 Hello and welcome to the session in which we will look at the cost volume profit analysis in an application format using as well the contribution margin and the contribution margin ratio which are integral part of the cost volume profit analysis and remember you have to really understand the contribution margin income statement which is sales minus variable cost which is sales minus variable cost gives you the contribution margin minus fixed cost so it's critical whether you are a student or a CPA candidate or a CMA candidate that you understand the contribution margin income statement that's right here will take sales and will deduct from the sales variable cost then that's going to give us contribution margin then we deduct fixed cost simply put we separate the cost into a fixed component and a variable component now we were working in the prior session with Adam electronics retailer which is Adam selling tablets the selling price for each tablet is five hundred dollars the variable cost or the variable expense remember whether I said variable cost or variable expense they mean the same thing what matters is it's a variable behavior five hundred which is the selling price minus the variable cost gives us the contribution margin if you're not copy this numbers down because I'm going to be using this example to work what if analysis then the total sales for this example is 500 units 500 tablets total sales is 250 000 which is 500 tablets times the selling price of 500 000 variable expense is 500 units times 300 dollars which is 150 sales minus variable expense will give us the contribution margin minus the fixed cost will give us the net operating income or simply it might be in your textbook as shown as profit the percentage is the contribution margin is 40 percent which is taken 200 divided by 500 which is the contribution margin divided by sales or you can take the total contribution margin 100 000 divided by 250 now we're going to work few examples to see what if what would happen to the profit if we change any of these components and this is what we mean by cost volume profit analysis let's assume we want to find out the profit impact if adam can increase unit sales from 500 which is the current status to 540 and how would adam's going to do so well one of the salesperson suggested let's increase monthly advertising by 10 000 say let's increase monthly advertising let's have more ads on facebook and youtube where people can see our product and as a result we're going to increase sales by 40 units the question is should we go with this option well we have to find out what happened well here's what happens we're going to increase sales by 40 additional units each unit will contribute 200 as a result we're going to have an increase in contribution margin of 8 000 well the fixed cost which is the advertising component will increase by 10 so we're going to have a plus 10 i'm sorry plus 8 minus 10 is this a good deal no overall it's going to be negative 2000 now again from a business perspective we're dealing strictly from numbers now maybe advertising maybe it did not increase our sales this month maybe it will increase sales next month maybe advertising is going to give us some brand name which is a value we cannot record yet but based on the numbers strictly on the numbers we will reject this offer we're going to tell them look find maybe a better way to advertise so we can increase by more than 40 units and this is the income statement format sales the new sales will be 270 000 the new variable expense is 162 and basically what we're doing here is we're taking 540 units times 500 540 units times 300 that's what's given us the number sales minus variable expense will give us the contribution margin and we have to increase remember we have to increase fixed expense which is the monthly advertising budget by 10 000 as a result we're going to be less off 10 000 so our profit goes from 20 000 to 18 000 strictly numbers thank you very much that's not a good deal let's take a look at another scenario let's assume we want to find out what we'd what would be the profit if adam can use higher quality material basically a better processing unit and by doing so we're going to increase the variable expense by 10 so remember the variable expense was 300 now the variable expense will be 310 maybe we'll add some sort of a cover that comes with the tablet i don't know we're just going to add something to it and as a result this additional feature it's going to give us an additional 80 000 not 80 an additional 80 unit in sales what should we undertake this option or should we pass that's the question well let's take a look at what we have well what's going to happen to our sales well our sales going to increase by how much well we're going to be increasing sales by 80 units 80 times 500 per unit the selling price we're going to increase sales by 40 000 what's going to happen to our variable expense well variable expense well we have an additional 80 units that's going to be times 310 and the 500 unit the old 500 unit will have to increase them by 10 dollars each so all in all total variable expense will increase by 29 800 well so far if we look at this if we look at this increase in sales is 40 000 increase in variable expense is 28 900 we we can compute what's the increase in the contribution margin by taking the difference between those two figures and the difference is 10 200 10 200 so the difference is a net increase of 10 200 is this a good deal and the answer is yes it looks like it's a good idea let's add a feature to that tablet by increasing adding some feature to it some what i meant by raw material here not quality raw material some feature maybe increasing the speed of the tablet the processing unit and if you want to see this from a contribution margin income statement it's always good to to know this i always tell my students in class everyone laughs tattoo that on your hand the contribution margin income statement because it's it's going to be very helpful either in your accounting courses or CPA exam so basically your sales is 290 less variable expense is 179 800 again here we're assuming 580 units and notice your contribution margin went up by 10 200 fixed cost is the same and that 10 200 will flow to the bottom and as a result you will have an additional 10 200 and net operating income and that's not a bad deal we should go with this before we look at additional scenarios i would like to remind you whether you are a student or a CPA candidate or a CMA candidate most likely that's who you are if you're watching this thank you very much i'm glad you're