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Object 2. CONTRIBUTION MARGIN AND ITS USE TO COMPUTE OPERATING INCOME

Contribution Margin: amount that contributes to covering the fixed costs and then to providing operating income;
Net sales revenue – Variable costs  the difference between net sales revenue and variable costs.

This is the answer for the total

amount . It can also be
expressed as a unit amount.

Unit
contribution
margin

Contribution Margin Ratio  The ratio of contribution margin to net sales revenue. Contribution margin / Net sales
revenue.

Contribution Margin Income Statement  income statement that groups cost by behavior–variable or fixed–and
highlights the contribution margin
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OBJECT 3 COST-VOLUME-PROFIT (CVP) ANALYSIS

Cost-Volume-Profit (CVP) Analysis  planning tool that expresses the relationships among costs, volume, and prices
and their effects on profits and losses

Assumptions
CVP analysis assumes the following for the relevant range:

 The price per unit does not change as volume changes. For example, Smart Touch Learning assumes that all
tablets will sell for $500 each
 Managers can classify each cost as variable, fixed, or mixed.
 Total fixed costs do not change. Smart Touch Learning assumes fixed costs are $13,500 per month.
 There are no changes in inventory levels. Smart Touch Learning assumes the number of tablets produced
equals the number of tablets sold.

Breakevenpoint  sales level at which operating income is zero: total revenues equal total costs.

Equation Approach
Net sales revenue – Variable costs – Fixed costs = Target profit

The Contribution Margin Approach 

Contribution Margin Ratio Approach  Companies can use the contribution margin ratio approach to compute
required sales in terms of sales dollars rather than in units. The formula is the same as using the contribution margin
approach, except that the denominator is the contribution margin ratio rather than contribution margin per unit.

Notice that when we use the ratio as the denominator in the formula, we are dividing dollars by a percentage.
Therefore, the result will be expressed in dollars.
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Target profit  The operating income that results when net sales revenue minus variable and fixed costs equals
management’s profit goal.
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USE OF CVP ANALYSIS  A GRAPHIC PORTRAYAL
A CVP graph provides a picture that shows how changes in the levels of sales will affect profits. As in the variable,
fixed, and mixed cost graphs of Exhibits 20-1, 20-2, and 20-4, the volume of units is on the horizontal axis and dollars
are on the vertical axis. The five steps to graph the CVP relationships for Smart Touch Learning are illustrated in
Exhibit 20-8.
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