 Hello and welcome to the session in which you would look at the contribution margin income statement, which is used for analysis and decision-making. Analysis and decision-making means it's used for internal purposes. So this statement is not gap, not generally accepted accounting principle. The best way to illustrate the difference between traditional income statement, gap, and contribution margin is to actually look at both statements side by side to study the differences. So this is a gap and this is a contribution margin income statement. Let's take a look at gap first. We have sales minus cost of goods sold, sales of 100,000 minus 60,000 will give us something called the gross margin. From the gross margin, we are going to deduct our selling and administrative expenses, which in turn will give us net operating income. Under the contribution income statement, we're also going to start with sales, which it should be the same 100,000 minus variable expenses. So what we do here is we separate our expenses. We emphasize between the expenses that changes when the level of activity changes and the one that don't. Well, what does that mean? It means we're breaking our expenses into variable expenses and fixed expenses. So 100,000 minus 55 will give us 45,000. We call this contribution margin, not gross margin. Gross margin is a gap term. Contribution margin is not gap. It's basically for management purpose contribution margin. Then from the contribution margin, we deduct the fixed expenses. Fixed expenses are unaffected by the level of activity. Remember, fixed expenses by nature, they don't change versus variable expenses, which are consist of mainly direct material, direct labor, variable overhead. And we have to include also any variable period cost. Then from those we'll get to the net operating income. Notice the net operating income is the same whether you are using the traditional or the contribution margin. But the contribution margin will help management understand better how changes in production and sales will affect the bottom line. That's the purpose of it. So to put it in a dollar amount, let's assume we are selling 10,000 unit, 10,000 unit for this company. If we're selling 10,000 unit, it means we're selling each unit for $10 and this is how we came up with 100,000. If that's the case, our variable expenses is $55,000, which is so the selling price is $10 per unit. The variable expenses must be $5.50, $10 minus $5.55. It's going to give us $4.50 in contribution margin minus the fixed expenses. So here we are, we are looking at per dollar per each unit, not per dollar per each unit. So how does that help? Simply put, from a management perspective, now we know for every dollar in sale, simply put, every dollar in sale has to be split between variable expenses, variable cost and contribution margin. Here the variable cost is $5.50 and what's left for the contribution margin is $4.50. Now this contribution margin will have to cover your fixed expenses and whatever is left will be considered net operating income. So the point is to know what is your contribution margin and once you know your contribution margin, you will need to know how many units you need to sell to cover your fixed cost. Once you cover your fixed cost, once you know how many units you need to sell to cover your fixed cost, everything from the contribution margin, once you cover fixed cost will start to float the net operating income. So the contribution margin income statement will help managers make better decision about the company, better decision in terms of how many units I need to sell to break even, how many units am I going to need to sell before I incur a loss. What happened if my sales increased by 5,000 unit or decreased by 5,000 unit? What happened if I increase my variable expenses or reduce my variable expenses? What happened if I change some of my fixed expense into a variable expense or I change my variable expense into fixed expense? All these questions, the contribution margin income statement will help you answer them. We're not going to answer them here in this session, but don't worry, we're going to answer those questions later on when we talk about cost volume profit analysis. But in this session, all what you want you to know is, what is the contribution margin income statement? How does it differ from the traditional? How does it differ? Well, the expenses here, we have 70,000 of expenses, 60 plus then equal to 70. True. All what we did here is we took those expenses and we broke them into variable cost and fixed cost expenses, which is 50, 55 plus 15 also equal to 70. That's all what we did. We broke them down and the reason we did so for decision making purposes. 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