Income Statement Contribution Method Revenue

¶ … Income Statement

Contribution Method

Revenue

$5,985,000

$5,985,000

Variable mfg cost

$1,543,500

Variable op cost

$414,000

Total Variable cost

$1,957,500

$1,957,500

Contribution

$4,027,500

Fixed Costs

Mfg Overhead

$1,600,000

$1,200,000

Total Fixed Costs

$2,800,000

$2,800,000

Net Profit

$1,227,500

Absorption Method

Revenue

$6,555,000

COGS

$1,690,500

Operating Expense

$2,014,000

S&A Expense

$1,200,000

Net Income

$1,650,500

The main difference between the contribution method is that it factors in the cost of goods sold for the goods produced that year. Production costs factor in the inventory at the beginning and end of the period. This makes the contribution margin approach valuable from a management accounting perspective because it provides more direct insight into the cost structure of the year's revenues.

The absorption method is more suitable for financial accounting. The method is valuable because it outlines the year's activities. The cost of goods sold includes the cost of the beginning inventory, but not the cost of the ending inventory. This is more in line with GAAP than is contribution margin.

We can see that one of the most significant differences is that the contribution margin method gives a different profit for the period compared with the absorption method. This is the result of the decline in inventory levels. If the inventory levels had not changed, there would have been no difference between the net profit for the two methods.

If the company sold another 10,000 units, it would have a higher profit. This calculation was based on the contribution margin method. What occurs in this method is that the company sells more, but it does not produce more. Therefore, the variable operating and selling cost increases, but the variable production cost does not increase. The inventory is run down further than in the first example, increasing the spread between the profit in the two methods.