Contribution approach income statement example

Individual Project Introduction to the Subject of the Project

Prepare income statements for a merchandising company using the traditional and contribution formats.

Learning objective number 5 is to prepare income statements for a merchandising company using the traditional and contribution formats.

Contribution Approach Income Statement

The contribution approach income statement organizes costs by behavior, first deducting variable expenses to obtain contribution margin, and then deducting fixed expenses to obtain net operating income.

The traditional approach organizes costs by function, such as production, selling, and administration. Within a functional area, fixed and variable costs are intermingled.

The contribution margin is total sales revenue less total variable expenses.

The Traditional and Contribution Formats

Used primarily for external reporting.

Used primarily by management.

The contribution format allocates costs based on cost behavior. The contribution approach differs from the traditional approach illustrated in an earlier chapter.

The traditional approach organizes costs in a functional format. Costs relating to production, administration, and sales are grouped together without regard to their cost behavior.

The traditional approach is used primarily for external reporting purposes.

Uses of the Contribution Format

The contribution income statement format is used as an internal planning and decision-making tool. We will use this approach for:

Cost-volume-profit analysis

Budgeting

Segmented reporting of profit data

Special decisions such as pricing and make-or-buy analysis

This approach is used as an internal planning and decision-making tool. For example, this approach is useful for and discussed further in Cost-volume-profit analysis (Chapter 5), Budgeting (Chapter 8), Segmented reporting of profit data (Chapter 6), Special decisions such as pricing and make or buy analysis (Chapter 12).

Review Questions T/F

1. Traditional format income statements are prepared primarily for external reporting purposes.

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True

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2. In a contribution format income statement, sales minus cost of goods sold equals the gross margin.

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False

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3. In a traditional format income statement for a merchandising company, the cost of goods sold reports the product costs attached to the merchandise sold during the period.

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True

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4.Contribution format income statement is useful for external reporting purposes, it has serious limitations when used for internal purposes because it does not distinguish between fixed and variable costs.

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False

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5. In a contribution format income statement for a merchandising company, cost of goods sold is a variable cost that gets included in the "Variable expenses" portion of the income statement.

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True

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6. The traditional format income statement is used as an internal planning and decision-making tool. Its emphasis on cost behavior aids cost-volume-profit analysis, management performance appraisals, and budgeting.

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