Question

PROBLEM 3-11 Contribution Format versus Traditional Income Statement |LO3 ) Home Entertainment is a small, family-owned business that purchases LCD televisions from a reputable manufacturer and sells them at the retail level. The televisions sell, on average, for $1.500 each. The average cost of a television from the manufacturer is $900. Home Entertainment has always kept careful accounting records, and the costs that it incurs in a typical month are as follows: Casts Cost Formula Selling: Advertising $950 per month Delivery of televisions $40 per television sold Sales salaries and commissions $2,900 per month, plus 4% of sales Utilities $400 per month Depreciation of sales facilities $3,000 per month Administrative: Executive salaries $8,000 per month Depreciation of office equipment $500 per month Clerical $1,500 per month, plus $40 per television sold Insurance $400 per month During April, the company sold and delivered 150 televisions Required: 1. Prepare an income statement for April using the traditional format with costs organized by function 2. Redo (1) above, this time using the contribution format with costs organized by behaviour. Show costs and revenues on both a total and a per unit basis down through contribution margin. 3. Refer to the income statement you prepared in (2) above. Why might it be misleading to show the fixed costs on a per unit basis?

Answer 1

Solution

Home Entertainment Inc

1. Income Statement for April using the traditional format with costs organized by function:

Home Entertainment
Income Statement for the Month Ended April
Revenue		$225,000
Cost of goods sold		$135,000
Gross Margin		$90,000
Selling and administrative expenses:
Selling:
Advertising	$950
Delivery expenses	$6,000
sales, salaries and commission	$11,900
Utilities expense	$400
Depreciation, sales facilities	$3,000
Total	$22,250
Administrative:
Executive salaries	$8,000
Depreciation, office equipment	$500
Clerical	$7,500
Insurance	$400
Total	$16,400
Selling and administrative expenses:		$38,650
Net Operating Income		$51,350

Computations:

Revenue = $1500 x 150 television sets = $225,000

Cost of goods sold = $900 x 150 TVs = $135,000

Delivery expenses = $40 x 150TVs = $6,000

Sales salaries = $2,900 + 4% x 225,000 = $11,900

Clerical = $1,500 + $40 x 150 = $$7,500

2. Contribution format income statement:

Home Entertainment
Income Statement for the Month Ended April
(Contribution format)	Per Unit	Total
Sales	$1,500	$225,000
Variable expenses:
Cost of goods sold	$900	$135,000
Delivery expenses	$40	$6,000
Sales commission	$60	$9,000
Clerical	$40	$6,000
Total variable expenses	$1,040	$156,000
Contribution Margin	$460	$69,000
Fixed costs:
Selling expenses:
Advertising	$6.33	$950
Sales salaries	$19.33	$2,900
Utilities	$2.67	$400
Depreciation, sales facilities	$20	$3,000
Administrative expenses:
Executive salaries	$53.33	$8,000
Depreciation, office equipment	$3.33	$500
Clerical	$10	$1,500
Insurance	$2.67	$400
Total selling and administrative expenses	$117.67	$17,650
Net Operating Income		$51,350

3. Fixed costs are costs that remain constant as a whole regardless of the level of output. Hence, the fixed cost per unit is not constant. Fixed costs do not vary with the changes in the levels of output and do not provide a correct basis for per unit computations.

Fixed costs are period costs and mostly incurred regardless of the level of output. Also, fixed costs include sunk costs such as depreciation. Hence, these costs taken on per unit basis are not suitable for short term decision making processes.