Question

Use your own example or graph to show: a) the difference between variable cost and fixed cost; b) the difference between a financial income statement and a managerial (contribution-format) income statement.

Answer 1

Variable cost

Variable cost is a cost that changes with the level of output. Variable cost is fixed per unit but is variable in total.It will not incur if business activity is not carried out.It increases and decreases with level of production. Variable cost is calculated by multiplying output quantity with variable cost per unit.

Fixed Cost

Fixed cost is a cost that remains fixed even at zero level of production. It does not vary as per the production. It can not be avoided.

Example

A company is manufacturing shoes. It has to acquire material from the market @$6 per unit. It has to pay labour $2 per hour and one pair of shoes takes 1 labour hour to manufacture. Company has taken the factory space on rent and its monthly rent is $500 also it has to pay salaries to other office staffs @ $600 per month.

now here variable cost is material cost i.e. $6*2(being rate per unit not per pair)= $12 per pair

and labour cost is also variable cost i.e. $2*1= $2(per pair)

total variable cost is $12+2 =$14

now fixed costs are factory rent = $500(pm)

and salary = $600 (pm) now here salary and rent has to be paid till the time we use factory space even if we don't produce anything. But on the other side if we don't buy material than we won't be liable to pay anything.

b. Financial income statement

Financial income statement is a statement of all the incomes and expenses earned or incurred during the financial year.It does not classifies expenses into fixed or variable .

Managerial (contribution margin) income statement

This income statement is used by management to understand the expenses incurred and to classify the expenses which are primarily related to business and which expenses are not related to business.

Example

A company has made sales and earned a revenue of $20000. To earn this income it has to incur following expenses

rent - 2000

labor - 1050

material - 5200

salaries - 2000

fixed selling expenses - 300

variable selling overheads - 60

insurance - 200

So now we will compare income statements

Financial income statement

	Debit	Credit
Revenues
Gross Revenue		20000
Expenses
Rent	2000
Salary	2000
Material	5200
Labor	1050
Insurance	200
Variable selling overhead	60
Fixed selling overhead	300
Total expenses		(10810)
Net Income		9190

Managerial contribution margin income statement

Sales 20000 Variable expenses Material (5200) Labor (1050) Variable selling overhead (60) Contribution margin 13690 Fixed expenses Rent (2000) Salary (2000) Insurance (200) Fixed selling overhead (300) Net profit 9190