Sample Essay
What are E’s contribution margin ratio, gross profit ratio and operating (net) income ratios?
Contribution margin ratio = (sales- variable costs)/sales (Khan & Jain, 2006) = (10,005-2,104.5)/10,005 = 0.79 = 79%
Gross profit ratio = gross profit/net sales = 8,314.5/10,005 = 0.83 = 83%
Net income ratios = operating income/sales= 4,100.5/10,005= 0.41 (contribution margin approach)
Net income ratios = operating income/sales= 6,700.5/10,005= 0.67 (absorption approach)
3. Explain the difference and reconcile operating income for the two methods
The operating income using the absorption approach is $6,700.5 while when using contribution margin approach it gets to $4,100.5. This shows that by the use of the contribution margin approach, the operating lower by $2,600 compared when using the absorption approach. The difference is brought about by the fact that the absorption approach recognizes only the fixed and variable selling costs and ignores the other costs. This makes it not useful when the management is making decisions (Horngren, 2006).
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