Chapter 6, Problem 3AE

To determine

Concept Introduction:

Contribution and Fixed and Variable Costs in Manufacturing

• Variable costs refer to the costs of manufacture that have a direct co-relation with the volume of the goods manufactured, i.e. the costs increase with an increase in the goods produced.

• Examples are costs of direct material and direct labor.

• Fixed costs refer to the costs of manufacture that have an inverse co-relation with the volume of the goods manufactured, i.e. the costs decrease with an increase in the goods produced.

• Examples are costs of factory rent, depreciation on plant and equipment

• Manufacturing costs are costs that are directly incurred in connection with manufacture of goods.

• Examples are Direct materials and Manufacturing Overhead

• Contribution is the difference between the Sales revenue and the Variable cost per unit. This is an indicator of the contribution of the goods manufactured to the profit and bottom line of the organization.

• Margin of Safety represents that portion of the sales over the breakeven point, that acts as a buffer to protect the company’s revenue, in the event that there is a drop in the sales.

• Operating Leverage is the degree to which the contribution and net operating income are related and represents the relation between the Sales and Variable costs.

To Compute:

Percentage change in net operating income if the unit sales increase by 15%.