AQA A-Level Accounting: Marginal costing (7127)

This guide covers section 3.10, Marginal costing, of the AQA A-level Accounting (7127) specification, version 1.1 (October 2026), for A-level exams from June 2019 onwards. The course is untiered, and section 3.10 is assessed on Paper 2, which draws on sections 1–3, 8–13 and 17–18. Every business and figure below is invented.

Useful links: AQA A-level Accounting hub, printable checklist, revision notes for this topic, practice questions and the free 10-minute diagnostics. Marginal costing is a management accounting technique; the difference between financial and management accounting is covered in The role of the accountant.

What this section covers

Specification content (3.10)	What you must be able to do
Categorisation of costs by behaviour and understanding of terms	Define and classify direct, indirect, variable, semi-variable, fixed and stepped costs; explain marginal cost, contribution (total and per unit) and break-even
Calculation and interpretation of break-even point; break-even charts; uses and limitations	Calculate break-even, interpret a break-even chart, and judge its reliability
Use of marginal costing in decision making	Make or buy, additional work, price setting, scarce resources, closing a loss-making line or department, target profit; weigh non-financial factors

1. Costs by behaviour and the key terms

Costs are grouped in two separate ways: can the cost be traced to a unit, and how does it behave as output changes?

Traced to the product or not

• Direct costs can be traced directly to each unit made: direct materials, direct labour and any direct expenses (for example a royalty paid per unit).
• Indirect costs (overheads) cannot be traced to a single unit: factory rent, a supervisor’s salary, insurance.

Behaviour as output changes (within the relevant range)

• Variable costs rise in total in direct proportion to output. The cost per unit stays the same.
• Fixed costs stay the same in total whatever the output, within a period and a range of activity. Fixed cost per unit falls as output rises.
• Semi-variable costs have a fixed element and a variable element, such as electricity with a standing charge plus a charge per unit used.
• Stepped costs are fixed over a range of output, then jump to a new level when a capacity limit is passed, such as a second supervisor once output exceeds what one can oversee.

Marginal cost is the extra cost of making one more unit. In practice it is the variable cost per unit: direct materials + direct labour + direct expenses + variable overheads.

Contribution is selling price minus marginal cost. Contribution per unit = selling price per unit − variable cost per unit. Total contribution = sales revenue − total variable costs, or contribution per unit × units sold. Contribution first covers fixed costs; after that, every extra pound is profit.

Break-even is the level of output or sales at which total contribution exactly equals fixed costs, so there is neither profit nor loss.

Worked example 1: classifying costs

Fernhill Joinery makes garden benches.

Cost	Direct or indirect?	Behaviour
Timber, £38 per bench	Direct	Variable
Joiners paid £22 per bench completed	Direct	Variable
Workshop rent, £18 000 a year	Indirect	Fixed
Electricity: £2 400 a year standing charge + £1.50 per bench	Indirect	Semi-variable
Supervisor, £28 000 a year; one supervisor per 2 500 benches	Indirect	Stepped

At 2 000 benches, electricity = 2 400 + (2 000 × 1.50) = £5 400. At 2 500 benches one supervisor is enough (£28 000); at 2 501 a second is needed and the cost steps up to £56 000.

Each bench sells for £110. Variable costs are timber £38, labour £22 and variable overheads £6 (including the electricity variable element). Total fixed costs are £61 600 a year.

• Marginal cost per bench = 38 + 22 + 6 = £66
• Contribution per bench = 110 − 66 = £44

2. Break-even analysis

Break-even by calculation

Break-even point (units) = total fixed costs ÷ contribution per unit
Break-even revenue      = break-even units × selling price
                        or total fixed costs ÷ C/S ratio
C/S ratio               = contribution per unit ÷ selling price per unit
Units for target profit = (total fixed costs + target profit) ÷ contribution per unit

Worked example 2: Fernhill Joinery

1. Break-even = 61 600 ÷ 44 = 1 400 benches.
2. Break-even revenue = 1 400 × 110 = £154 000. Check: C/S ratio = 44 ÷ 110 = 0.4, and 61 600 ÷ 0.4 = £154 000.
3. Budgeted sales are 2 000 benches. Profit = (2 000 × 44) − 61 600 = £26 400.
4. The gap between budgeted sales and break-even is often called the margin of safety: 2 000 − 1 400 = 600 benches, or 600 ÷ 2 000 = 30% of budgeted sales. Sales could fall by 30% before a loss is made.
5. To earn a target profit of £44 000: (61 600 + 44 000) ÷ 44 = 2 400 benches. This is still within one supervisor’s range, so fixed costs do not step up.

Always check a target output against stepped costs. Had the target needed more than 2 500 benches, the extra supervisor’s salary would have to be added to fixed costs before dividing.

Break-even charts

A break-even chart plots output (units) on the horizontal axis and costs and revenue (£) on the vertical axis. It has three lines:

• fixed costs: horizontal, at £61 600
• total costs: starts at £61 600 on the vertical axis and rises by £66 per unit
• sales revenue: starts at the origin and rises by £110 per unit.

The figures for Fernhill’s chart:

Benches	Fixed costs £	Total costs £	Revenue £	Profit/(loss) £
0	61 600	61 600	0	(61 600)
1 000	61 600	127 600	110 000	(17 600)
1 400	61 600	154 000	154 000	0
2 000	61 600	193 600	220 000	26 400
2 500	61 600	226 600	275 000	48 400

Interpreting the chart. Break-even is where the revenue line crosses the total cost line (1 400 benches, £154 000). The gap between the lines to the left of that point is the loss; to the right it is the profit. The vertical distance between the two lines at any output is the profit or loss there. A steeper revenue line (higher price) or a flatter total cost line (lower variable cost) moves break-even to the left.

