computerized System Profit Impact

Produces 3x the profit increase on a 15% sales rise, but also 3x the decline if sales fall.

Manual System Net Income Increase

$30,000 on $150,000 sales increase

Computerized System Net Income Increase

$90,000 on same increase

Practical Use of DOL

Multiply DOL by % sales change to instantly calculate % change in net income.

Variable Costing

Only variable manufacturing costs in COGS; fixed overhead expensed in full.

Absorption Costing

Fixed manufacturing overhead absorbed into unit cost.

Manufacturing Cost per Unit

$16.75 (variable) vs. $19.25 (absorption, includes fixed OH divided by 90,000 units produced)

Net Income Comparison

$87,100 (variable) vs. $62,100 (absorption) when production (90,000) exceeds sales (80,000)

Reconciliation of Net Income Difference

$25,000 difference = fixed OH deferred in inventory (10,000 units x $2.50)