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Discussion Questions Related to Contribution Margin

Provided by James R. Martin, Ph.D., CMA
Professor Emeritus, University of South Florida

Contribution Margin Main | Contribution Margin MC Questions | Graduate MA Course

1. What is the main difference between variable (or direct) costing and full absorption costing? (See Chapter 2, Exhibit 2-3, the example from Chapter 8, and the Hepworth summary).

2. Which inventory valuation methods do not provide proper matching according to GAAP? (See the CM controversy summary, Exhibit 2-1 and Exhibit 2-3).

3. Which inventory valuation method, or methods, includes an underlying assumption that production volume is the only major cost driver? (See the Cost Volume Profit Models and the CM controversy summary).

4. Which audience was full absorption costing mainly designed to serve? (See Exhibit 2-4).

5. Which audience was direct or variable costing designed to serve? Why? (See Exhibit 2-4).

6. What type of analysis must be performed before variable (or direct) costing statements can be prepared? (See Chapter 2 and Exhibit 1-3).

7. What is contribution margin? (See Chapter 2, Chapter 8 and Figure 11-17).

8. Is gross profit comparable to contribution margin? Explain. (See Chapter 2).

9. Generally, when will net income under full absorption costing be different from net income under variable costing? Why? (See Chapter 2).

10. Which of the two traditional inventory valuation methods would you expect to provide the largest amount of net income when the number of units produced are greater than the number of units sold? Why? (See Chapter 2 and Chapter 8).

11. Which net income amount is more meaningful, throughput costing net income, direct costing net income or absorption costing net income? Include your definition of meaningful? (See Chapter 8).

12. Do you see a potential behavioral problem with absorption costing? Explain. (See Chapter 8 and the CM controversy summary or Chapter 11).

13. Would the use of variable costing correct the problem in the previous question? Explain. (See Chapter 8 and the CM controversy summary or Chapter 11).

14. Do you see any potential behavioral problems associated with variable costing? Explain. (See the CVP Model Figure 11-15, Exhibit 8-6 graphs, the CM controversy summary or Chapter 11).

15. Would the use of absorption costing correct the problem in the previous question? Explain. (See the CM controversy summary or Chapter 11).

16. Would the use of throughput costing solve the behavioral problems associated with absorption costing and variable costing? Explain. (See Chapter 8).

17. The advocates of variable costing say that variable costing is more consistent with economic reality. What do you think they mean by this? (See the CM controversy summary).

18. Why are the generalizations about the relationship between absorption costing and variable (or direct) costing called generalizations? (See Chapter 2).

19. What are the assumptions underlying the conventional linear cost volume profit analysis? (See Chapter 11).

20. What does a constant sales price mean? Is this realistic? (See Chapter 11, Figure 11-1 and Figure 11-2).

21. What does constant variable cost per unit mean? (See Chapter 11 and Figures 11-5, 11-6, 11-13 and 11-15).

22. What assumption causes the total variable cost function to be linear? (See Chapter 11, Figure 11-5 and Figure 11-6).

23. What are some of the arguments against the conventional linear CVP analysis? (See the CM controversy and the Kaplan & Shank and Hepworth summaries). (Other
arguments can be developed from the ABC articles and the environmental cost articles. For example, see the summaries of Hammer & Stinson, Kite and Lawrence & Cerf).

24. Develop an equation for direct or variable costing net income using the following symbols and data from Bob’s Boats: (See Bob's Boats solution).

NIA = Absorption costing net income before taxes
NID = Direct costing net income before taxes
Xs = Units sold = 6,500
Xp = Units produced = 12,000
P = Sales price per unit = $320
V = Variable cost per unit = Vm + Vs
Vm = Variable manufacturing cost per unit = DM + DL + Variable overhead = $100 + $10 + $40 = $150
Vs = Variable selling & administrative cost per unit = $10
TFC = Total fixed costs per year = 720,000 manufacturing + 240,000 S&A = $960,000
F = Fixed overhead per unit = $720,000/12,000 units = $60

25. Calculate direct costing net income based on your equation and the data given above. (See Bob's Boats solution).

26. Develop an equation for absorption costing net income using the symbols above assuming the fixed overhead per unit is constant from period to period. Note: The easiest way to do this is to start with the equation for direct costing and make the appropriate adjustment. (See Bob's Boats solution).

27. Calculate absorption costing net income based on your equation and the data given above. (See Bob's Boats solution).

28. Develop an equation for throughput costing net income using the symbols above. Note: The easiest way to do this is to start with the equation for direct costing and make the appropriate adjustment. (See Bob's Boats solution).

29. Calculate throughput costing net income based on your equation and the data given above. (See Bob's Boats solution).

30. Compare and discuss the differences between your answers to the previous three questions.

Now, assume Bob’s Boats produced zero units the following year, i.e.,
Xp=0, but sold 5,500 units, i.e., Xs = 5,500.

31. Calculate direct costing net income. (See Bob's Boats solution).

32. Does direct costing have a unique break-even point? Why? If so what is the break-even point? (See Bob's Boats solution).

33. Using the data for year two above (i.e., Xp = 0 and Xs = 5,500) calculate absorption costing net income. The fixed overhead rate per unit is still $60, i.e., based on a denominator activity level of 12,000 units. (See Bob's Boats solution).

34. Does absorption costing have a unique break-even point? Why? If so what is the break-even point? (See Bob's Boats solution).

35. Using the data for year two above (i.e., Xp = 0 and Xs = 5,500) calculate throughput costing net income. (See Bob's Boats solution).

36. Does throughput costing have a unique break-even point? Why? If so what is the break-even point? (See Bob's Boats solution).

37. Which method of costing is the closest to the cash flow method?

38. What are the arguments against the contribution margin approach from the GAAP perspective? (See the CM controversy summary).

39. What are the arguments against the contribution margin approach from the ABC perspective? (See the CM controversy and Kaplan & Shank summaries).

40. What are the arguments against the contribution margin approach from the continuous improvement Lean Enterprise perspective? (See the CM controversy summary).

41. What are the arguments for the contribution margin approach provided by Boer and Horngren? (See the CM controversy and Boer and Horngren summaries).

42. What is an argument in defense of CM related to management information and decisions? (See the CM controversy summary).

43. What is an argument in defense of CM related to management signals and resulting behavior? (See the CM controversy summary).

44. Can the CM concept be defended against the claim that it is inconsistent with the continuous improvement concept? (See the CM controversy summary).

45. Luther and O'Donovan defend the CM approach and discuss a method they refer to as "cost-constraint-profit analysis". How does this differ from the usual cost-volume-profit analysis? (See the Luther & O'Donovan summary).

46. What was Kaplan’s suggestion concerning a possible reconciliation of the CM approach with ABC? (See the Kaplan and Shank, Chapter 11 and the Ali and Kee 2001 summaries).

47. Atwater and Gagne provide an argument against the contribution margin approach from the TOC perspective related to product mix decisions. Explain their view. (See the Atwater & Gagne and the TOC problems).

48. Primrose argues that there is really nothing wrong with traditional cost management. What is the main basis for Primrose's arguments? (See the Primrose summary).

49. What is the relationship between the contribution margin ratio (CMR) and the return on sales ratio (ROS)? (See Chapter 14).

50. In the Cal Company problem illustrated in MAAW's Chapter 11, P =10, V = 6, TFC = 120,000 and the tax rate is 40%. (See Chapter 11 for more specifics). Assume total assets = $500,000 and determine the Return on Sales (ROS) and Return on Investment (ROI) ratios after taxes when X = 80,000? (See Chapter 14).