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It also should be clear why the fixed cost elements are not shown as a percentage. This information
would be at best meaningless, and at worst misleading, since these percentages would only be for a
sales volume of $1,102. These costs are fixed, so the percentage of sales amounts would change as
sales change. Note that in this format only the variable costs of sales are considered product-related
costs and all the fixed cost are now termed period costs since they are more related to a period of time
than a level of output. Also note that regardless of how the data are formatted, the operating profit is
still the same (except of the minimal error of our estimates); all that is changed is the financial data
now conveyed in a manner that facilitates scenario analysis.
Now turning to the scenarios, Exhibit 12.4 demonstrates how the contribution format facilitates
forecasting. The first two columns show the base case from the past fiscal year, and the next four
columns reflect the results of the price-cut scenario to increase volume split into two stages. The first
two columns show the results of a 10% increase in volume under the current pricing scheme. The
large increase in operating profit should not be surprising since the fixed costs have already been
covered, and the 10% volume increase is utilizing idle facilities, so no additional infrastructure is
needed. For any increase in sales dollars, 66% would drop through to the bottom line for a 10%
increase in sales or $110; about $73 ($110 × 66%) would drop to the operating profit line, increasing it
from $56 to $128.
But this volume increase might necessitate a corresponding 10% price decrease. The next two
columns reflect the second stage of the scenario. Net sales would now be $1,091.3 ($1,102.3 × 110%
× 90%) since a 10% price decrease would drop the first-stage forecasted sales of $1,212 by $121. And
since the price has been changed, the 34% variable cost factor has to be adjusted. The easiest way is as
follows: Since there is still the 10% volume increase, the variable costs of $412 from column 3 would
remain the same but now these units would be sold for less, $1,091 versus $1,212, thereby increasing
the variable cost percentage to 37.8% ($412.1/$1,091.3). Fixed costs would again remain the same,
resulting in a drastic cut in operating profit. The conclusion of this scenario: It is highly unlikely that
the top management of Company X would increase volume by dropping prices by this amount.
Exhibit 12.3 Company X—Quarterly Income Statements (costs reported by behavior).