1. Managerial Accounting
Balakrishnan | Sivaramakrishnan | Sprinkle | Carty | Ferraro
Chapter 4: Short-Term Planning and Control: Maximizing Contribution
Prepared by Debbie Musil, Kwantlen Polytechnic University

2. Traditional Income Statement
LO1: Prepare a contribution margin income statement.

3. Contribution Margin Statement
Traditional statement mingles controllable and non-controllable costs
In short-term, variable costs are usually controllable and fixed costs are not
Contribution margin statement separates fixed and variable costs
Some Terms
Contribution margin: Revenues less variable costs
Include both manufacturing and marketing costs
Unit Contribution Margin: The contribution margin from one unit
LO1: Prepare a contribution margin income statement.

4. Contribution Margin Statement
How does this help Pierre and Anja’s decision?
LO1: Prepare a contribution margin income statement.

5. Application to Hercules
Can also be computed directly as:
LO1: Prepare a contribution margin income statement.

6. Hercules’ rental cost does not change by offering yoga
Hercules’ rental cost does not change by offering yoga. Hercules will incur this cost regardless of Pierre and Anja’s decision. The decrease in salaries paid would be a benefit. We would include the amount as a controllable fixed cost with a negative value.

7. How to Construct CM Statement?
Two step process
Estimate company’s cost structure
The variable and fixed portion’s of costs
Using historical data
Use model to project future costs and benefits
Confidence in estimate depends on
Traceability
Relevant range for the model
LO1: Prepare a contribution margin income statement.

8. Using Historical Data to Estimate Cost Structure
LO1: Prepare a contribution margin income statement.

9. Benefits to Plotting Data
Obtain visual confirmation of expected relation
Help determine cost driver
Identify unusual patterns
Curvilinear, Steps
Identify outliers
Eliminate from further analysis
Help determine relevant range
LO1: Prepare a contribution margin income statement.

10. Cost Patterns
LO1: Prepare a contribution margin income statement.

11. Account Classification
Categorize each account / type of cost as fixed or variable
We then estimate the change in variable costs:
Sum the costs classified as variable to obtain the total variable costs for the most recent period.
Divide the amount in (1) by the volume of activity for the corresponding period to estimate the unit variable cost (e.g., variable cost per member).
Multiply (2) by the change in activity to estimate the total controllable variable cost.
LO2: Use the account classification method to identify fixed and variable costs.

12. Application to Hercules
We can calculate
Total revenue = $80,000 or $80 per member per month
Total variable costs = $30,000 or $30 per member per month
Contribution is $50 per month per member
The change in the fixed cost is $12,000 per month
Change in profit = 30 members * 12 months * $50 - $12,000 = $6,000
LO2: Use the account classification method to identify fixed and variable costs.

13. Account Classification: Evaluation
Benefits
Accurate if done well
Allows for entire cost hierarchy
Costs
Time consuming and subjective
Based on expertise of person doing the task
May be best suited for “new” operations where historical patterns are not likely to occur.
LO2: Use the account classification method to identify fixed and variable costs.

14. High-Low Method
Construct model that classifies all costs as being fixed or variable
Need to estimate two parameters
Fixed cost and unit variable cost
Pick two points (highest and lowest activity level) to estimate
LO3: Compute fixed and variable costs using the high-low method.

15. Graphical Illustration
LO3: Compute fixed and variable costs using the high-low method. 15

16. Numerical Example = $78,000 – (1,250 members ×$32 per member)
Fixed cost per month
= $78,000 – (1,250 members ×$32 per member)
= $38,000
LO3: Compute fixed and variable costs using the high-low method. 16

17. Difference in total costs = $76,000 - $73,000 = $3,0001
$3,000 2
100 3
$30 4
$40,000 1
Difference in total costs = $76,000 - $73,000 = $3,000 2
Difference in activity volume = 1, ,100 = 100 members 3
Variable cost per member = $3,000/1,000 = $30 4
Fixed costs per month = $76,000 - ($30 x 1,200) = $40,000

18. High-Low Method: Evaluation
Advantages
Simple, easy to implement
Requires only aggregate cost data
Can easily try alternate drivers
Drawbacks
Assumes simple cost structure
Yields only rough estimates of fixed costs
Caveats
Be sure to plot. Identify outliers, unusual patterns
Use high and low activity (to maximize relevant range) and not the high and low cost
LO3: Compute fixed and variable costs using the high-low method.

