Contribution (HL)

Business Management Toolkit

Unit content
Content
Contribution analysis as a decision-making tool
Make or buy analysis
Contribution costing
Absorption costing
Evaluation of contribution
Contribution analysis as a
decision-making tool
 Contribution analysis of a taco truck
9

Contribution

Price, average variable cost & contribution per unit ($)

8

analysis 7

• Contribution refers to the

6
difference between sales
revenue earned from selling a 5

product and the variable costs 4

of producing the product.
3
• Contribution analysis is used
2
as a decision-making tool for:
1. Make or buy analysis 1

2. Contribution costing
0
3. Absorption costing VEGAN TACO CHICKEN TACO FISH TACO BEEF TACO
Menu items

Average variable cost Unit contribution

 Contribution analysis of a taco truck
9

Price, average variable cost & contribution per unit

Unit contribution 8
Contribute to
7 payment of total
• This is the Unit contribution:
3 fixed costs e.g.:
$3
proportion of the 6 • Truck hire
selling price for each • Parking fees
5
• Salaries
unit of output that

($)
4
will go towards (i.e.
contribute to) paying 3 Average variable
off total fixed costs. cost5per unit:
2 $5 Selling price per
unit:
1
Unit contribution = $8
Price – AVC 0
BEEF TACO
 Contribution analysis of a taco truck
9

Price, average variable cost & contribution per unit

Total 8 Each beef taco
contributes $3
contribution 7
Unit contribution: towards fixed
• This refers to the 3
costs. The
$3
quantity of output 6 business will have
needed to go 5
to sell 1,000 beef
tacos to pay off
towards (i.e.

($)
4 TFC.
contribute to) paying
off total fixed costs. 3 Average variable
cost5per unit: Selling price per
Total contribution = 2 $5 unit:
TFC ÷ Unit contribution $8
1

0 Total fixed costs:

BEEF TACO $3,000
Make or buy analysis
 Volkswagen (VW) – car or sausage producer?
True or false?
Volkswagen’s factory
produces more sausages
than it makes cars
worldwide.

Watch this video of the VW

factory and answer the below
questions:
1. Does VW produce more
sausages than cars?
2. Why does Volkswagen
produce sausages?
Make or buy analysis
• A business faces a make-or-buy
decision when it has a choice
between manufacturing a
product or purchasing it from an
external supplier.
• To decide whether to make or to
buy, a firm uses quantitative and
qualitative factors in their
decision making.
Quantitative factors in make or buy decisions
Cost to buy = Price × Quantity
versus
Cost to make = Fixed costs + (Variable costs × Quantity)

Cost to Cost to
Cost to buy Cost to buy
make make

$ $

The firm
$ $ $ $ The firm
should buy the should
product from $ $ $ $ manufacture
a third-party the product
supplier. in-house.
 Qualitative factors in make or buy decisions

Time frame of Spare capacity Reliability of In-house Size of capital

production suppliers expertise expenditure

Core & non-core Strategic Significance of External

competencies importance the product to influences
the firm
Over to you

• Hoang textbook
• Question 57.1 Sami Ikea Inc.
• Page 713
• Answer all parts
Contribution costing
 Contribution analysis of a taco truck

Contribution costing 9

• This is a method of valuing costs 8

Price, AVC & contribution per unit ($)

by allocating direct costs to 7
products or divisions of a
business. 6

The strongest product is the chicken taco. It 5

earns the firm $5 contribution per unit
sold. 4
• The most vulnerable product is the 3
vegan taco. It earns the firm only $2
contribution per unit sold. 2
• Sales of vegan tacos must be 2.5 times
more than chicken tacos in order to 1
earn the same contribution as one unit
of chicken tacos. 0
Vegan Chicken Beef
All tacos are profitable as they all Fish taco
taco taco taco
make positive contributions
Unit contribution 2 5 3 3
towards paying off TFC.
Average variable cost 4 3 4 5
Benefits and limitations of contribution
costing
Benefits Limitations
• Greater awareness of total cost • Indirect costs are not accounted
of a product which leads to for in this method.
better pricing decisions. • Subjective nature of classifying
• Profitability of each product line costs as direct or indirect costs.
or department can be measured
and analysed.
Absorption costing
 Vegan Chicken Fish Beef
taco taco taco taco
Absorption costing
• It involves deciding on the most Average unit
6 8 7 8
appropriate way to apportion a price
firm’s indirect or fixed costs.
• This is an extension of
Average
contribution costing. 4 3 4 5
variable cost

Total fixed costs for the taco truck:

$3,000
Unit
2 5 3 3
If TFC is allocated equally between contribution
each product, the FC allocation will
be $750* per product.
Fixed cost
*3,000 ÷ 4 = 750 750 750 750 750
allocation
 Vegan Chicken Fish Beef
Absorption costing taco taco taco taco

and the break-even Average unit

6 8 7 8
price
quantity
• Absorption costing allows
a firm to calculate the Average
4 3 4 5
break-even quantity for variable cost
each product for the taco
truck.
Unit
2 5 3 3
contribution
Break-even quantity =
Fixed cost ÷ Unit contribution
Fixed cost
750 750 750 750
allocation

Break-even
375 150 250 250
quantity
 Vegan Chicken
Fish taco Beef taco
taco taco
Criteria for allocating Average unit
a firm’s indirect costs price
6 8 7 8
• Indirect costs are not always equally
apportioned between products or Average
4 3 4 5
divisions in a business. variable cost
• For example:
Unit
Total fixed costs for the taco truck: 2 5 3 3
contribution
$3,000

If TFC is allocated based on the Number of

number of staff preparing each staff to
product, the FC allocation will be 1 1 2 1
prepare
apportioned as $600* per staff per product
product.
Fixed cost
*3,000 ÷ 5 staff = 600 600 600 1200 600
allocation
Advantages and disadvantages of absorption
costing
Advantages Disadvantages
• Cost allocation is more fair for multi- • Complex and time-consuming to
product/multi-departmental firms. calculate.
• Greater awareness of total cost of a • Benefits may not be significant
product which leads to better pricing enough, especially for small firms.
decisions. • Not all indirect costs can be divided
• Profitability of each product line or accurately.
department can be measured and • Subjective nature of indirect cost
analysed. allocation.
Over to you

• Hoang textbook
• Question 57.2 Dolls-R-Us
• Page 717
• Answer all parts
Evaluation of contribution
Uses of contribution analysis for businesses

Pricing strategy Product portfolio Make or buy decisions

management

Allocation of overheads to Special order decisions Break-even analysis

cost and profit centres
 Strategies to improve
profits
Strategies to improve profits
1. In groups, recommend three
strategies to improve profits at Contribution analysis provides
your school. managers and decision makers with
2. Swap your strategies with three broad strategies for improving
profits:
another group.
3. Identify one advantage and one i. Increase sales revenue
disadvantage for each strategy ii. Reduce variable costs
for your school. Be prepared to iii. Reduce fixed costs
share your reasons why with the
rest of the class.
Over to you

• Hoang textbook
• Review Questions
• Page 718