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What is Contribution Margin Income Statement?
A Contribution Margin Income Statement is a special format of the income statement that segregates the variable and fixed expenses involved in running a business. It shows the revenue generated after deducting all variable and fixed expenses separately. In simple words, this format expresses the revenue generated after all the variable costs are paid.
- The Contribution Margin Income Statement format has fixed expenses as a part of overhead costs instead of production costs. To explain it in a better way, fixed expenses are incurred even if the sales volumes go up or down and hence are independent of what the sales are. However, the variable expenses tend to shoot as the production increases.
- All we need to do is deduct the variable expenses from revenue which would give contribution margin as the result. From the contribution margin, all fixed expenses are deducted that would conclude to Net Profit or Net Loss.
- It cannot be used for Generally Accepted Accounting Principles (GAAP) statements and is used by managers internally. This format is very useful in decision making. It helps in understanding the cost behavior by separating the fixed and variable expenses.
Contribution Margin Income Statement Format
A simple Contribution Margin Income Statement format is given below:
Every dollar of revenue generated goes into either of Contribution Margin or Variable Costs. What’s left in contribution margin goes in covering Fixed Costs and remaining into the Net Profit / Loss.
Unlike a traditional income statement, the expenses are bifurcated based on how the cost behaves. Variable cost includes direct material, direct labour, variable overheads, and fixed overheads. It does not matter if your expenses are production expenses or selling and administrative expenses. If they are variable, they must be included in variable costs. The same thing goes with fixed expenses, if they are fixed, they must be included in fixed costs.
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The contribution margin and the variable cost can be expressed in percentage of the Revenue. These are called as the contribution margin ratio and variable cost ratio respectively.
Examples of Contribution Margin Income Statement
Let’s see some examples of the contribution margin income statement to understand it better.
Example #1
‘My Cake Shop’ is a cake and pastry business that you run. With the rising demand in customers asking for workshops for baking their own cakes you started weekend workshops for the same. The revenue generated for the month was $7,500 which included direct sales of $6,000 and income from conducting Weekend Cake Workshops was $1,500. Wages paid were $2,000 and the expense incurred in procuring materials summed up to a total of $1,500. Rent of $1,000 was paid and the insurance premium payment of $200 was also made. The contribution margin income statement would look like this:
Example #2
Last month, Vienna Inc. sold its product for $2,000 per unit. Fixed production costs were $3,000 and fixed selling and administrative costs were $50,000. Variable production costs were $1,000 per unit and variable selling and administrative costs were $500 per unit. Vienna Inc. sold 500 units for the previous month.
Prepare a contribution margin income statement.
Calculation:
- Sales = Selling price per unit x No. of units sold =$2,000 x 500 =$1,000,000
- Cost of Goods Sold = $1,000 x No. of units sold =$1,000 x 500 =$500,000
- Selling and administrative costs = $500 x No. of units sold =$500 x 500 =$250,000
Contribution Margin Ratio
Contribution Margin Ratio = (250,000 / 1,000,000) x 100
Contribution Margin Ratio = 25%
Variable Cost Margin Ratio
Variable Cost Margin Ratio = (750,000 / 1,000,000) x 100
Variable Cost Margin Ratio = 75%
Contribution Margin Income Statement vs Traditional Income Statement
- It replaces gross margin.
- Fixed expenses are cached lower after contribution margin.
- Variable expenses are a part of calculating the contribution margin.
Advantages
- Data is placed in an organized manner which helps the management to understand how changes in production and sales volumes will affect the profit.
- Helps in identifying variable expenses that are eating up too much of the revenue.
- Even though the numbers remain the same, it gives a different perspective of the current financial condition.
- A better analysis can be done as the fixed and variable expenses are bifurcated.
- It can be used for break-even analysis.
Disadvantages / Limitations
- The format is not recognized by GAAP and hence cannot be shared with the external consumers of the financial statements.
- Focuses only on the expenses side.
- The income statement is accessible only to the internal audience.
Important Points
- It depicts expenses on the basis of its functional area.
- It distinguishes between fixed and variable expenses.
- The statement helps in decision making for the management
- With the help of the statement, break-even analysis can be conducted.
Conclusion
The contribution margin income statement is a special format of the income statement that focuses on expenses which are bifurcated for better understanding. Looking at the contribution margin income statement, it can be easily understood as to which business activity is resulting in a revenue leak.
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