Let’s compare two different formats of the income statement. We have been looking at the absorption costing income statement

all the way through the financial accouting portion of the course. Right, so the traditional format of the income statement. When you’re in a

managerial context you would call it the absorption costing format. And it’s

because we’re looking at cost of goods sold and we are absorbing the variable costs and the fixed costs. We’re concerned more about the category of the cost, and not whether it’s

variable or fixed. When we get to the contribution margin

format, which is more helpful in the managerial setting, then the emphasis is not so much on is an operating cost, is it cost of good

sold, or is it cost of goods manufactured. The emphasis is exclusively on, is a cost variable ot is it fixed? So let’s just

look at a bit of comparison. So that traditional or absorption costing format, sales minus cost of good sold, gives us gross

profit, less operating expenses, gives us net income. In the

contribution margin format, same sales number less, now, variable costs, ALL of the variable costs, it doesn’t matter what their category is,

whether they are part of CoGS, or operating expenses, if its variable, it’s placed above, so that we can then

determine contribution margin. Then we subtract the

fixed costs and we get the same net income number. So it is a different breaking out of the expenses, but the top line sales and

the bottom line net income, are going to be exactly the same. So

let’s look at this with a numerical example, just to highlight the

differences. Say we have sales of $80,000. It was 800 units at $100 each.

Less, cost of goods sold, of $60,000. That would give us

gross profit of $20,000. That $60,000 of CoGS, some of those costs are fixed, related to the rent, or perhaps

straight-line depreciation for some of the factory equipment. Or salaries for the factory supervisor.

So some of the CoGS is fixed cost, $20,000, and part of the

CoGS amount is $40,000 of variable costs.

But it’s all part of CoGS in the traditional format. It’s up top. And so we have gross profit,

$20,000 Subtract out the operating expenses, of $4000 and in this case, half of them are fixed costs, half of it’s variable cost. And you end up with net income of $16,000. Let’s look at how this information

would be organized in the contribution margin format of the

income statement. So we’d still have the same $80,000 of sales. Right, 100 units at $80 apiece. And so eighty thousand dollars. Then we would subtract all of the

variable costs and we would come up with contribution margin. And those variable costs, are both categories. The $40,000 that came from cost of good

sold and $2000 that came from the operating expenses. but the

order is that we subtract out the variable costs first to come up with the contribution margin.

And so both categories of variable cost are up top. So our contribution margin of $38,000. Now we’re going to subtract the fix costs,

and again that’s $20,000 that was related to the CoGS on the previous slide, plus $2000 related to the operating expenses, from the previous slide, we end up with

net income of $16,000. So there are two different ways to go from

sales to net income one is through the absorption format

income statement, that you see more in financial accounting. And the other is the contribution margin

format income statement, that we’ll use very heavily in the managerial

portion of the course.