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Lecture 3

Management and Organizational Studies 3370A/B Lecture 3: Lecture 3


Department
Management and Organizational Studies
Course Code
MOS 3370A/B
Professor
Laura Timusk
Lecture
3

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Lecture 3 – Chapter 3 continued, Chapter 4
Question P3-15 – testable
Contribution Format
Traditional income statement is organized by function and fixed/variable costs are not
distinguished
Separating costs into fixed and variable elements is often crucial in making decisions
Contribution format facilitates planning, control, decision making
- contribution margin format
emphasizes cost behaviour
- Contribution margin is meant to
cover fixed costs and any profit
Uses of Contribution Format
- Contribution income statement format is used as an internal planning and decision making tool.
oCost-volume-profit analysis (CH4)
oBudgeting (Chapter 9).
oSegmented reporting of profit data (Chapter 11).
oSpecial decisions such as pricing and make-or-buy analysis (Chapter 12).
- traditional primarily used for external
- contribution primarily used by management
Cost-Volume-Profit Relationship Interactions
- CVP analysis is a powerful tool that managers use to help them understand the interrelationship
among cost, volume, and profit in an organization by focusing on the interactions among the
following five elements:
oPrices of products
Total Unit
Sales Revenue 100,000$ 50$
Less: Variable costs 60,000 30
Contribution margin 40,000$ 20$
Less: Fixed costs 30,000
Net operating income 10,000$
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oVolume of activity
oVariable costs
oTotal fixed costs
oMix of products sold
Basics of CVP Analysis
- Contribution income statement is helpful to managers in judging the impact on profits of
changes in selling price, cost, or volume. The emphasis is on cost behaviour.
- Contribution Margin (CM) is the amount remaining from sales revenue after variable expenses
have been deducted
Contribution Margin (CM)
- Sales, variable expenses, and
contribution margin can also be
expressed on a per unit basis. If
Racing sells an additional bicycle,
$200 additional CM will be
generated to cover fixed expenses
and profit.
- CM Ratio = CM per Unit / Sales Price per Unit = 200/500 = 0.4 (40%)
oWhen CM = Fixed expenses, operating at break even point
- We doo not need to prepare income statements to estimate profits at every level – simply
multiple number of units sold above break even by their contribution margin
- Can express CVP relations using a CVP graph
oUnits on X, dollars on Y
oBelow BE point – net loss area, above is
profit range
oBlue = FC, black = TC, red = sales
Contribution Margin Ration (CMR)
- CMR = Total CM / Total Sales
oi.e. for each $1 increase in sales, the total CM increases by 0.40 dollars
- CMR (Per unit) = unit CM / Unit selling price
Total Per Unit CM Ratio
Sales (500 bicycles) 250,000$ 500$ 100%
Less: Variable expenses 150,000 300 60%
Contribution margin 100,000 200$ 40%
Less: Fixed expenses 80,000
Net operating income 20,000$
Racing Bicycle Company
Contribution Income Statement
For the Month of June
-
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
450,000
- 100 200 300 400 500 600 700 800
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