Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
• 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
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
• 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
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
The break-even point is the point at which no
profit or loss is made in a set of business
transactions. For example:
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
• 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
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
Add a line for sales revenue
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
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
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
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?
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
Mulberry Piggott (continued): target profit = £30 000
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
Mulberry Piggott Limited
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
Mulberry Piggott Limited
If projected sales of 4500 are realistic, and break even point is
3000 units, the margin of safety is:
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
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
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
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
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
Example: Spindrift & Schooner Limited
Estimated effect of extending a boatyard
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
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
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
Example: Crosthwaite and Crosby Limited
Cost structures for three products
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
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?
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
Example: Crosby and Crosthwaite Limited
Product A gives the highest contribution per unit of limiting
factor
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning
• 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
Use with Business Accounting and Finance
Second Edition by Catherine Gowthorpe ISBN 1-84480-200-0
© 2005 Thomson Learning