The contribution margin approach to the income statement classifies costs based on their behaviour rather than their function, helping businesses understand how their costs contribute to revenue generation. It categorizes costs into two main types: variable costs and fixed costs. Variable costs, such as direct materials, labour, and overhead costs, change in proportion to the level of production or sales, while fixed costs remain constant over a specific period. These costs are incurred regardless of the business's activity level.
By classifying costs according to behaviour, the contribution margin approach helps businesses analyze their profitability and make informed decisions. It determines the contribution margin, which is the difference between sales revenue and variable costs. This represents the portion of sales revenue available to cover fixed costs and contribute to profits. Understanding the behaviour of costs is crucial for businesses, as it helps them determine the breakeven point, the level of sales needed to cover all costs. This information guides pricing decisions and helps set sales targets. In conclusion, the contribution margin approach to the income statement classifies costs based on their behaviour rather than their function, allowing businesses to gain insights into their cost structure and make informed decisions to improve profitability.