Response To Contribution Analysis According To Douglas 2012

Respond Tocontribution Analysis According To Douglas 2012 States

Respond to... Contribution analysis, according to Douglas (2012) states that an analysis that is used to compare the incremental costs to the benefits of the incremental revenue. The difference between the costs and the revenue is considered the contribution margin. Douglas goes into get detail in his book how the costs are considered and any relevant costs are considered when it comes to contribution analysis. There are three categories to consider when it comes to incremental costs: 1. Present period explicit costs- This is the actual amount paid for the items or the variable in the contribution analysis 2. Opportunity costs- this includes items that cannot be sold with the present period explicit costs but have the opportunity to be sold to a third party at a lower amount or used for scrap, etc. 3. Future Costs- this includes anything that could happen in the future, including repairs, maintenance, etc. (Douglas, 2012). Of course, the revenue is what you make when the item is sold on the market. This is used quite often in production. They are able to weight the costs versus the revenue and determine if it is worth producing the item or if they should just stop production altogether. I actually just had to do a contribution analysis not too long ago when we were looking at buying a home. We recently moved back to the United States after my husband and decided to buy a home. However, the house market is crazy right now and we found that we could build a home for the same price of buying a home. So we then had to determine the increment costs and revenue to determine how we should proceed With a home that was already built, the benefits, or "revenue" was that we could move in right away, would stay on budget, and would be able to live where we want to for the price we want. The costs were the costs of the home is a little elevated, there is a possibility there are hidden issues with the home. When it comes to building a home, the revenue or "benefits" was the fact that we could have exactly what we wanted, everything is brand new and would have warranty. However, the costs was we would probably go over budget, we would have to build wherever we can afford land. WE were able to take this analysis and make a decision based on the "costs and revenues". However, this is something that we do everyday when buying products in stores. WE determine the costs versus the benefits. I don't work in an industry where I really have to do this daily however, companies are definitely doing this nonstop as well to create enough profit to keep the business running. I think this is a great way to analyze if a product or item is worth producing or even buying.

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Contribution analysis is a managerial accounting technique utilized to evaluate the profitability of individual products, services, or decisions by focusing solely on the relevant costs and revenues that change as a result of a particular decision. This method isolates the costs and benefits that are directly attributable to a specific choice, enabling managers to assess whether pursuing a certain option will contribute positively to the organization's overall profitability. As Douglas (2012) emphasizes, contribution analysis is anchored in the concept of incremental costs and revenues, which represent the additional costs and income generated by a decision. The core objective of this analysis is to measure the net contribution of a decision—essentially, the excess of incremental revenues over incremental costs—thereby determining whether a decision should be pursued or avoided.

At its essence, contribution analysis involves calculating the contribution margin, which is the difference between the selling price per unit and the variable cost per unit. This margin indicates how much each unit sold contributes to fixed costs and profits after covering variable expenses. For example, a manufacturer might assess whether reducing the price of a product will still allow for a positive contribution margin—meaning the product will still contribute to covering fixed costs and generating profit despite the lower price. When the contribution margin remains positive, the decision to lower prices could potentially increase total profit due to higher sales volume; however, if the margin turns negative, such a move would diminish profitability.

Douglas (2012) details that contribution analysis involves classifying costs into relevant categories, primarily explicit costs, opportunity costs, and future costs. Explicit costs are direct monetary payments made during the current period—for instance, wages, raw materials, or utility bills. Opportunity costs represent the benefits forfeited when choosing one alternative over another, such as the potential sales of a product that cannot be pursued because resources are committed elsewhere. Future costs account for potential expenses that may arise after the decision is implemented, including repairs, maintenance, or replacement costs. Incorporating these categories ensures that the analysis reflects the true incremental costs associated with a decision.

To illustrate the application of contribution analysis, consider a retail scenario where a store evaluates whether to continue selling a particular product. The store calculates the contribution margin per unit by subtracting the variable costs from the selling price. If this contribution is positive, the product is contributing towards covering fixed costs and profit; if negative, it might be more economical to discontinue its sale. Similarly, companies deciding on whether to accept special orders or enter new markets utilize contribution analysis to determine the incremental profitability of such decisions.

In personal contexts, contribution analysis can be used to make informed financial decisions, such as deciding whether to keep an older vehicle or purchase a new one. For example, one might compare the incremental costs of maintaining an aging truck—such as repairs, fuel, and insurance—against the costs of buying a newer model, which might include a higher purchase price, increased insurance premiums, and lower fuel expenses. If the total incremental costs of the new vehicle outweigh the incremental benefits, such as fuel savings or improved performance, then retaining the old vehicle remains the more cost-effective choice. This process exemplifies how contribution analysis can aid individuals and organizations in making decisions that optimize resource allocation and profitability.

In conclusion, contribution analysis provides a structured approach for decision-making by isolating the specific costs and revenues that are directly impacted by a choice. It emphasizes the importance of understanding marginal impacts and aids managers in determining the most profitable course of action. By focusing on incremental costs and revenues, organizations and individuals can avoid decisions that are detrimental to overall financial health and identify opportunities that enhance profitability. The utility of contribution analysis spans diverse contexts, from manufacturing and retail to personal finance, underscoring its significance as a fundamental managerial accounting tool.

References

• Douglas, E. (2012). Managerial Economics (1st ed.).
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