If a system of marginal costing is operated in an organization with more than one product, it will not be possible to ascertain the net profit per product because fixed overheads are charged in total to the profit and loss account rather than recovered in product costing. The contribution of each product is charged to the firm’s total fixed overheads and profit is ascertained. Contribution is the difference between selling price and variable cost of sales. It is visualized as some sort of a fund or pool, out of which all fixed costs, irrespective of their nature are to be met, and to each product has to contribute its share. The excess of contribution over fixed costs is the profit. If the total contribution does not meet the entire fixed cost, there will be loss.
In normal circumstances, selling prices contain an element of profit but there may be circumstances, when products may have to be sold at cost or even at loss. Therefore, the character of contributions will have the following composition under different circumstances:
- Selling price containing profit:
Contribution = Fixed cost + Profit
- Selling price at cost:
Contribution = Fixed cost
- Selling price at loss:
Contribution = Fixed cost −Loss
