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    Absorption Income versus Contribution Margin Income - Accounting

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    Given the computations for both gross profit on sales and contribution margin, what benefits come from gross profit on sales instead of contribution margin? Is net income always the same no matter what the accounting approach is?

    Let me give you a simple example. Look at the income statements below before you answer the questions.

    ABC Company sells 10,000 widgets. The company has no beginning or ending inventory. Using the absorption approach (GAAP) the net income of the company is as follows:

    Sales (10,000 @ $20) $200,000
    Cost of goods sold (10,000 @ $12) 120,000
    Gross profit $ 80,000
    Expenses 20,000
    Net income $ 60,000

    Using the contribution margin approach the net income of the company is as follows:

    Sales (10,000 @ $20) $200,000
    Variable cost of goods sold (10,000 @ $8) 80,000
    Gross profit $120,000
    Fixed expenses 60,000
    Net income $ 60,000

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    Solution Preview

    The gross profit on sale is based on a functional approach and the cost of goods sold includes only the manufacturing costs. The contribution margin is based on behavioral approach and uses only the variable costs.

    The specific benefits to be derived from gross profit would be

    1. The gross profit indicates the amount left with the firm after meeting the required expense of the product cost. In ...