COMM-2016EL Study Guide - Midterm Guide: Cost Driver, Contribution Margin, Fixed Cost
by Meghan Lever
DepartmentCommerce and Administration
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Management accountants must make decisions that promote profitability and the
effective and efficient use of resources. In order to make these decisions accountants
accumulate, analyze, interpret and communicate financial information to
department or production managers.
Many decisions focus on profitability in the short run (a period when capacity is a
constraint). In order to remain profitable accountants focus on high contribution
margins. Before we discuss how to make decisions we must first discuss important
cost accounting terms.
Cost driver - is any factor that affects total cost. Any change in the quantity of the
cost driver will cause a change in the total cost of the object.
For example: A production plant would incur the following costs:
Variable cost – is a cost that changes in proportion to changes in the quantity of the
cost driver. Variable costs are incurred on a per unit basis. I.e. materials,
Fixed cost – a cost that does not change in total despite changes in the quantity of
the cost driver (within “relevant range”). Fixed costs are incurred as a total. I.e.
property taxes, insurance etc.
In the sales and manufacturing industry sales and production managers often need
to make critical decisions such as:
Future costs to reduce
Product/service to increase
Most profitable products/ least profitable products
Required sales level to cover costs
Sales required for target income (may be tied to bonus)
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Cost Volume Profit (CVP)- the study of the effects of output volume on revenue,
expenses and net income.
We can use the following equation technique to determine “net income”:
Revenues (sales) - Variable Costs - Fixed Costs = Net Income
Example: Malaya manufactures bobble head memorabilia
(actors/actresses). She sells them for $40 per bobble head. Variable cost is $15 per
bobble head. She can rent a booth at the Toronto International Film Festival for
$3,000. She is busy the festival weekend, but her nephew will sell them for her for
$4 per bobble head. She would like to give him the job and is only concerned about
Break-even point- the level of sales equals the level of expenses and net income is
How many bobble heads must her nephew sell in order for her to break even?
Using the equation, we can plug in “$0” for net income as the break even
amount. Assume the number of bobble heads we must sell is = “X”. The equation
$40 X – ($15 + $4) X - $3,000 = $0
$40 X – $19 X - $3,000 = $0
$21 X = $3,000 ; X = 142.86
Therefore, her nephew must sell 143 units to break even.
Notice in the equation both sales and variable costs are multiplied by “X”, that is
because as sales change, variable costs change. Only fixed costs remain constant.
Contribution Margin- the sales price minus the ALL variable expenses.
Unit Selling Price $40
Unit Variable Cost ($15+4) = $19
Unit Contribution Margin $21
Note –the Total Contribution Margin = # of units sold x unit contribution margin
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