Embedded Files
In-Class Activities
In-Class Activities
Review the PowerPoint https://docs.google.com/presentation/d/1WEnc2k08gJR86ZUGZOaSfwXgyVSexrNyRjj3lJQI-yw/edit?usp=sharing
In-Class Practice: Complete on the following questions in class
Cup Producer Question:
It costs $1 to produce each cup.
Rent and salaries together are $7000
Cups sell for $4 each
They are currently producing 3000 cups
Questions:
Calculate the contribution per unit
Calculate the total contribution
Calculate the break even point
Calculate the margin of safety
Construct a fully labelled break-even chart for the cup producer
Calculate the number of cups that the owner needs to sell to achieve a target profit of $4000
Explain how an increase in competition may affect the margin of safety
IB Syllabus 5.5 Contribution (HL)
IB Syllabus 5.5 Contribution (HL)
The learning outcomes (or assessment objectives) for this section of the IB Business Management syllabus are:
Total contribution versus contribution per unit (AO2)
Make or buy analysis
Contribution costing
Absorption costing
Contribution Vocabulary
Contribution Vocabulary
Contribution
This refers to the financial difference between a firm’s selling price and its direct or variable costs.
Contribution per unit
This is the difference between a firm’s selling price and its average variable costs (AVC) of production, i.e., P – AVC.
5.5 Extra Notes
5.5 Extra Notes
Total contribution versus contribution per unit (AO2)
Total contribution versus contribution per unit (AO2)
Total Contribution
Total contribution refers to the total amount of money earned from sales that is available to cover fixed costs after subtracting variable costs.
Formula:
Contribution per unit x Total number of units sold
Contribution Per Unit
Contribution per unit is the difference between the price per unit and the variable costs per unit.
It's the amount of money each individual unit contributes towards covering fixed costs after variable costs are accounted for.
Formula:
Contribution per unit = Price per unit – variable cost per unit
Contribution Formulas
Contribution per unit = P – AVC
Total contribution = TR – TVC
Total contribution = contribution per unit ⨉ Q
OR
Contribution per unit = price per unit – variable cost per unit
Total contribution (at a certain quantity) = contribution per unit × quantity (output)
Example:
Cup Producer Question:
It costs $0.50 in materials to produce each cup.
Workers are paid $0.50 commission for each cup they produce.
Rent is $4000
Salaries are $3000
Cups sell for $4 each
They are currently producing 3000 cups.
Questions:
Calculate the contribution per unit of cups.
Calculate the total contribution of cups.
Example Answer:
Questions:
Calculate the contribution per unit of cups.
Contribution per unit = P – AVC
P = $4
AVC = $0.5 materials + $0.5 worker commission = $1
Contribution per unit = $4 - $1 = $3
Calculate the total contribution of cups.
Total contribution = contribution per unit ⨉ Q
Total Contribution = $3 per cup x 3000 cups = $9000
Breakeven Analysis: Contribution & Contribution per Unit
Make or buy analysis
Make or buy analysis
Make or buy analysis is a decision-making tool that helps businesses decide whether to produce a product in-house (make / Insourcing) or purchase it from an outside supplier (buy / Outsourcing (subcontracting) ).
How do you choose?
costs
quality
capacity
Other companies may be able to specialize at making the product
more specialized equipment
hire more specialized workers
Produce larger quantities, cheaper, and/or at a higher quality
The key aspect is to compare the total costs of making (CTM) the product versus the costs of buying (CTB) it. If making the product is cheaper and meets quality standards, a business may choose to produce it internally. If buying is more cost-effective or produces at a higher quality, the business may opt to purchase it instead
If the CTM > CTB, the firm will use Outsourcing (subcontracting)
If the CTB > CTM, the firm will use Insourcing (in-house production)
Cost to Buy (CTB) Formula
Cost to buy (CTB) = Price × Quantity
or
CTB = P × Q
Cost to Make (CTM) Formula
Cost to make = Total costs of production = Total fixed costs + Total variable costs
or
CTM = TFC + TVC
Example
A hotel is considering whether to make or buy 3,000 luxury cupcakes for a special function. It can make these for a variable cost per unit of $4.50 per cupcake, and would allocate $4,500 in fixed costs to this order. Alternatively, the hotel can buy the cupcakes from a reputable supplier at a price of $7.0 per cupcake, less 10% discount for the bulk order.
