This income statement format is a superior form of presentation, because the contribution margin clearly shows the amount available to cover fixed costs and generate a profit or loss.
Indirect Expenses not allocated to Segments Segment A. An indirect cost is not traceable to a particular cost object; therefore, it only becomes an expense of the cost object through an allocation process. The depreciation expense is a direct cost for the company headquarters, but it is an indirect cost to each segment.
A contribution margin income statement varies from a normal income statement in the following three ways: Fixed production costs are aggregated lower in the income statement, after the contribution margin; Variable selling and administrative expenses are grouped with variable production costs, so that they are part of the calculation of the contribution margin; and The gross margin is replaced in the statement by the contribution margin.
Next, we describe each concept.
Be careful, however, not to equate direct costs with controllable costs. In contrast, indirect costs become segment costs only through allocation; therefore, most indirect costs are noncontrollable by the segment manager.
Fixed costs will increase if there is a step cost situation, where a block of expenses must be incurred to meet the requirements of an increase in activity levels. For example, the salary of a segment manager may be direct to that segment and yet is noncontrollable by that manager because managers cannot specify their own salaries.
As sales increase, the contribution margin will increase in conjunction with sales, while fixed costs remain approximately the same.