Question

Discuss contribution margin, what it is and how it is presented in the CVP income statement

Answer 1

The contribution margin is a concept used with breakeven point or in break-evenanalysis. In words, the contribution margin is the amount of money a company has to cover its fixed costs after it pays all of its variable expenses. It is also the amount, after covering fixed costs, that contributes to the net operating profit or net operating loss of the business firm.

Contribution margin (CM), or dollar contribution per unit, is the selling price per unit minus the variable cost per unit. "Contribution" represents the portion of sales revenue that is not consumed by variable costs and so contributes to the coverage of fixed costs. This concept is one of the key building blocks of break-even analysis.

• Contribution Margin = Sales Revenue - Variable Expenses
• On a per unit basis, contribution is calculated as:

Contribution Margin per unit of sales = Sales Revenue per Unit - Variable Expenses per Unit

• Contribution Margin - Fixed Costs = Net Operating Profit or Loss

In cost-volume-profit analysis, a form of management accounting, contribution margin—the marginal profit per unit sale—is a useful quantity in carrying out various calculations, and can be used as a measure of operating leverage. Typically, low contribution margins are prevalent in the labor-intensive tertiary sector while high contribution margins are prevalent in the capital-intensive industrial sector.

CONTRIBUTION MARGIN IN CVP INCOME STATEMENT

A CVP or cost-volume-profit income statement has the same information as a more traditional income statement, but is designed to show the effects of changes in costs and volume on the profit of a business. It is used as a tool to allow management to make decisions about such things as product mix, selling prices, and best use of production facilities.

The CVP income statement is for internal use only, and the exact format will depend on the business requirements. Typically, expenses are classified as either variable or fixed expenses, and totals are drawn to show contribution margin on a business and unit basis.

Key calculations when using CVP analysis are the contribution margin and the contribution margin ratio. The contribution margin represents the amount of income or profit the company made before deducting its fixed costs. Said another way, it is the amount of sales dollars available to cover (or contribute to) fixed costs. When calculated as a ratio, it is the percent of sales dollars available to cover fixed costs. Once fixed costs are covered, the next dollar of sales results in the company having income.

The contribution margin is sales revenue minus all variable costs. It may be calculated using dollars or on a per unit basis. If The Three M's, Inc., has sales of $750,000 and total variable costs of $450,000, its contribution margin is $300,000. Assuming the company sold 250,000 units during the year, the per unit sales price is $3 and the total variable cost per unit is $1.80. The contribution margin per unit is $1.20. The contribution margin ratio is 40%. It can be calculated using either the contribution margin in dollars or the contribution margin per unit. To calculate the contribution margin ratio, the contribution margin is divided by the sales or revenues amount.