Calculate the hotel's cost to make cupcakes.
Calculate the hotel's cost to buy cupcakes.
Determine whether it's cheaper for the hotel to make or buy cupcakes
Example Answer
The hotel’s CTM = $4,500 + ($4.50 × 3,000) = $18,000
The hotel’s CTB = ($7.0 × 0.9) × 3,000 = $18,900
It is cheaper for the hotel to make the cupcakes rather than using the specialist supplier (unless it can offer a discounted price of less than $6.0).
Make or Buy Decision Video on a more complicated question and answer
Contribution costing
Contribution costing
Contribution Costing is a method that helps businesses analyze their costs by focusing only on direct costs. Direct costs are the expenses that can be directly linked to a specific product or service. For example, the materials used to make a product or the wages paid to workers who produce it.
This is a method of valuing costs by allocating direct costs to products or divisions of a business.
How it Works
Contribution is calculated by subtracting direct costs from revenue (the money earned from sales).
The formula is:
Contribution = Revenue - Direct Costs
This method helps businesses see how much money each product contributes towards covering indirect costs (costs that are not directly linked to a product, such as rent or salaries of managers). If a product contributes positively, it helps the business stay profitable.
Benefits
Contribution costing allows managers to understand which products are profitable and which are not.
It helps in making decisions about pricing, production, and whether to continue selling a product.
Greater awareness of total cost of a product which leads to better pricing decisions.
Profitability of each product line or department can be measured and analysed.
Limitations
Indirect costs are not accounted for in this method.
Subjective nature of classifying costs as direct or indirect costs.
Absorption costing
Absorption costing
Absorption Costing is a different method that accounts for both direct costs and indirect costs when calculating the cost of a product. This means that all costs related to making a product are included in its price.
It involves deciding on the most appropriate way to apportion a firm’s indirect or fixed costs.
This is an extension of contribution costing.
How it Works
In absorption costing, businesses allocate indirect costs to each product. This includes costs like utilities, rent, and salaries of staff not directly involved in production.
The formula for absorption costing is:
Total Cost of Product = Direct Costs + Allocated Indirect Costs
Benefits
Cost allocation is more fair for multi-product/multi-departmental firms.
Greater awareness of total cost of a product which leads to better pricing decisions.
Profitability of each product line or department can be measured and analysed.
Absorption costing gives a clearer picture of the total cost of producing a product, which is important for financial reporting.
It can help businesses understand how much they need to sell to cover all costs and make a profit
Disadvantages
Complex and time-consuming to calculate.
Benefits may not be significant enough, especially for small firms.
Not all indirect costs can be divided accurately.
Subjective nature of indirect cost allocation.
Absorption Costing Examples
Total fixed costs for the taco truck: $3,000
If TFC is allocated equally between each product, the FC allocation will be $750* per product.
*3,000 ÷ 4 = 750
Absorption Costing and the Break-Even Quantity
Absorption costing allows a firm to calculate the break-even quantity for each product for the taco truck.
Break-even quantity =
Fixed cost ÷ Unit contribution
Criteria for allocating a firm’s indirect costs
Indirect costs are not always equally apportioned between products or divisions in a business.
For example:
Total fixed costs for the taco truck: $3,000
If TFC is allocated based on the number of staff preparing each product, the FC allocation will be apportioned as $600* per staff per product.
*3,000 ÷ 5 staff = 600
5.5 Contribution - Cases IB Biz 2024.pdfPage updated
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