To calculate the contribution margin, we must deduct the variable cost per unit from the price per unit. Instead of looking at the profitability of a company on a consolidated basis with all products grouped together, the contribution margin enables product-level margin analysis on a per-unit basis. If the contribution margin for an ink pen is higher than that of a ball pen, the former will be given production preference owing to its higher profitability potential. Such decision-making is common to companies that manufacture a diversified portfolio of products, and management must allocate available resources in the most efficient manner to products with the highest profit potential.

When preparing internal reports on the
performance of segments of a company, management often finds it is
important to classify expenses as fixed or variable and as direct
or indirect to the segment. As a result, many companies prepare an income statement
for internal use with the format shown below. Contribution margin income statements, by contrast, are often presented to managers and stakeholders to analyze the performance of individual products or product categories. Companies can benefit from contribution margin income statements because they can provide more detail as to the costs and resources needed to produce a given product or unit of a product. However, ink pen production will be impossible without the manufacturing machine which comes at a fixed cost of $10,000. This cost of the machine represents a fixed cost (and not a variable cost) as its charges do not increase based on the units produced.

The difference between traditional income statements and contribution margin income statements

It is important to note that this unit contribution margin can be calculated either in dollars or as a percentage. To demonstrate this principle, let’s consider the costs and revenues of Hicks Manufacturing, a small company that manufactures and sells birdbaths to specialty retailers. In this part, we’ll explore what a margin means when we look at income statements.

This income statement format is a superior form of presentation, because the contribution margin clearly shows the amount available to cover fixed costs and generate a profit (or loss). A segmented income statement is based on the contribution margin income statement format. The contribution margin income statement and segmented income statement by division for Media Masters is presented in Exhibit 5-2. Although variable and fixed costs are allocated differently on the segmented income statement, net operating income will always be the same. The contribution margin format is used to prepare segmented income statements.

Utilizing Contribution Margin to Determine Break-Even Point

Fixed production costs were $3,000, and variable production costs amounted to $1,400 per unit. Fixed selling and administrative costs totaled $50,000, and variable selling and administrative costs amounted to $200 per unit. Segmented income statements allocate contribution margin income statement format revenue and cost to the identified segments within an organization and report the profitability of each segment. An organizational segment is a part or activity within an organization about which managers would like cost, revenue, or profit data.