This document discusses cost-volume-profit relationships and different income statement formats. It explains the traditional income statement format which separates revenues, costs of goods sold, gross margin, operating expenses and net income. An alternative is the contribution format which highlights variable and fixed expenses. Cost structure refers to the mix of variable and fixed costs and has implications for operating leverage. Companies with mainly fixed costs have high operating leverage and net income increases significantly with small revenue increases.

1. Cost-Volume Profit
Relationships and
The Income
Statement

2. Introduction
The management functions of planning, control, and
decision making all are facilitated by an understanding
of cost-volume-profit relationships. These
relationships are important enough to operating
managers that some businesses prepare income
statements in a way that highlights CVP issues.

3. TRADTIONAL INCOME STATEMENT
• Contains several blocks of revenue and expense
information: Revenue Block, Cost of goods sold Block, Gross
margin line, Selling and administrative block, Operating
profit/loss line, Non-operating expenses block and Net
Income Line.
• Its approach is the dominant format used by nearly all
companies, because it’s required by the accounting
standards for the reporting of financial results to outside
parties.

4. TRADITIONAL INCOME STATEMENT
(example)
AccuTime Company is a manufacturer of digital
clocks. During 2011, the firm manufactured and
sold 20,000 clocks at a price of $25 each. This
income statement is prepared in the traditional
manner.

5. Cost of Goods Sold includes both variable and
fixed manufacturing costs, as measured by the
firm’s product costing system. The gross margin
is computed by subtracting Cost of Goods Sold
from sales. Selling and administrative expenses
are then subtracted; each expense includes both
variable and fixed cost.

6. A. Traditional Format
ACCUTIME COMPANY
Income Statement
For the Year Ended December 31, 2011
Sales ……………...................................................................... $500,000
Less: Cost of Goods sold …………………………………………………. 380,000fdff
Gross Margin ………………………………………………………………….. $120,000
Less: Operating Expenses:
Selling Expenses ……………………………………………………….. $35,000
Administrative Expenses …………………………………………… 35,000 70,000
Net Income ……………………………………………………………………… $ 50,000

7. CONTRIBUTION INCOME STATEMENT
• Variable expenses are aggregated into what would have
been the cost of goods sold block in a traditional income
statement.
• The contribution margin approach can be of use for internal
reporting, when a company wants better visibility into the
results of its operations and how its net income will vary in
response to different changes in revenue levels
• Highlights the distinction between variable and fixed
expenses.

8. CONTRIBUTION INCOME STATEMENT
(example)
The variable manufacturing cost of each clock is $14,
and the total fixed manufacturing cost is $100,000. For
AccuTime, $200,000 remains from total sales revenue,
after all variable costs have been covered, to
contribute to covering fixed costs and making a profit.
All variable expenses are subtracted from sales to obtain the
contribution margin.

9. A. Contribution Format
ACCUTIME COMPANY
Income Statement
For the Year Ended December 31, 2011
Sales ……………...................................................................... $500,000
Less Variable Expenses:
Variable Manufacturing ……………………………………………. $280,000
Variable Selling …………………………………………………………. 15,000
Variable Administrative …………………………………………….. 5,000 300,000
Contribution Margin ……………………………………………………….. $200,000
Less: Fixed Expenses:
Fixed Manufacturing ………………………………………………… $100,000
Fixed Selling ……………………………………………………………… 20,000
Fixed Administrative ………………………………………………… 30,000 150,000
Net Income …………………………………………………………………….. $ 50, 000

11. Cost Structure and
Operating Leverage

12. COST STRUCTURE
• Its concept is a management accounting concept; it has no
applicability to financial accounting
• Refers to the types and relative proportions of fixed and
variable costs that a business incurs.
• This concept can be defined in smaller units, such as by
product, service, product line, customer, division or
geographic region.
• Used as a tool to determine prices

13. COST STRUCTURE
(Example)
Company A’s data comes from the firm’s 2011 contribution
income statement. Although these three have the same sales
revenue ($ 500,000) and net income ($ 50,000), they have very
difficult cost structures. Company B’s production process is
largely manual, and its cost structure is dominated by variable
costs. It has low contribution-margin ratio of only 20%. In
contrast, company C employs a highly automated production
process, and its cost structure is dominated by fixed costs. The
firm’s contribution-margin ratio is 90 percent. Company A falls
between these two extreme with a contribution-margin ratio of
40%.

14. Company A Company B Company C
(AccuTime
Company)
(Manual System) (Automated
System)
Amount % Amount % Amount %
Sales $ 500,000 100 $ 500,000 100 $ 500,000 100
Variable Expenses 300,000 60 400,000 60 50,000 10
Contribution
Margin
$ 200,000 40 $ 100,000 40 $ 450,000 90
Fixed Expenses 150,000 30 50,000 30 400,000 80
Net Income 50,000 10 $ 50,000 10 $ 50,000 10

15. OPERATING LEVERAGE
• The extent to which an organization uses fixed costs
in cost structure
• Greatest in Firms with a large proportion of fixed
cists, low proportion of variable costs, and the
resulting high contribution-margin ratio
• The ability of the firm to generate an increase in net
income when sales revenue increases.

16. Operating Leverage Factor
• A measure, at a particular level of sales, of the percentage
impact on net income of a given percentage change in sales
revenue.
• The managerial accountant can measure a firm’s operating
leverage, at a particular sales volume, using the operating
leverage factor:
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐿𝑒𝑣𝑒𝑟𝑎𝑔𝑒 𝐹𝑎𝑐𝑡𝑜𝑟 =
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒

17. Using this data…

18. the company leverage factors of companies A, B and C
are computed as follows:
𝑪𝒐𝒏𝒕𝒓𝒊𝒃𝒖𝒕𝒊𝒐𝒏
𝑴𝒂𝒓𝒈𝒊𝒏 ÷
𝑵𝒆𝒕
𝑰𝒏𝒄𝒐𝒎𝒆 =
𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈
𝑳𝒆𝒗𝒆𝒓𝒂𝒈𝒆
𝑭𝒂𝒄𝒕𝒐𝒓
Company A
(AccuTime)
$200,000 ÷ $ 50,000 = 4
Company B
(High Variable
Expenses)
$100,000 ÷ $ 50,000 = 2
Company C
(High Fixed
Expenses)
$450,000 ÷ $ 50,000 = 9

19. Multiplying the percentage change in sales revenue by the
operating leverage factor yields the percentage change in net
income…
𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆
𝑰𝒏𝒄𝒓𝒆𝒂𝒔𝒆 𝒊𝒏
𝑺𝒂𝒍𝒆𝒔 𝑹𝒆𝒗𝒆𝒏𝒖𝒆
x
𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈
𝑳𝒆𝒗𝒆𝒓𝒂𝒈𝒆
𝑭𝒂𝒄𝒕𝒐𝒓
=
𝑷𝒆𝒓𝒄𝒆𝒏𝒕𝒂𝒈𝒆
𝑪𝒉𝒂𝒏𝒈𝒆 𝒊𝒏
𝑵𝒆𝒕 𝑰𝒏𝒄𝒐𝒎𝒆
Company A
(AccuTime)
10% X 4 = 40%
Company B
(High Variable
Expenses)
10% X 2 = 20%
Company C
(High Fixed Expenses)
10% X 9 = 90%