Variable costs vary in line with the level of business

activity
Fixed costs do not vary with the level of business
activity (true only up to a point)
Stepped costs: where the business reaches the level of
activity where a fixed cost must increase, the increase is
sudden
Semi-variable costs have both fixed and variable
elements
 In economics, a marginal cost is the cost of one
additional item

Marginal costing describes an approach to costing

that excludes fixed costs

Contribution refers to the amount that is left over

after deducting variable costs from sales
The break-even point is the point at which no
profit or loss is made in a set of business
transactions. For example:
 It is important to understand the relationships
between the level of business activity, the
different types of cost, and profitability

The analysis of the interaction of these

factors is Cost-Volume-Profit analysis (CVP
Add a line for sales revenue
We can work out break-even points using
the relationship between sales and
costs:

Selling price per unit - variable costs per unit =

contribution per unit
Example: Mulberry Piggott Limited
Selling price of a raincoat = 30
Variable costs = 10 per raincoat
Expected fixed costs = 60 000

How many raincoats must the company sell to break

even?
Mulberry Piggott (continued): target profit = 30 000
Mulberry Piggott Limited
Mulberry Piggott Limited
If projected sales of 4500 are realistic, and break even point is
3000 units, the margin of safety is:
Decision rule: if an order or a contract at a
special price would produce a positive
contribution to fixed costs, the order should
be accepted
BUT
there are likely to be other factors relevant to
the decision
If a business is considering major increases in
activity levels it must take into account any
likely increases in fixed costs

If incremental revenues exceed incremental

costs, the project should be accepted
Example: Spindrift & Schooner Limited
Estimated effect of extending a boatyard
Limiting factors are constraints on sales or
production, for example:
a product may require specialist labour for
which there is a shortage
a product may require a material that is in
short supply
Example: Crosthwaite and Crosby Limited
Cost structures for three products
Example: Crosby and Crosthwaite Limited

Product B gives the highest contribution,

but labour is scarce. Which product
provides the highest contribution per
unit of limiting factor?
Example: Crosby and Crosthwaite Limited

Product A gives the highest contribution per unit of limiting

factor
 Assumes that variable costs increase at a
steady rate - assumption may not be valid
Very few costs are truly variable
Fixed costs remain fixed only up to a point
Analysis more difficult in multi-product firms
There may be other factors to take into
account