topic 30 marginal costing introduction

• Direct costs


  The same as the prime costs studied under manufacturing accounts and change in direct proportion to the level of activity/output
• Direct cost


  A cost that is expressed as 'per unit', e.g. raw materials, direct wages, royalties
• CIMA definition of direct cost

  Expenditure which can be economically identified with a specific saleable cost unit
• Direct costs


  Also known as variable costs, which always change in direct proportion to a change in the level of activity (output or sales) undertaken by the business
• Indirect costs


  Costs which cannot be identified directly to the end product, also known as 'overheads' which stay the same regardless of the level of activity output and are paid on a time basis
• Indirect costs


  Also known as fixed costs, which do not change with the level of business activity
• Semi-variable costs


  Contain both a fixed element and a variable element
• Fixed costs


  Are not affected by changes in the number of units produced, so if the number of units produced is increased then only the variable costs will change
• Contribution per unit


  Selling price - marginal (variable) costs per unit
• Total contribution


  CPU X output, which is the same as Total revenue - Total variable costs
• Break-even point


  Where Total revenue = Total Costs, where the total contribution (contribution per unit X output) = fixed costs
• Margin of safety


  The difference between Break even output and planned (actual) output, showing how far the sales of a product can fall before it moves out of profit and into a loss making situation
• Usefulness of break-even analysis

  • Very useful in short term decision making and planning
  • Identifies the margin of safety
  • Part of a business plan
• Limitations of break-even analysis

  • Simplistic assumptions about costs
  • Assumes a single product is sold
  • Ignores unsold goods
• Contribution to sales ratio


  Shows how much each £ of sales contributes to the fixed costs of the firm, used to calculate the sales revenue needed to break-even or achieve a target profit = Total contribution divided by Sales revenue
• Break-even graph


  • Shows the relationship between total costs and the level of output by plotting revenue and costs on a graph, with revenue and costs measured on the y axis and output in units on the x axis
• Benefits of break-even charts

  • Visually attractive and understandable for non-accountants
  • Provides clarity of information and emphasises the main features
  • Can be generated in a spreadsheet
• Limitations of break-even charts

  • Assumes fixed costs are always the same and selling price and variable cost per unit are the same regardless of the level of output
  • Does not account for semi-variable or semi-fixed costs
• Break even output = FC divided by (SP-VC)
• Margin of safety = Actual output − Break-even output
• Target profit output = (Target profit + Fixed costs) divided by CPU, so CPU = (Target profit + Fixed costs) divided by Planned output
• Break even sales revenue = Fixed costs divided by Contribution/Sales ratio
• Target profit revenue = (Target profit + Fixed costs) divided by Contribution/Sales ratio