chapter 6 - contirbution margin income statement - fixed costs, variable costs, mixed costs Flashcards
Will I find a contribution margin in ASPE or IFRS? why?
no, because it’s not an externally used metric - only used by internal stakeholders
What’s the formula and purpose for total operating costs using period and product costs
formula: total operating costs = product costs + period costs
purpose: prepare gross margin income statement for internal + external stakeholders
What’s the formula and purpose for total operating costs using variable + fixed costs
formula: total operating costs = variable costs + fixed costs
purpose: prepare contribution margin income statements for internal stakeholders
What’s the formula and purpose for total operating costs using direct + indirect costs
formula: total operating costs = direct costs + indirect costs
purpose: prepare segmented income statement for internal stakeholders
define variable costs
costs that vary in total depending on the amount of goods produced/sold or services provided.
What’s a behaviour of variable costs?
total variable costs correlate to the amount of activity taking place while the cost per unit remain constant
define fixed costs
costs that remain constant regardless of the amount of goods produced/sold or services provided
do fixed costs impact cost per unit?
yes, it has an impact on the fixed cost per unit
define a relevant eange
reflect the span of activity within which assumption about cost behaviour hold true
what’s the relationship between fixed costs and relevant range?
relevant range implies that fixed costs per item decrease as more items are sold while fixed costs remain constant will hold true for a certain volume of item but at some point the fixed costs will increase to support an increased level activity.
define mixed costs
costs that are a combination of fixed + variable costs
what’s the cost behaviour of variable in total and per unit?
in total: total variable cost increases and decreases in proportion to changes in activity level
per unit: variable cost remains constant
what’s the cost behaviour of fixed in total and per unit?
in total: total fixed cost remains constant regardless of activity level (within the relevant range)
per unit: fixed cost decreases as the activity level increases and increases as the level of activity decreases
what’s the cost behaviour of mixed in total and per unit?
total cost: dependent on the proportion of variable to fixed cost for a given cost
per unit: dependent on the proportion of variable to fixed cost for a given mixed cost
what’s the formula for mixed cost behaviour
Y = aX + b
Y = total mixed cost
a = variable cost per unit of activity/slope of the line
X = units of activity
b = total fixed cost (vertical intercept)
Define the high-low method
method to separate fixed and variable cost components in a mixed cost by comparing the total cost at the highest level of activity to the total cost at the lowest level of activity.
what is the high-low method also known as?
cost model
what are the steps in a high-low method
- among the data points available, identify the period of highest and lowest levels of activity
- using these levels, calculate the variable cost per unit of activity by dividing the change in cost by the change in activity
- choose either level of activity (highest or lowest) and plus the known amounts into “Y = aX + b” to solve for fixed costs
- use the calculated variable and fixed components to present the formula for the cost model
What are the limitations to the high-low method
assumption that the fixed and variable costs will stay constant, when practice this rarely heppens
define the contribution margin
difference between revenue and variable costs
what does the contribution part in contribution margin represent?
contribution represents the amount of revenue that contributes to the coverage of fixed costs
what happens when a company’s contribution does cover fixed costs?
we are left with is operating income
what’s the whole formula for revenue to net income/loss
revenue (or sales) - variable expenses = contribution margin - fixed expenses = earning before interest and taxes (EBIT or operating income) - interest and taxes = net income/loss
what’s the formula for contribution margin ratio
contribution margin ratio = (contribution margin)/sales
what does the contribution margin ratio indicate to the company?
indicates to the the company what percentage of sales is left over to cover fixed costs.
eg. if contribution margin ration = 30%. 30% OF ALL MONEY EARNED THROUGH SALES IS LEFT OVER TO COVER FIXED COSTS - EVERY $1 of sales made, 30 cents remain to cover fixed costs
why is the contribution margin income statement only used by internal users?
As it is not prepared in a format that is allowed under any of the accounting standards frameworks
Gross margin (GM) income statement vs contribution margin (CM) income statement
GM includes cost of goods sold line item
CM does not include cost of goods sold line item
why create a GM and CM income statement?
CM income statement is useful tool for internal decision-making - pricing and cost management
GM provides general overview for both internal and external users
what cost of goods sold are included in a merchandising company?
all the costs incurred to acquire the goods being sold, shipping costs, shipping insurance, and any discounts
do all merchandisers have COGS as variable expenses and are all variable expenses classified as COGS?
all merchandisers have COGS that are variable but all variable expenses are not classified as COGS
what types of costs do manufacturing overheads include?
variable and fixed costs
how to compare companies in regards to cost structure
consider companies with a high up-front capital requirement compared to those without - those with higher capital requirements have a higher contribution margin since their variable costs are lower relative to their fixed costs
How to reconstruct the GM income statement to CM income statement
using the definition of COGS
for companies that require a large initial investment, what’s the proportion of fixed costs to their total cost
high fixed costs in proportion to their total costs
for companies that require a small initial investment, what’s the proportion of fixed costs to their total cost
low fixed costs in proportion to their total costs
what must we first understand to consider the contribution margin of a company and why is this important?
understand how the company makes money to help us understand what the relative split between fixed and variable costs is.
this is important to understand as it will allow us to make more informed judgements about whether the resultant contribution margin is strong or not
