A contribution margin income statement format is the one in which all variable costs are deducted from the value of sales to obtain a contribution margin. All the fixed costs are then subtracted from the value of the contribution margin to obtain the value of the net profit or loss of the period. The traditional income statement applies the use of absorption methodology in its computations and formulation. In this format of traditional income statement approach, all fixed and variable costs of any given organization or business enterprise always constitute part of the inventory costs of that organization. The fixed and variable costs also collectively form part of the cost of commodities sold by the organization in question (Drury, 2007).
Traditional income statement format
In this format, the top section of it shows the detailed computation of gross profit of a business enterprise. The gross profit is computed as a summation, which includes net revenue earned by the company less the cost of goods sold by the business company. The next section of the traditional income statement shows the list of operating costs or expenses of the business. These operating costs or expenses are such as marketing, selling and distribution, rent and supplies among others. The net profit generated, or loss incurred by a business enterprise, simply refers to the statistical difference between the gross profit made by that company in question and total costs or expenses incurred by it in its operations.
Contribution margin income statement format
Contribution margin income statement separates the fixed and variable costs of the company in question. Variable costs of a business enterprise include costs such as variable production costs, for instance, the costs of acquiring raw materials and direct labor, and variable selling and administrative costs incurred by such organizations during their operations. The contribution margin refers to the difference between revenues earned by an organization and its variable costs. The last section lists the fixed production and overhead costs such as rent, depreciation and insurance. The net profit earned, or loss incurred by an organization simply refers to the difference between the contribution margin and the fixed costs (Garrison et al., 2003).
Question: Show your calculations when using a projected sales increase of 20%.
Question: Explain exactly why the contribution approach is more useful to project profits
The effect of fixed costs on profits is more emphasized in contribution approach than in the traditional approach; this is because the total fixed cost appears separately in the contribution margin approach rather than mixed with variable cost in the computation of the cost of goods sold and closing inventory (Lere, 2000).
Contribution margin approach allows for analysis of incremental effect of costs. It separates the fixed and variable costs hence giving a clear outline of measurement of the impact of increase of variable cost. Variable costs are controllable costs. That is these are costs that can be adjusted by management of an entity. Contribution margin approach by separating the variable and a fixed component of costs allows management to control the variable costs and this result to improved or higher contribution (Dubinsky & Ingram, 1984).
Contribution margin approach, as opposed to the traditional approach categorizes costs according to behavior; this can in turn helps management in the cost volume effect on profits of the entity in a given financial year. Using contribution approach the contribution margin per unit of the product is determinable which is useful in the decision making of a company. Managers find it much easier to understand the contribution margin because of clear separation of both variable and fixed elements of costs (Hopwood, 2009).
Question: Using the data, show how expected profits would be different if there were a sales increase of 10% and the CFO used variable COGS of 50% vs. 60%.
References
Drury, C. (2007). Management and cost accounting. Hampshire, United Kingdom: Cengage Learning EMEA.
Dubinsky, A.J., & Ingram, T.N. (1984). A portfolio approach to account profitability. Industrial Marketing Management, 13(1), 33-41.
Garrison, R.H., Noreen, E.W., & Brewer, P.C. (2003). Managerial accounting. New York, NY: McGraw-Hill/Irwin.
Hopwood, A.G. (2009). Accounting and the environment. Accounting, Organizations and Society, 34(3), 433-439.
Lere, J.C. (2000). Activity-based costing: a powerful tool for pricing. Journal of Business & Industrial Marketing, 15(1), 23-33.