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Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773

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BuyFindarrow_forward

Managerial Accounting: The Corners...

7th Edition
Maryanne M. Mowen + 2 others
ISBN: 9781337115773
Textbook Problem
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Suppose a firm with a contribution margin ratio of 0.3 increased its advertising expenses by $10,000 and found that sales increased by $30,000. Was it a good decision to increase advertising expenses? Suppose that the contribution margin ratio is now 0.4. Would it be a good decision to increase advertising expenses?

To determine

Explain if the decision to increase advertising expense with the given contribution margin ratio was right. Also, explain the decision with increased contribution margin ratio.

Explanation

Contribution Margin Ratio:

Contribution margin ratio refers to the balance of sales dollar that is left after total variable cost is recovered. It is calculated by dividing unit contribution margin with the price. The contribution margin ratio is used to determine the remaining profit after the fixed cost is recovered.

The decision to increase the advertisement expense was not appropriate. The increase in contribution margin is calculated and is compared with the increase in advertisement expense to check the viability of the decision.

Use the following formula to compute the increased contribution:

Increased Contribution=Contribution margin ratio×Sales

Substitute 0.03 for contribution margin ratio and $30,000 for sales.

Increased Contribution=0.03×$30,000=$9,000

Therefore, the increased contribution is less than the increased advertising expense. The contribution is $1,000($10,000$9,000) less than the advertising expense

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