FUNCTIONAL AND CONTRIBUTION margin income STATEMENTS
Up until now, we have been using the functional, or traditional, income statement format that you learned in financial accounting. But managers are better aided in their decision making by a contribution margin income statement.
A traditional, functional income statement is required for external financial statements. It separates costs by their function: product costs or period costs. Product costs (COGS) are subtracted from sales to show gross margin (gross profit).
All period costs (selling, general, and administrative) are then subtracted to show operating income.
Sales
Less Cost of goods sold (including DM, DL, VOH, and FOH)
Gross margin
Less operating expenses
Variable selling, general, and administrative expenses
The Essay on Classification and Format in the Income Statement
Investors commonly assess a firm’s value based on the firm’s expected future sustainable earnings stream. To inform analysts and other financial statement users about sustainable earnings, firms often report income from recurring business activities separately from income effects from unusual or nonrecurring activities (such as asset impairments, restructuring, discontinued business segments, and ...
Fixed selling, general, and administrative expenses
Net operating income
The contribution margin income statement is preferable for management purposes. It separates costs by their behavior: variable costs and fixed costs. It also works very well with CVP analysis. All variable costs, both product and period, are subtracted from sales to show contribution margin. All fixed costs, both fixed overhead (a product cost) and fixed period costs, are then subtracted to show operating income. Fixed overhead is subtracted in total regardless of how many are produced or sold.
Sales
Less variable costs
Variable cost of goods sold (including DM, DL, and VOH)
Variable selling, general, and administrative expenses
Contribution margin
Less fixed costs
Fixed overhead
Fixed selling, general, and administrative expenses
Net operating income
We’ll use the following data for some examples:
|Production |60,000 units |Assume no beg. inv. |
|Sales |60,000 units |$12/unit |
|Costs: | | |
|Direct material |$180,000 |$3 per unit produced |
|Direct labor |$120,000 |$2 per unit produced |
|Variable overhead |$ 60,000 |$1 per unit produced |
|Fixed overhead |$150,000 | |
|Variable selling/administrative |$ 60,000 |$1 per unit sold |
|Fixed selling/administrative |$ 30,000 | |
The Essay on Budget Line Units Income Utility
6. 6 A) If a consumer has a certain income and at this level of income the consumer prefers to purchase 50 units of y and 0 units of X, if the price of good Y is $10, then the consumers income is $10 units of Y. Disposable income = $10 y = $10 50 = $500. B) If the same consumer wished to purchase 40 units of X and 0 units of Y, the price of good X would be disposable income divided by the number ...
Since all the units produced were sold, our income statements are as follows:
|Functional Income Statement | | | |
|Sales (60,000 x $12) | | |$720,000 |
|Less COGS (product costs) | | | |
| Direct material (60,000 x $3) | |$180,000 | |
| Direct labor (60,000 x $2) | | 120,000 | |
| Variable overhead (60,000 x $1) | | 60,000 | |
| Fixed overhead* (60,000 x $2.50) | | 150,000 | 510,000 |
|Gross margin | | | 210,000 |
|Less operating expenses (period costs) | | | |
| Variable selling & administrative (60,000 x $1) | |$ 60,000 | |
| Fixed selling & administrative | | 30,000 | 90,000 |
|Operating income | | |$120,000 |
*FOH: $150,000 / 60,000 units produced = $2.50 per unit.
|Contribution Margin Income Statement | | | |
|Sales (60,000 x $12) | | |$720,000 |
|Less variable costs | | | |
| Variable COGS: | | | |
The Essay on Cost Allocation Method
KAI uses an inappropriate volume- based cost allocation method that causes inefficient resource allocation, disincentive among employees and weaker financial performance. To improve the existing method, Senior Management should consider reviewing the current situation to identify the problems, followed by adopting an alternative cost allocation method. The current revenue-based cost allocation ...
| Direct material (60,000 x $3) |$180,000 | | |
| Direct labor (60,000 x $2) | 120,000 | | |
| Variable overhead (60,000 x $1) | 60,000 |$360,000 | |
| Variable selling & administrative (60,000 x $1) | | 60,000 | 420,000 |
|Contribution margin | | | 300,000 |
|Less fixed costs | | | |
| Fixed overhead | |$150,000 | |
| Fixed selling & administrative | | 30,000 | 180,000 |
|Operating income | | |$120,000 |
If all units produced are also sold, the operating income will be the same regardless of the type of income statement produced.
On the contribution margin income statement, note that everything, including sales, direct materials, direct labor, variable overhead, variable selling/general/administrative, and contribution margin will vary in direct relationship to the number of units sold. The fixed costs, both fixed overhead and fixed selling/general/administrative, remain the same whether we sell any number of units or no units. We’ll find this concept very helpful when we analyze the relationships among costs, volume, and profit.
