Contribution Analysis

Explain what is meant by “contribution analysis”. Carefully define the term and provide examples to illustrate it.

Can you think of a recent example where incremental costs had to be used and benefit different options in order to make a decision?

Contribution Margin

Contribution Margin as described by the authors is the excess revenue over the incremental costs incurred over a period. The contribution analysis is the estimation of the selling price and the direct costs of products for computing how each unit sold will cover the indirect costs and also contribute to the net income. This study is handy in evaluating the cost structure of the operation. It helps the company analyze which costs are constraining its ability to achieve higher net income (Warren, Reeve, & Duchac, 2016).

(Heisinger, 2015)

As shown in the tables above an illustration for the aim of understating has been developed. Table 1 shows the basic data for Product X which is sold for $1000 per unit. Here, the contribution analysis is conducted on 1 unit. In another scenario, the selling price is multiplied by the number of units sold to get the value of total revenue. It shows the basic difference between the two formats. The variable or direct cost of product X is given as $700, and the indirect or fixed cost is given as $200. The contribution analysis is shown in Table 2. It shows that firstly, the variable cost I deducted from the selling price of the Product X to yield the contribution margin. It is the excess incremental revenue earned on the incremental costs of Product X. Secondly, the fixed costs of producing X i.e. 200 is deducted from the contribution margin to arrive at the net income of the product. The net income of the product is $100.

References:

Heisinger, K. (2015). Essentials of Managerial Accounting. Cengage Learning.

Warren, C., Reeve, J. M., & Duchac, J. (2016). Financial & Managerial Accounting. Cengage Learning.