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:
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).