OxfordAQA A-Level Accounting: Marginal costing (9615)

This guide teaches section 3.1.10 Marginal costing of the OxfordAQA International AS and A-level Accounting (9615) specification, Version 1.2. It is International AS content, assessed on Paper 2: Financial & Management Accounting. The comparison of marginal, absorption and activity based costing belongs to 3.2.2, which is International A-level only. All figures are in dollars and all the businesses are fictional.

Use it with the revision notes and the practice questions. Management accounting is introduced in the role of the accountant guide; paper layouts are in exam preparation. Links: course hub · printable checklist · free 10-minute diagnostic.

What 3.1.10 covers

Specification content	Skills you need
Categorisation of costs by behaviour and understanding of terms	Use each listed cost type and term correctly
Calculation and interpretation of break-even point, interpreting break-even charts and the uses and limitations of break-even analysis methods	Calculate, read a chart, judge both methods
The benefits and limitations of marginal costing	Calculate profit using marginal costing and weigh up the technique
The use of marginal costing in decision making situations	The six listed situations, with non-financial factors

Costs and terms

The running example is Hessary Lamps, which makes one desk lamp and sells it for 75. A cost can be described in two ways, and answers often need both.

Can it be traced to one lamp?

• A direct cost is spent on a particular unit and can be identified with it. Hessary’s direct materials (21 per lamp) and the assemblers’ piece-rate pay (14 per lamp) are direct.
• An indirect cost supports production as a whole, such as workshop rent.

What happens to it as output changes?

• A variable cost changes in total in line with output, so the cost per lamp stays level. Materials and piece-rate pay behave this way.
• A fixed cost keeps the same total for the period across the normal range of output, so it falls per lamp as output grows.
• A semi-variable cost combines both. Hessary leases a delivery van for 6,000 a year and pays fuel of 0.80 for each lamp delivered. At 2,200 lamps the van costs 6,000 + (2,200 × 0.80) = 7,760.
• A stepped cost holds steady until a capacity limit, then jumps. Hessary hires a packing machine for 9,000 a year; one machine handles up to 3,000 lamps, so lamp 3,001 doubles the cost to 18,000.

Hessary’s variable overheads (power plus van fuel) come to 5 per lamp. Its fixed costs for the year are rent 22,000, salaries 19,500, packing machine 9,000, van lease 6,000 and insurance 3,000: a total of 59,500.

Marginal cost is what one additional lamp adds to total cost. That is the variable cost per unit:

Marginal cost = 21 + 14 + 5 = 40 per lamp

Contribution is the selling price less the marginal cost. Each lamp’s margin goes first towards the fixed costs; only once they are paid does it become profit.

Contribution per unit = 75 − 40 = 35 per lamp
Total contribution    = contribution per unit × units sold
                      = sales revenue − total variable costs
Profit                = total contribution − fixed costs

Break-even is the output at which total contribution just pays the fixed costs. Profit there is zero.

Break-even calculations

Break-even point (units)  = fixed costs ÷ contribution per unit
Break-even sales revenue  = break-even units × selling price

Worked example 1: Hessary’s break-even

1. Break-even = 59,500 ÷ 35 = 1,700 lamps.
2. Break-even revenue = 1,700 × 75 = 127,500.
3. Hessary expects to sell 2,200 lamps. Profit = (2,200 × 35) − 59,500 = 17,500.
4. Expected sales exceed break-even by 500 lamps (about 22.7%), a cushion known as the margin of safety: sales could drop that far before a loss.

A lower price, a higher variable cost or extra fixed costs all push break-even up.

Break-even charts

Hessary’s chart has lamps along the bottom and dollars up the side, with three straight lines:

• fixed costs, level at 59,500
• total costs, leaving the vertical axis at 59,500 and gaining 40 per lamp
• sales revenue, leaving the origin and gaining 75 per lamp.

Points for Hessary’s chart:

Lamps	Total costs	Sales revenue	Profit or (loss)
0	59,500	0	(59,500)
1,000	99,500	75,000	(24,500)
1,700	127,500	127,500	0
3,000	179,500	225,000	45,500

Reading the chart:

• Break-even is the point where the sales revenue line cuts the total cost line: 1,700 lamps and 127,500. Read both axes.
• Below 1,700 lamps total cost is above revenue (loss); above 1,700 revenue is higher (profit).
• The vertical gap between the two lines at any output equals the profit or loss at that output. At 1,000 lamps the gap is 24,500 of loss.
• Beyond 3,000 lamps both cost lines would jump by 9,000 (the stepped packing cost).

Uses and limitations of break-even analysis

Uses	Limitations
Shows the lowest sales that avoid a loss	Every cost must be sorted into fixed or variable; semi-variable costs need splitting
Tests “what if” changes in price or costs before acting	Straight lines assume one price and one variable cost per unit at all outputs
Shows how far sales could fall before a loss	Fixed costs assumed constant, which stepped costs break
A chart is easy for non-accountants, such as a lender, to follow	Assumes all output is sold and a single product (or fixed sales mix)
	Only as good as the forecasts; a hand-drawn chart is less precise than a calculation

Calculating profit using marginal costing

Under marginal costing, only variable production costs are product costs. Fixed costs are charged in full to the period, and closing inventory is valued at marginal cost.

Worked example 2: Hessary’s marginal costing income statement

Hessary makes 2,400 lamps and sells 2,200. There is no opening inventory.

                                              $
Sales revenue (2,200 × 75)                 165,000
Variable cost of production (2,400 × 40)    96,000
Less closing inventory (200 × 40)           (8,000)
Variable cost of sales                      88,000
Contribution                                77,000
Fixed costs                                 59,500
Profit for the year                         17,500

The 200 unsold lamps carry no share of the fixed costs.

