Contribution Margin Accounting

Contribution margin accounting is an umbrella term for different variants of multilevel gross income calculations. There are two basic types. The relative calculation of direct costs and contribution margins according to Riebel distinguishes between direct costs and overhead, whereas other types, such as direct costing, base the analysis of fixed-cost allocation or marginal costing on a separation of fixed and variable costs.

Direct costs is a relative term, since it can refer to costs on many items, including products, product groups, or units of capacity in which only certain products or product groups are manufactured. An example of product-related direct costs would be leasing costs for special-purpose machines that are only used for a single product, such as a chromium plating machine. Costs for advertising that relate to a whole product group (such as flat screen televisions) are an example of product group direct costs. Distinguishing between direct costs and overhead costs is based on the principle of identity. According to this principle, it is only possible to definitively align costs and revenues for calculating a contribution margin if they can be traced back to the same decision.

The relative calculation of direct costs and contribution margins primarily focuses on decision-making. Its main purposes are:

1. Preliminary costing

2. Control of the effect on net income of different alternatives for action

3. Profit planning related to orders, projects, and specific periods as well as across periods, and analysis of the source of profit by multidimensional evaluation objects (Riebel 1994)

Contribution margin accounting therefore offers significant support in deciding whether products should be added or removed from an existing product line. For example, less complex products in the product line may be suffering from adecline in prices, while products at the upper end may be suffering from a lack of demand, making the lot sizes too small.