19. Regression Analysis
Statistical method to find line that best fits the data
Defined criterion for “best fit”
Difficult to do by hand
Spreadsheet programs
Statistical software
LO4: Perform regression analysis to estimate fixed and variable costs.

20. Regression: Inputs into Excel
LO4: Perform regression analysis to estimate fixed and variable costs.

21. Regression Output in Excel
LO4: Perform regression analysis to estimate fixed and variable costs.

22. Total variable costs = $29.30 x 1,000 = $29,300
$40,715.88 4
$70,015.88 1
Unit variable cost = $29.30 2
Total variable costs = $29.30 x 1,000 = $29,300 3
Fixed costs = $40,715.88 4
Total costs = $29,300 + $40, = $70,015.88

23. Regression: Evaluation
Benefits
Uses all available data
Precise statements possible
Can use many drivers
Costs
Makes many assumptions regarding data
Applying technique well requires extensive training and considerable work
Best suited when historical cost patterns are complex and are likely to continue
LO4: Perform regression analysis to estimate fixed and variable costs.

24. Choosing the Best Method
No one method is always best
Account classification is best when historical patterns may not continue
High-low may be preferred for quick and simple estimates
Regression might be called for when cost patterns are complex and we expect historical relations to continue
Estimates are only valid under relevant range
LO4: Perform regression analysis to estimate fixed and variable costs.

26. Segmented Statements
Firms often prepare contribution margin statements for individual products / markets
Such a presentation helps with decision making
Can assign traceable fixed costs to get:
Segment (product) margin
Can extend to regional and customer-level groupings, if needed
We do not allocate common fixed costs to segments
LO5: Construct segmented contribution margin statements.

27. Segment Contribution Margin
LO5: Construct segmented contribution margin statements.

28. Total variable costs are: $16,422,000 + $901,600 + $418,600 = $17,742,200
Thus, each desk has a variable cost of: ($17,742,200/32,200) = $551
In turn, Office Gallery would experience a negative contribution of $26 per desk that it sells for $525.
At a volume of 1,000 desks, Office Gallery would lose $26,000. Notice that fixed costs are not controllable for this decision.

29. Appendix: Learning Curves

30. Learning Effects Empirical phenomenon
Most applicable to labour costs
Strong effects in assembly operations
People learn and become more efficient over time
The reduction is predictable
Appendix : Learning Curves

31. Graphical Representation
Appendix : Learning Curves

32. Doubling Approach Average Time to Produce all Units to Date*
Total Number of Units Produced
Average Time to Produce all Units to Date*
Total Time to Produce all Units to Date** 1
500.00 2
450.00
900.00 4
405.00
1,620.00 8
364.50
2,916.00 16
328.05
5,248.80
* The first unit takes 500 hours. Every time production doubles, we take the previous average time and multiply it by .90 to obtain the new average time. For example, the average time to produce 8 units = 405 × .90 =
** Total number of units produced × Average time to produce all units to date.
Appendix : Learning Curves

33. Exercise 4.32 Contribution margin statement (LO1)
Suppose a firm provides you with the following information for the most recent period of operations: (a) Sales = 500 units; (b) Revenues = $15,000; (c) Variable manufacturing costs = $5,000; (d) Variable selling and administrative costs = $1,000; (e) Fixed manufacturing costs = $6,000, and; (f) Fixed selling and administrative costs = $2,000.
Required:
Calculate both the unit contribution margin and contribution margin, and prepare a contribution margin statement.

34. Contribution margin = number of units × unit contribution margin
Exercise 4.32 (Continued)
Unit contribution margin = Price – all variable costs
We first calculate price = ($15,000 revenue/500 units) = $30 per unit. Given that variable manufacturing costs = $10 per unit and variable selling costs = $2 per unit, then unit contribution margin = $30 - $10 - $2 = $18 per unit.
Contribution margin = number of units × unit contribution margin
Thus, contribution margin = 500 units × $18/unit = $9,000.

35. Exercise 4.32 (Concluded)
The following is the contribution margin statement.

36. Copyright
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