chapter 6 - contirbution margin income statement - fixed costs, variable costs, mixed costs

Question 1

Will I find a contribution margin in ASPE or IFRS? why?

Answer 1

no, because it’s not an externally used metric - only used by internal stakeholders

Question 2

What’s the formula and purpose for total operating costs using period and product costs

Answer 2

formula: total operating costs = product costs + period costs

purpose: prepare gross margin income statement for internal + external stakeholders

Question 3

What’s the formula and purpose for total operating costs using variable + fixed costs

Answer 3

formula: total operating costs = variable costs + fixed costs

purpose: prepare contribution margin income statements for internal stakeholders

Question 4

What’s the formula and purpose for total operating costs using direct + indirect costs

Answer 4

formula: total operating costs = direct costs + indirect costs

purpose: prepare segmented income statement for internal stakeholders

Question 5

define variable costs

Answer 5

costs that vary in total depending on the amount of goods produced/sold or services provided.

Question 6

What’s a behaviour of variable costs?

Answer 6

total variable costs correlate to the amount of activity taking place while the cost per unit remain constant

Question 7

define fixed costs

Answer 7

costs that remain constant regardless of the amount of goods produced/sold or services provided

Question 8

do fixed costs impact cost per unit?

Answer 8

yes, it has an impact on the fixed cost per unit

Question 9

define a relevant eange

Answer 9

reflect the span of activity within which assumption about cost behaviour hold true

Question 10

what’s the relationship between fixed costs and relevant range?

Answer 10

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.

Question 11

define mixed costs

Answer 11

costs that are a combination of fixed + variable costs

Question 12

what’s the cost behaviour of variable in total and per unit?

Answer 12

in total: total variable cost increases and decreases in proportion to changes in activity level

per unit: variable cost remains constant

Question 13

what’s the cost behaviour of fixed in total and per unit?

Answer 13

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

Question 14

what’s the cost behaviour of mixed in total and per unit?

Answer 14

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

Question 15

what’s the formula for mixed cost behaviour

Answer 15

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)

Question 16

Define the high-low method

Answer 16

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.

Question 17

what is the high-low method also known as?

Answer 17

cost model

Question 18

what are the steps in a high-low method

Answer 18

1. among the data points available, identify the period of highest and lowest levels of activity
2. using these levels, calculate the variable cost per unit of activity by dividing the change in cost by the change in activity
3. choose either level of activity (highest or lowest) and plus the known amounts into “Y = aX + b” to solve for fixed costs
4. use the calculated variable and fixed components to present the formula for the cost model

Question 19

What are the limitations to the high-low method

Answer 19

assumption that the fixed and variable costs will stay constant, when practice this rarely heppens

Question 20

define the contribution margin

Answer 20

difference between revenue and variable costs

Question 21

what does the contribution part in contribution margin represent?

Answer 21

contribution represents the amount of revenue that contributes to the coverage of fixed costs

Question 22

what happens when a company’s contribution does cover fixed costs?

Answer 22

we are left with is operating income

Question 23

what’s the whole formula for revenue to net income/loss

Answer 23

revenue (or sales) - variable expenses = contribution margin - fixed expenses = earning before interest and taxes (EBIT or operating income) - interest and taxes = net income/loss

Question 24

what’s the formula for contribution margin ratio

Answer 24

contribution margin ratio = (contribution margin)/sales

Question 25

what does the contribution margin ratio indicate to the company?

Answer 25

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

Question 26

why is the contribution margin income statement only used by internal users?

Answer 26

As it is not prepared in a format that is allowed under any of the accounting standards frameworks

Question 27

Gross margin (GM) income statement vs contribution margin (CM) income statement

Answer 27

GM includes cost of goods sold line item CM does not include cost of goods sold line item

Question 28

why create a GM and CM income statement?

Answer 28

CM income statement is useful tool for internal decision-making - pricing and cost management GM provides general overview for both internal and external users

Question 29

what cost of goods sold are included in a merchandising company?

Answer 29

all the costs incurred to acquire the goods being sold, shipping costs, shipping insurance, and any discounts

Question 30

do all merchandisers have COGS as variable expenses and are all variable expenses classified as COGS?

Answer 30

all merchandisers have COGS that are variable but all variable expenses are not classified as COGS

Question 31

what types of costs do manufacturing overheads include?

Answer 31

variable and fixed costs

Question 32

how to compare companies in regards to cost structure

Answer 32

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

Question 33

How to reconstruct the GM income statement to CM income statement

Answer 33

using the definition of COGS

Question 34

for companies that require a large initial investment, what's the proportion of fixed costs to their total cost

Answer 34

high fixed costs in proportion to their total costs

Question 35

for companies that require a small initial investment, what's the proportion of fixed costs to their total cost

Answer 35

low fixed costs in proportion to their total costs

Question 36

what must we first understand to consider the contribution margin of a company and why is this important?

Answer 36

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