Contribution Margin Vs Gross Margin

THOMAS BUTTROSS: This lesson is on contribution margin versus gross margin.

Most students who are taking a managerial accounting course or studying managerial accounting have already had a course in financial accounting. And they don't always understand the connection between the financial accounting course and the new managerial accounting course.

The learning objective here is to understand how contribution margin, which is used in managerial accounting, differs from gross margin, which is used in financial accounting.

The contribution margin format of the income statement, which is presented on the left, is used in managerial accounting. The financial account view of the income statement on the right is used in the financial reports prepared for those outside the organization.

The first thing you need to understand is that the layout of the income statement does not change the operating income. Whether you use a contribution margin format on the left or the financial accounting format on the right, you get the same operating income. They put the same operating costs in different places on the income statement, but they do not change the operating costs.

Under the financial accounting format, with which you may already be familiar, you take revenues minus cost of goods sold to get a subtotal called gross margin or gross profit. From that, you subtract operating expenses and get operating income.

In managerial accounting, the same costs are divided into variable and fixed. Variable operating expenses are the variable portion of the cost of goods sold. That is, the direct materials, direct labor, and variable manufacturing overhead, and the variable selling and administrative expenses, such as sales commissions.

Fixed operating expenses are the fixed portion of cost of goods sold. That is, the fixed manufacturing overhead and the fixed selling and the administrative expenses, such as sales and office salaries.

So you take revenues minus the variable operating expenses to get a subtotal called contribution margin. Then you subtract the fixed operating expenses to get operating income.

This the end of contribution margin versus gross margin.