Uses and limitations of break-even analysis

Uses

• shows the minimum sales needed to avoid a loss
• shows the effect of “what if” changes in price, variable cost or fixed cost
• gives the output needed for a target profit
• a chart shows the position clearly to non-accountants.

Limitations

• assumes all costs can be split cleanly into fixed and variable; semi-variable costs make this hard
• assumes a single selling price and constant variable cost per unit at every output, ignoring bulk discounts and price cuts needed to sell more
• assumes fixed costs are constant, which ignores stepped costs outside the relevant range
• assumes everything produced is sold, with no change in inventory
• is harder to apply with several products, because the result depends on the sales mix
• relies on estimates, so it is only as reliable as the forecasts.

3. Marginal costing in decision making

The principle is the same in every situation: compare the change in contribution with any change in fixed costs. Fixed costs that continue whatever the decision are not relevant. Then weigh non-financial factors before recommending.

Make or buy

Fernhill makes its own bench brackets: direct materials £4.20, direct labour £3.10 and variable overheads £0.90, plus £2.50 of fixed overheads absorbed per bracket (full cost £10.70). A supplier offers brackets at £9.40. Fernhill uses 12 000 a year.

• Marginal cost of making = 4.20 + 3.10 + 0.90 = £8.20
• The £2.50 of fixed overheads will still be paid if Fernhill buys, so it is not relevant.
• Buying costs 9.40 − 8.20 = £1.20 more per bracket: 12 000 × 1.20 = £14 400 less profit.

Decision on financial grounds: keep making, unless freed capacity could earn over £14 400 of contribution or buying avoided some fixed costs. Non-financial factors: the supplier’s quality and reliability, dependence on one supplier, and lost in-house skills and jobs.

Acceptance of additional work

Fernhill has spare capacity. A garden centre offers a one-off order for 500 benches at £80 each, below the normal £110.

• Extra contribution = 500 × (80 − 66) = £7 000. Fixed costs are already covered by normal sales.
• If a special jig costing £2 500 were needed, the gain would be 7 000 − 2 500 = £4 500.

Accept on financial grounds if there is spare capacity. Non-financial factors: regular customers may demand the same lower price; the order may bring repeat business.

Price setting

In the short run, any price above marginal cost adds contribution. In the long run, prices must cover fixed costs and give a profit. A price can be built up from marginal cost plus the contribution needed.

Fernhill expects to sell 1 800 benches next year and wants a profit of £28 400.

• Contribution needed = 61 600 + 28 400 = £90 000
• Contribution per bench = 90 000 ÷ 1 800 = £50
• Price = 66 + 50 = £116

Competitors’ prices and likely demand must be checked before using it.

Optimum use of scarce resources

When one input (the limiting factor) is in short supply, rank products by contribution per unit of the limiting factor, not by contribution per unit.

Kestrel Kitchens has 4 000 skilled labour hours. Fixed costs are £30 000.

Product	Price £	Variable cost £	Contribution £	Hours per unit	Contribution per hour £	Maximum demand
A	60	36	24	2	12	800
B	90	54	36	4	9	600
C	45	30	15	1	15	1 000

Rank: C, then A, then B.

Product	Units	Hours used	Contribution £
C	1 000	1 000	15 000
A	800	1 600	19 200
B	350 (1 400 hours ÷ 4)	1 400	12 600
Total		4 000	46 800

Maximum profit = 46 800 − 30 000 = £16 800. Product B has the highest contribution per unit but uses the scarce hours least well. Non-financial factors: B’s customers may go elsewhere and take other business with them.

Closing a potentially loss-making line or department

A department may show a loss only because general fixed costs are apportioned to it. Ask what would actually change if it closed.

Hollin Stores, statement for the year:

	Garden £	Home £	Gifts £	Total £
Sales	180 000	120 000	60 000	360 000
Variable costs	99 000	66 000	42 000	207 000
Contribution	81 000	54 000	18 000	153 000
Fixed costs apportioned	58 500	39 000	19 500	117 000
Profit/(loss)	22 500	15 000	(1 500)	36 000

Only £6 000 of the fixed costs charged to Gifts would be saved if it closed. Closing loses £18 000 of contribution and saves £6 000, so profit falls by £12 000, from £36 000 to £24 000.

Keep Gifts open unless its space could earn more than £12 000 of extra contribution. Non-financial factors: redundancies, staff morale, and gift customers who also buy in other departments.

Target profit

Use (fixed costs + target profit) ÷ contribution per unit, as in worked example 2 (2 400 benches for £44 000).

Common errors

• Including absorbed fixed overheads in the marginal cost in make-or-buy or special-order questions.
• Ranking by contribution per unit when a limiting factor is given.
• Using apportioned fixed costs as if closing a department would save them all.
• Rounding a break-even or target figure down: if the formula gives 1 812.5 units, you need 1 813 to reach the target.
• Recommending with no non-financial factors when asked to evaluate.
• Ignoring a stepped cost when output moves past a capacity limit.

Next steps

Test yourself with the marginal costing practice questions, condense with the revision notes, check gaps with the diagnostics, and see how the papers are built in AQA A-level Accounting exam preparation.

Official syllabus

AQA A-level Accounting (7127) specification, version 1.1, October 2026, for A-level exams June 2019 onwards (AQA). Section 3.10 Marginal costing.