Segment Contribution Margin Analysis

The operating revenues of the three largest business segments for Time Warner, Inc., for a recent year follow. Each segment includes a number of businesses, examples of which are indicated in parentheses.

Time Warner, Inc. Segment Revenues (in millions)
Turner (cable networks and digital media)	$45,100
Home Box Office (pay television)	92,900
Warner Bros. (films, television, and videos)	36,600

Assume that the variable costs as a percent of sales for each segment are as follows:

Turner	54%
Home Box Office	26%
Warner Bros.	25%

a. Determine the contribution margin and contribution margin ratio for each segment from the information given. When required, round to the nearest whole millionth (for example, round 5,688.7 to 5,689). Round contribution margin ratio to whole percents for each segment from the information given.

	Turner		Home Box Office		Warner Bros.
Revenues	$fill in the blank 1		$fill in the blank 2		$fill in the blank 3
Variable costs	fill in the blank 4		fill in the blank 5		fill in the blank 6
Contribution margin	$fill in the blank 7		$fill in the blank 8		$fill in the blank 9
Contribution margin ratio (as a percent)	fill in the blank 10	%	fill in the blank 11	%	fill in the blank 12	%

b. Does your answer to (a) mean that the other segments are more profitable businesses?

The higher contribution margin ratio of a segment should not be interpreted as being the

leastmost

profitable segment. If the volume of business is not sufficient to exceed the break-even point, then the segments would be

somewhat profitableunprofitable

. In the final analysis, the fixed costs also should be considered in determining the overall profitability of the segments. The

contribution margin ratiofixed costsvariable costs

shows how sensitive the profit will be to changes in volume.

Income Statements under Absorption Costing and Variable Costing

Gallatin County Motors Inc. assembles and sells snowmobile engines. The company began operations on July 1 and operated at 100% of capacity during the first month. The following data summarize the results for July:

Sales (17,500 units)				$2,450,000
Production costs (23,000 units):
Direct materials		$1,191,400
Direct labor		572,700
Variable factory overhead		285,200
Fixed factory overhead		190,900		2,240,200
Selling and administrative expenses:
Variable selling and administrative expenses		$347,200
Fixed selling and administrative expenses		134,400		481,600

If required, round interim per-unit calculations to the nearest cent.

Question Content Area

a. Prepare an income statement according to the absorption costing concept.

Gallatin County Motors Inc. Absorption Costing Income Statement For the Month Ended July 31

Cost of goods soldDirect laborDirect materialsFixed factory overhead costsSales	$- Select -
Cost of goods soldGross profitSalesSelling and administrative expensesVariable factory overhead	- Select -
Direct laborDirect materialsGross profitFixed factory overhead costsSales	$- Select -
Cost of goods soldFixed factory overhead costsSalesSelling and administrative expensesVariable factory overhead	- Select -
Operating incomeLoss from operations	$- Select -

Question Content Area

b. Prepare an income statement according to the variable costing concept.

Gallatin County Motors Inc. Variable Costing Income Statement For the Month Ended July 31

Contribution marginFixed selling and administrative expensesManufacturing marginSalesVariable selling and administrative expenses		$- Select -
Fixed factory overhead costsFixed selling and administrative expensesManufacturing marginVariable cost of goods soldVariable selling and administrative expenses		- Select -
Contribution marginManufacturing marginSalesVariable cost of goods soldVariable selling and administrative expenses		$- Select -
Fixed factory overhead costsFixed selling and administrative expensesManufacturing marginVariable cost of goods soldVariable selling and administrative expenses		- Select -
Contribution marginFixed selling and administrative expensesManufacturing marginSalesVariable selling and administrative expenses		$- Select -
Fixed costs:
Contribution marginFixed factory overhead costsManufacturing marginSalesVariable cost of goods sold	$- Select -
Fixed selling and administrative expensesManufacturing marginSalesVariable cost of goods soldVariable selling and administrative expenses	- Select -
Contribution marginOperating incomeManufacturing marginSalesTotal fixed costs		- Select -
Operating incomeLoss from operations		$- Select -

Question Content Area

c. What is the reason for the difference in the amount of operating income reported in (a) and (b)?

Under the

absorption costingvariable costing

method, the fixed manufacturing cost included in the cost of goods sold is matched with the revenues. Under

absorption costingvariable costing

, all of the fixed manufacturing cost is deducted in the period in which it is incurred, regardless of the amount of inventory change. Thus, when inventory increases, the

absorption costingvariable costing

income statement will have a higher operating income.