Question

GAAP and the IRS require the use of absorption costing: however, the contribution margin approach is very intuitive. Ignoring the external requirements, which system do you think provides better information for decision making? Should be around 200-250 words and if found any information from an article or a website.

Answer 1

Under absorption costing, inventory cost includes variable and fixed manufacturing cost.

Unit cost under absorption costing =(Variable production cost + Fixed Production Cost)/Units Produced

Contribution margin approach uses the variable costs together and the fixed cost includes all the fixed costs.

Contribution margin = Selling Price - Variable costs

As production and sales increases, the contribution margin remains constant.

Thus contribution margin is simple to apply and tells with additional sales how much money will be generated to cover fixed costs.

Hence contribution margin is a better approach for decision making.