watching you have arrived you want to check out my website farhatlectures.com the reason you are here because you are looking for some help and i can help you i have lectures multiple choice through false i don't replace your CPA review course if that's what you are studying for i don't replace your accounting course all my accounting courses are organized by chapter so it's very easy to follow all my CPA exam resources are organized just like your CPA review material if you have not connected with me on linkedin please do so take a look at my linkedin recommendation like this recording please click on the like button it doesn't cost you anything share it with other connect with me on instagram facebook twitter reddit and i i created a CPA exam support the group on group me please join us let's take a look at this scenario what if what is the profit if adam does the following they cut the selling price by 20 dollars we're going to reduce the price from 500 minus 20 the new price is 480 increase the advertising budget by 15 000 maybe you want to advertise that we cut the price and as a result we think sales can't go from 500 to 650 is this a good deal well we have to see we have to see what what if basically what if what if this happened what would happen first let's start with sales sales we're going to have 650 unit times 480 we're going to have sales of 312 so we're going to increase sales by 62 000 always well comparing to this data variable expense it's going to stay the same 650 times 300 unit it's going to increase by 190 sorry by it's going to increase to 195 which is an increase of 45 now if we look at the sales minus the contribution margin we will see that our contribution margin will increase overall by 17 000 17 k now our fixed cost our advertising fixed cost will increase by 15 well that's a negative those are positive well overall we're going to have a net increase of 2000 not bad not bad let's take a look at our contribution margin income statement this is what this is what it looks like sales minus variable expenses again I keep repeating this because the goal of my courses is to make sure you understand so by repeating it will help sales minus variable expense gives you the contribution margin minus fixed expenses which is an increase of 15 000 will give us 22 000 a 2000 dollar increase in net operating profit now you might see those examples maybe not in a maybe in an exercise or in a multiple multiple choice format so be quick make sure you know the formula and run through it real quick let's look at this scenario what what's the profit impact if adam pays $15 sales commission so rather than paying flat salary adam says i'm going to use motivation i'm going to motivate my employees and tell them look rather than paying you a salary specifically salespeople i'm going to give you $15 per unit right now i'm paying them $6 000 per month and i think by doing so i'm going to motivate them and as a result we're going to increase sales from 500 to 750 is this a good decision well we're going to have to run through the numbers sales will increase to 287 500 which is 575 unit times 500 per unit variable expenses will increase to 181 125 now we see that the country the new contribution margin is 106 375 which is 6 375 more the current contribution margin but the good thing about this is we are going to deduct 6 000 from our fixed expenses our fixed expenses used to be 80 000 now our fixed expenses are 74 so our new profit our new profit is 32 375 while the old profit the current option is 20 000 so simply put overall we increased profit by increasing contribution margin 6 375 plus savings of 6 000 by paying commission rather than rather than flat flat flat salary as a result we increased net profit by 12 375 and this looks like the best option thus far again no one how to motivate employees is extremely important if you could motivate them to sell more the company will benefit let's take a look at this scenario if adam has the opportunity to sell 150 tablets to a wholesaler without disturbing sales to other customers or changes any fixed expenses what price with adam quote to the wholesaler if adam wants to increase monthly profit by 3000 so adam wants to do what they want to they have the opportunity maybe an international customer where we don't serve that market say okay um we're interested in buying 150 unit but we really want a deep discount okay like okay 150 unit we think about what do we want to do we want to make a profit of three thousand dollar from this deal increase our profit by three thousand dollar how do we approach this problem well if we want to increase our profit by three thousand dollar we're selling 150 units what does that mean it means we have to make a profit per each unit so we're going to take 3000 divided by 150 we're going to have to make a profit from each unit of 20 that's the goal profit of 20 now remember our fixed expense does not change we are told here that it doesn't it's not going to disturb our sales to other customers it's not going to disturb our fixed expenses basically this market is in i don't know in south america where we don't have any any business data just one time order if that's the case how much we will need to charge this customer to make a profit of three thousand dollar well remember to manufacture those tablets the only thing that we have to worry about is the variable expense the variable expense is 300 now we're going to add to it 20 profit for each unit and as a result we can sell those tablets for 320 which is a deep discount as long as these people don't go and advertise those tablets on the internet and sell them back to our market we should be in good shape matter of fact we should have a deal with them that they cannot resell it they cannot resell it inserting geographical area or over the internet some place that that's going to compete with us because that's not a good thing so that's how we will price it we will need to sell it for 320 dollar now another way to look at it just to kind of confirm it if we sell 150 tablets at 320 our sales incremental increase in sales 48 000 150 tablet will cost us 300 dollars in variable expenses that's 45 000 plus 48 minus 45 will give us the profit that we desire an increased profit of three thousand dollar what should you do now go to farhatlectures.com if you're not a subscriber subscribe and work mcqs to help solidify increase your knowledge increase your confidence so when you have multiple choice questions on the exam you're ready to answer them and you did learn the topic inside out invest in yourself invest in your career good luck study hard