Question

Contribution Margin Income Statement. Last month Kumar Production Company sold its product for $60 per unit. Fixed production costs were $40,000, and variable production costs amounted to $15 per unit. Fixed selling and administrative costs totaled $26,000, and variable selling and administrative costs amounted to $5 per unit. Kumar Production produced and sold 7,000 units last month.

Required:

1. Prepare a traditional income statement for Kumar Production Company.
2. Prepare a contribution margin income statement for Kumar Production Company.
3. Why do companies use the contribution margin income statement format?

Answer 1

a)

Kumar Production Company Traditional Income statement
sales (7000*60)	420000
less:cost of goods sold [40000+(15*7000)]	(145000)
Gross margin	275000
less:selling and administrative cost [26000+(5*7000)]	(61000)
Net operating income	214000

b)

Kumar Production Company Contribution margin Income statement
sales		420000
less:variable expense
Variable production cost (15*7000)	105000
Variable selling and administrative costs (5*7000)	35000
Total variable cost		(140000)
contribution margin		280000
Less:fixed cost
Fixed production cost	40000
Fixed selling and administrative cost	26000
Total fixed cost		(66000)
net operating income		214000

c)

Since Fixed cost is a cost that will be incurred whether production is carried on or not (unless avoidable) or irrespective of number of units sold ,so it is irrelevant for making decision

whereas variable cost varies with number of units produced or sold thus it is a relevant cost in decision making .

Contribution margin income statement provides complete distribution of variable and fixed cost thus companies prefer to use this format.