Contribution Margin Ratio
If you will notice, both formulas use something called Contribution Margin. Contribution Margin represents the amount of revenue available after all variable costs have been paid for. It represents what is left over to pay for the fixed costs. The Contribution Margin ratio is the percentage Revenue that the Contribution Margin represents. In concept this is similar to Gross Profit.
In Cost Accounting Variable Costs are grouped together, and Fixed Costs are grouped together to create a variation of the traditional Income Statement. This variation is called a Contribution Margin Income Statement.
Read the following ethical dilemma.
Spillproof Company produces molded plastic cup holders for automobiles. Below is a summary of its Contribution Margin Income Statement from last year:
- Revenues: $5,750,000
- Variable costs: $3,850,000
- Fixed costs: $2,00,000
- Net Loss: ($100,000)
Because the company's CEO is very concerned about the firm's net losses, she asks the production manager if there are any ways in which they can reduce costs.
A few weeks later, the production manager returns with a proposal to reduce variable costs to 53% of revenues by lowering the cost estimates that the company uses for environmental clean-up costs. Some years the company has to perform waste clean-up and other years it does not. Either way, the company records this estimated cost as part of Variable Cost since it is based on the number of units produced.
The CEO likes the new projected net income and new break-even point, but is concerned that this change in the estimate will misrepresent the potential liability. The manager disagrees. He feels that the company will not be violating any laws by changing their estimate, and that there is only a possibility of environmental costs in the future anyway.
Requirements for your Main thread post:
- Calculate the CURRENT breakeven revenues using the current Contribution Margin Income Statement information above. Show us your work!
- Re-calculate the breakeven revenues if variable costs are 53% of revenues. Show us your work!
- Calculate Spillproof's projected Net Income/Loss. Show us your work!
Discuss the following:
- What are the ethical issues involved in this case? Explain your answer.
- Do you feel that the Production Manager is acting improperly or immorally? Why or why not? Please explain your response.
- What stakeholders would be affected if the CEO implemented the Production Managers suggestions? Why?
- What should the CEO do?