Benefits and limitations of marginal costing

Benefits

• It shows contribution clearly, so managers see what each product adds towards fixed costs and profit.
• It suits short-term decisions, because unchanged fixed costs stay out of the comparison.
• No arbitrary sharing out of fixed overheads is needed.

Limitations

• Some costs are hard to split into fixed and variable elements.
• Prices based on marginal cost alone may not cover fixed costs in the long run.
• Inventory valued at variable cost ignores the fixed production costs used to make it.

Marginal costing in decision making

Ask two questions each time. How much contribution does the choice add or remove? Which fixed costs would genuinely start or stop because of it? Overheads paid under every option play no part. Then come factors money cannot measure.

Make or buy

Hessary makes its own lamp shades: materials 6.50, labour 4.20 and variable overheads 1.30, plus 3.00 of absorbed fixed overheads. An outside supplier quotes 13.10 a shade. Hessary needs 2,400 shades a year.

• Marginal cost of making = 6.50 + 4.20 + 1.30 = 12.00. The full cost of 15.00 is the wrong comparison, because the absorbed fixed overheads continue either way.
• Buying costs 13.10 − 12.00 = 1.10 more per shade: 2,400 × 1.10 = 2,640 extra cost.
• Buying would let Hessary end a 3,500 lease on a shade press. Net effect = 3,500 − 2,640 = 860 better off by buying.

Non-financial factors: can the supplier match Hessary’s finish and delivery dates, and what happens to the shade-makers?

Acceptance of additional work

A hotel group offers to buy 300 lamps at 52 each, with its logo plate fitted at an extra 4 per lamp. Hessary has spare capacity.

• Contribution per lamp on the order = 52 − 40 − 4 = 8. Total = 300 × 8 = 2,400.

If only 200 lamps of capacity were spare, 100 normal sales would be lost at 35 each: 2,400 − 3,500 = 1,100 worse off. Always check capacity first.

Non-financial factors: shops paying 75 may hear of the 52 deal and press for discounts, while a hotel chain could become a steady buyer.

Price setting

For a single order, anything above 40 a lamp raises profit. A normal list price, though, has to recover fixed costs as well and leave the owner a return.

Next year Hessary expects to sell 2,000 lamps, fixed costs rise to 63,000, and the owner wants profit of 15,000.

Contribution needed   = 63,000 + 15,000 = 78,000
Contribution per lamp = 78,000 ÷ 2,000  = 39
Price                 = 40 + 39         = 79

Before announcing 79, Hessary should look at rival lamps and ask whether 2,000 buyers will still appear.

Optimum use of scarce resources

If labour time or material cannot be obtained in full, that input is the limiting factor: divide each product’s contribution by the amount of it the product uses, and rank.

Corrallo Rugs has 1,880 weaving hours next quarter and fixed costs of 19,000.

Rug	Price	Variable cost	Contribution	Hours each	Contribution per hour	Demand
Kilim	180	108	72	6	12	150
Runner	95	59	36	2	18	300
Medallion	320	200	120	8	15	100

All demand needs 2,300 hours, so hours are limiting. Rank: Runner, Medallion, Kilim.

Rug	Rugs made	Hours	Contribution
Runner	300	600	10,800
Medallion	100	800	12,000
Kilim	80	480	5,760
Total		1,880	28,560

Maximum profit = 28,560 − 19,000 = 9,560. Ranking by contribution per rug instead (Medallion, Kilim, Runner) would give only 26,040 of contribution. Non-financial point: Kilim customers turned away may not return.

Closing a potentially loss-making line or production department

Carrowmore Textiles runs three production lines. Fixed costs of 136,500 are shared out on machine hours.

	Line X	Line Y	Line Z	Total
Sales	210,000	140,000	90,000	440,000
Variable costs	126,000	77,000	64,000	267,000
Contribution	84,000	63,000	26,000	173,000
Fixed costs	63,000	42,000	31,500	136,500
Profit or (loss)	21,000	21,000	(5,500)	36,500

If line Z closed, only 9,000 of its fixed costs would stop. Closing loses 26,000 of contribution and saves 9,000, so profit falls by 17,000 to 19,500. Even if the space were let for 12,000 a year, profit would be 31,500, still lower than now. Line Z should stay open on financial grounds.

Non-financial factors: the Line Z weavers’ jobs, the signal sent to staff on X and Y, and buyers who order from all three lines.

Target profit

Units for a target profit = (fixed costs + target profit) ÷ contribution per unit

For a profit of 28,000, Hessary needs (59,500 + 28,000) ÷ 35 = 2,500 lamps.

For a profit of 50,000 the first answer is (59,500 + 50,000) ÷ 35 = 3,128.6 lamps. That passes the 3,000-lamp limit of one packing machine, so fixed costs rise by 9,000:

(68,500 + 50,000) ÷ 35 = 3,385.7, so 3,386 lamps

Round up: 3,385 lamps would fall just short of the target.

Common errors

• Pricing Hessary’s own shade at 15.00 instead of 12.00 in the make-or-buy test.
• Putting the Medallion first because it earns most per rug.
• Counting all 31,500 charged to Line Z as a saving on closure.
• Valuing Hessary’s 200 unsold lamps at more than 40 each.

Next: practice questions · revision notes.

Official syllabus

OxfordAQA International AS and A-level Accounting (9615) specification, Version 1.2, for International AS exams May/June 2025 onwards and International A-level exams May/June 2026 onwards (OxfordAQA). Section 3.1.10 Marginal costing.