The contribution margin income statement is a very useful tool in planning and decision making. While it cannot be used for GAAP financial statements, it is often used by managers internally.
The contribution margin income statement is a cost behavior statement. Rather than separating product costs from period costs, like the traditional income statement, this statement separates variable costs from fixed costs.
The basic format of the statement is as follows:
Variable costs, no matter if they are product or period costs appear at the top of the statement. Fixed costs are treated the same way at the bottom of the statement. It is helpful to calculate the variable product cost before starting, especially if you will need to calculate ending inventory.
Let’s run through an example to see how the income statement is constructed. We will use the same figures from the absorption and variable product cost post.
The first thing to remember about any income statement is that the statement is calculated based on the amount of product sold, not the amount of product produced. Therefore, this income statement will be based off the sale of 8,000 units.
To calculate sales, take the price of the product and multiply by the number of units sold.
Sales = Price X Number of units sold
Sales = $100 X 8,000
Sales = $800,000
Next, we need to calculate the variable costs. In the absorption and variable costing post, we calculated the variable product cost per unit.
This covers the product costs, but remember we must include all the variable costs. There is also $5 of variable selling cost that should be included. Multiply the total variable cost per unit by the number of units sold.
Total variable cost = Variable cost per unit X Number of units sold
Total variable cost = ($44 + $5) X 8,000
Total Variable Cost = $392,000
Contribution margin is the amount of sales left over to contribute to fixed cost and profit. Contribution margin can be expressed in a number of different ways, including per unit and as a percentage of sales (called the contribution margin ratio). In the contribution margin income statement, we calculate total contribution margin by subtracting variable costs from sales.
Total contribution margin = Sales – Variable costs
Fixed costs include all fixed costs, whether they are product costs (overhead) or period costs (selling and administrative). One thing that causes the contribution margin income statement and variable costing to differ from the traditional income statement and absorption costing is the fact that fixed overhead is treated as if it were a period cost. All fixed overhead is expensed in the period it is incurred. Under absorption costing, fixed overhead is attached to each unit. Therefore if there are units that are not sold, a portion of the fixed overhead ends up in inventory. That is not the case when using variable costing.
Add fixed overhead and fixed selling and administrative to calculate total fixed cost.
Total fixed cost = Fixed overhead + Fixed selling and administrative
Total fixed overhead = $48,000 + $112,000
Total fixed overhead = $160,000
Last step: subtract fixed costs from contribution margin to calculate operating income.
The contribution margin income statement is all about behavior. Remember the format and ignore the traditional (absorption) income statement. Most students that have trouble with this statement try to relate it back to what is happening on the traditional income statement. Throw out what you know about the traditional income statement when doing the contribution margin income statement. Focus on the format of this statement and you should be fine.
The contribution margin income statement
Kristin is a Certified Public Accountant with 15 years of experience working with small business owners in all aspects of business building. In 2006, she obtained her MS in Accounting and Taxation and was diagnosed with Hodgkin's Lymphoma two months later. Instead of focusing on the fear and anger, she started her accounting and consulting firm. In the last 10 years, she has worked with clients all over the country and now sees her diagnosis as an opportunity that opened doors to a fulfilling life. Kristin is also the creator of Accounting In Focus, a website for students taking accounting courses. Since 2014, she has helped over one million students succeed in their accounting classes.