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CONTRIBUTION COSTING is a costing method in which ONLY VARIABLE COSTS ARE USED and DEDUCTED from REVENUE, and the remainder, which is called the 'CONTRIBUTION' is what is left to COVER ANY INDIRECT/FIXED COSTS and CREATE PROFIT
Therefore, CONTRIBUTION = REVENUE - VARIABLE COSTS
TOTAL CONTRIBUTION is the total contribution of all units sold, therefore...
TOTAL CONTRIBUTION > FIXED COSTS, then the SURPLUS is PROFIT.
TOTAL CONTRIBUTION < FIXED COSTS, then their is A LOSS.
Hang on!!!! Isn't contribution per unit the same as gross profit margin?
No! Gross margin is REVENUE - COGS, which includes variable and some fixed costs, as such it is smaller than contibution per unit, which only deducts variable costs.
Direct costs can be variable or fixed, eg rent, salary
Variable cost 'vary' when production rises or falls eg per hour workers, delivery costs
Variable costs do not have to be direct costs and can be INDIRECT COSTS, eg electricity is variable but not direct to the production of one particular good.
indirect costs can also be fixed such as Computers and salary of other workers.
Q. A good can have a positive contribution per unit but makes no profit, so should a firm stop the production of a good that contributes no profits?
As noted above positive contribution can be used to pay off FIXED/INDIRECT COSTS which MUST BE PAID REGARDLESS of whether the business is making a profit or loss, as such even though the unit isn't making a profit it is making a contribution to the reduction of these indirect costs. Let's look at two scenarios in which contribution costing is used to make decisions.
--LIMITATIONS--
--LIMITATIONS--
--WHEN TO USE CONTRIBUTION COSTING--
--WHEN TO USE CONTRIBUTION COSTING--
--WHEN NOT TO USE CONTRIBUTION COSTING--
--WHEN NOT TO USE CONTRIBUTION COSTING--
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