Anagene Inc. established itself in an emerging market that features fluctuating sales. The fast growth in the genetics market and the emergence of new customers makes it difficult for our analysts to project future sales. In the past, Anagene sold workstations with four cartridges; however, our current marketing strategy focuses on selling more expensive individual cartridges. Another reason for fluctuating sales margins is customers reusing cartridges instead of purchasing new cartridges.

Expected demand is the basis for budgeted volume. Therefore, budgeted volume adversely affects pricing and gross margin stability because Anagene has fluctuating sales. Anagene's use of a volatile budgeted volume as the denominator volume leads to varying allocated fixed overhead costs (Exhibit A). Assigning budgeted volume to fixed overhead costs causes gross margin to fluctuate (in this case decrease) in the long run. If management uses gross margin as the basis for pricing strategy, it could lead to a death spiral1 (Exhibit B).

Assignment of Overhead Costs to Cartridges

The assignment of overhead costs is an important factor for Kelly. It affects cost measurement and explores the possible existence of idle capacity. Currently, Anagene's assignment of overhead costs is based on budgeted volume. However, by using practical capacity as the denominator volume, Anagene reduces allocated fixed overhead costs per unit and increases gross margin. Anagene's stable2 level of operations, based on practical capacity, reveals the company's true operating potential. However, using budgeted volume allows managers to hide idle capacity, since it is based on demand rather than production capacity. Overhead cost assignment is important because it affects gross margin and shows idle capacity.

Disadvantages of Using Contribution Margin

The primary problem with contribution margin