Contribution

Contribution can be seen either as part of a discussion on marginal costing OR as a key part of short term decision making. Contribution can be seen either as part of a discussion on marginal costing OR as a key part of short term decision making.

For example, a company manufactures only one product called XY. The following information relates to the product :

Fixed costs for the period are $25,000.

The following table can be presented :

 The table illustrates that contribution per unit remains constant at all levels of activity. However, profit per unit changes. Hence, marginal costing is a useful method when trying to analyse and manage costs. Absorption costing does not distinguish between fixed and variable cost elements. It is not a useful method for internal reporting.

Short term decisions

Short term decisions have two characteristics that make them considerably simpler than longer term ones:

• The time value of money can be ignored
• Most fixed costs will be incurred anyway so can be ignored as not relevant

In such cases the main approach is usually to consider relevant cash flows, which may simplify to looking at the impact of the decision on the total contribution.

Methods here include:

• Cost volume profit (CVP) analysis (incorporating break even analysis)
• Key factor analysis 
• Linear programming 

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