Updated June 16, 2000
Contribution accounting refers to a method of accounting in which accountants track revenues and costs to various segments of a firm. By tracking revenues and expenses to firm segments, accountants enable managers to quickly estimate the profit impact of dropping a firm segment, or of adding another segment just like one of the existing ones. Consider the following diagram for a firm with four contribution segments.
This firm has four segments for which accountants track revenues and expenses. In addition, segments A and B jointly share annual costs of $40,000 that support their operation; segments C and D jointly receive support from annual expenditures of $30,000. Changes in the activities of any of the segments do not impact these two cost amounts--only a change in the management policy that established the $40,000 or the $30,000 support costs will make these costs go up or down.
The bottom part of the diagram indicates this company has annual costs of $200,000 that support all firm activities. Changes in any cost or segment in the upper part of the diagram that this expenditure supports have no impact on this cost. Only a reconsideration of the management decision that established the annual $200,000 cost will bring about a change in this cost.
Only the costs and revenues in the colored box disappear. None of the $30,000 cost that supports the two segments C and D are impacted by this decision. This $30,000 includes administrative costs that support both segments, and these costs will still be incurred if the manager drops segment D.
The company manager would consider this $30,000 cost only if he if considered dropping both segments C and D. With both these segments gone the company does not need to spend the $30,000 since the segments this expenditure supports are gone. The next diagram shows the costs and revenues that disappear if the manager decides to get rid of the two segments.
Here company profits drop by $170,000 per year if the manager decides to eliminate the cross hatched areas of the diagram.
To sum up, contribution accounting allows managers to quickly estimate the profit impact of dropping pieces of the company or of adding similar pieces.
Observe the circled numbers in this schedule because they relate to numbers in the following schedules.
The circled numbers here relate to the first schedule. See if you can trace them to this schedule. Notice also how the fixed costs relate to the division fixed costs in the first schedule.
The numbers in this schedule make up the totals shown in the previous schedule. Trace the marked numbers back to the schedule above.
