An income statement is also known as a statement of profit and loss because it indicates whether or not a company has made a profit or a loss for the period indicated in the income statement heading. A contribution approach income statement and a traditional income statement produce the same result in terms of determining a company’s net income. However, the traditional income statement provides different information than the contribution approach.
The contribution approach is not used often when preparing an income statement because it is standard to present a traditional income statement where cost of goods sold gets deducted from total revenue to determine the gross profit for the period, as explained by the Accounting Tools website. When a company uses the contribution approach, the income statement deducts variable expenses and various manufacturing costs from total revenue to determine the contribution margin. The contribution margin equals variable expenses minus total revenue.
Another difference between a contribution approach income statement and the traditional income statement concerns the presentation of variable expenses. When a company uses the contribution approach, the company’s variable selling and administrative expenses, along with manufacturing expenses, are the first deduction from total revenue. When a company uses the traditional income statement method, the company deducts variable selling and administrative expenses after determining the company’s gross profit. Using the traditional method means variable expenses are deducted to determine the company’s net income prior to taxes.
Fixed costs and expenses are costs that never change despite fluctuations in a company’s productivity. When a company uses the contribution approach, fixed costs appear at the bottom of the income statement. In this case, the company subtracts fixed selling and administrative costs and fixed manufacturing costs from the contribution margin to determine the company’s net income. When a company uses the traditional approach to prepare an income statement, fixed expense accounts are blended with variable expense accounts to determine net income before taxes. Examples of fixed expense accounts found on a traditional income statement include depreciation expense, rent expense, utilities expense and salaries expense.
Income taxes do not appear on a contribution approach income statement. After the company subtracts fixed expenses from the contribution margin, the result indicates the company’s net income. When a company uses the traditional method of preparing an income statement, the company must subtract income taxes from net income before taxes. The result indicates whether or not the company generated a profit or loss for the period.