Essay on Accounting: Contribution Margin Ratio

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Income statement on page 50 was prepared using an absorption format, while the income statement on page 33 was prepared using a contribution format. The annual report explains the contribution format income statement shown on page 33 was used for internal reporting purposes. The contribution format income statement treats all cost of sales as variable costs. The selling, general and administrative expenses shown on the absorption income statement have been broken down into variable and fixed components in the contribution format income statement.

The Distribution and Transport expenses and the Sales Commissions were the variable selling costs on the contribution format income statement. The sum of these two expenses according to the absorption income statement on page 50 is €103,561 and €114,309 in 2004 and 2003, respectively. If these numbers were rounded, they agree with the variable selling costs shown in the contribution format income statements on page 33.

The break-even computations are as follows (see page 33 of annual report):

(in millions; figures are rounded) 2003 2004
Total fixed costs €464 €436
Contribution margin ratio ÷ 0.374 ÷ 0.387
Breakeven in euros €1,241 €1,127

The break-even point in 2004 is lower than in 2003 because Benetton’s fixed costs in 2004 are lower than in 2003 and its contribution margin ratio in 2004 is higher than in 2003.

4. The target profit calculation is as follows:

(in millions; figures are rounded) 2004
Total fixed costs + target profit €736
Contribution margin ratio ÷ 0.387
Sales needed to achieve target profit €1,902

5. The margin of safety calculations are as follows:

(in millions; figures are rounded) 2003 2004
Actual sales €1,859 €1,686
Breakeven sales 1,241 1,127
Margin of safety €618 €559

The margin of safety has declined because the drop in sales from 2003 to 2004 (€173) exceeds the decrease in breakeven sales from 2003 to 2004 (€114).

6. The degree of operating leverage is calculated as follows:

(in millions; figures are rounded) 2004
Contribution margin €653
Income from operations ÷ €217
Degree of operating leverage (rounded) 3

A 6% increase in sales would result in income from operations of:

(in millions; figures are rounded) 2004
Revised sales (€1,686 ×1.06) €1,787
Contribution margin ratio 0.387
Contribution margin 692
Fixed general and administrative expenses 436
Income from operations €256

The degree of operating leverage can be used to quickly determine that a 6% increase in sales translates into an 18% increase in income from operations (6% × 3 = 18%). Rather than preparing a revised contribution format income statement to ascertain the new income from operations, the computation could be performed as follows: Research and Application 5-34 (continued)
(in millions; figures are rounded) 2004
Actual sales €217
Percentage increase in income from operations 1.18
Projected income from operations €256 7. The income from operations in the first scenario would be computed as follows:

(in millions; figures are rounded) 2004
Sales (1,686 × 1.03) €1,737
Contribution margin ratio 0.387
Contribution margin 672
Fixed general and
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