ASCMS04 — CVP & AS-Level Management Decisions
Using Contribution to Make Better Business Decisions
Cost-volume-profit analysis connects:
- Sales volume
- Selling price
- Variable costs
- Contribution
- Fixed costs
- Profit
- Break-even
- Target profit
- Margin of safety
The real value of marginal costing is not only calculating figures. It is using those figures to support business decisions.
This supplementary resource focuses on applying contribution and marginal-costing information to common AS-Level management decisions.
Calculate the contribution. Compare the alternatives. Consider the wider business impact.
Learning Objectives
By the end of this supplementary topic, students should be able to:
- Explain the relationship between cost, volume and profit.
- Use contribution to support management decisions.
- Apply marginal-costing information to make-or-buy decisions.
- Evaluate special-order decisions.
- Analyse the possible closure of a business unit.
- Apply contribution analysis to limiting-factor decisions.
- Use contribution information when considering target profit.
- Distinguish relevant and irrelevant financial information.
- Consider qualitative and non-financial factors.
- Explain the limitations of using marginal-costing information for decisions.
- Make a reasoned recommendation based on both financial and non-financial information.
Concept Framework
CVP
What is CVP analysis?
Cost-volume-profit (CVP) analysis examines how changes in:
- costs,
- sales volume, and
- selling price
can affect contribution and profit.
The basic relationship is:
Sales revenue − Variable costs = Contribution
Then:
Contribution − Fixed costs = Profit
Therefore:
Profit = Contribution − Fixed costs
The CVP relationship
A useful way to remember the relationship is:
Sales
↓ deduct variable costs
Contribution
↓ deduct fixed costs
Profit / Loss
This means that contribution is central to many short-term management decisions.
CONTRIBUTION AS A DECISION-MAKING TOOL
Contribution is important because it shows how much each product or decision contributes towards fixed costs and profit.
Contribution per unit
Selling price per unit − Variable cost per unit
Total contribution
Contribution per unit × Units sold
Profit
Total contribution − Fixed costs
Worked Example 1 — Contribution and Profit
A business sells Product A for £80.
Variable cost per unit = £50
Fixed costs = £60,000
Expected sales = 3,000 units.
Step 1 — Contribution per unit
£80 − £50
= £30
Step 2 — Total contribution
3,000 × £30
= £90,000
Step 3 — Profit
£90,000 − £60,000
= £30,000
Therefore:
Expected profit = £30,000
RELEVANT COSTS FOR DECISION-MAKING
Not every accounting cost is relevant to every decision.
A relevant cost is a future cost that changes as a result of the decision being considered.
For example, when deciding whether to accept a special order, management should consider costs that will actually arise because of the order.
Potentially relevant:
- Additional materials
- Additional labour
- Additional variable production costs
- Additional transport
- Additional special packaging
- Additional fixed costs caused by the decision
Potentially irrelevant:
- Costs already incurred
- Costs that will remain unchanged regardless of the decision
- Some allocated fixed costs that do not change
The exact relevance depends on the decision and the information provided.
MAKE-OR-BUY DECISIONS
A business may produce a component internally or purchase it from an external supplier.
The decision should compare the relevant costs of each alternative.
Worked Example 2 — Make or Buy
A business currently manufactures 10,000 components.
Cost per component:
- Direct materials = £4
- Direct labour = £3
- Variable overhead = £1
- Allocated fixed overhead = £2
An external supplier offers the component for £9 each.
Cost of making
Relevant variable cost:
£4 + £3 + £1
= £8 per component
The £2 allocated fixed overhead should not automatically be included if it will continue regardless of the decision.
Cost of buying
£9 per component
Comparison
Make = £8
Buy = £9
Financially, making the component costs £1 less per unit based on the relevant costs given.
For 10,000 components:
£1 × 10,000
= £10,000
Interpretation
Based only on the relevant costs provided, continuing to manufacture the component would save £10,000.
However, management should also consider:
- Supplier reliability
- Quality
- Delivery times
- Available production capacity
- Long-term supplier relationships
- Employee implications
- Strategic importance of the component
SPECIAL ORDERS
A special order is an additional order that may be offered at a price different from the normal selling price.
The key question is whether the order provides an acceptable contribution after considering the relevant additional costs.
Worked Example 3 — Special Order
A business normally sells a product for £50.
Variable cost per unit = £32.
A customer offers to purchase 1,000 units for £38 each.
There is sufficient spare capacity.
Contribution from special order
Selling price = £38
Variable cost = £32
Contribution:
£38 − £32
= £6 per unit
Total contribution:
1,000 × £6
= £6,000
Interpretation
If the order creates no additional fixed costs or other relevant costs, it would generate £6,000 additional contribution.
However, management should consider:
- Whether spare capacity really exists
- Whether the order creates additional costs
- Whether normal customers may be affected
- Whether the special price could affect the normal market
- Whether the customer relationship is strategically important
SPECIAL ORDERS AND CAPACITY
A special order cannot be evaluated only by looking at its selling price.
With spare capacity
The additional contribution may be important because existing fixed costs are already being incurred.
Without spare capacity
Accepting the order may require:
- reducing normal production;
- overtime;
- additional machinery;
- subcontracting;
- other additional costs.
The opportunity cost of using limited capacity may therefore become relevant.
CLOSURE OF A BUSINESS UNIT
A business may consider closing a department, product line or branch that appears to be making a loss.
A reported accounting loss does not automatically mean that closure will improve profit.
Management must determine:
- Which costs will disappear?
- Which costs will remain?
- What contribution will be lost?
- Can resources be used elsewhere?
- Are there strategic reasons for keeping the unit?
Worked Example 4 — Closure Decision
A business unit currently generates:
Sales = £150,000
Variable costs = £90,000
Fixed costs = £80,000
Contribution
£150,000 − £90,000
= £60,000
Reported profit/loss
£60,000 − £80,000
= £20,000 loss
The unit appears to make a £20,000 loss.
However, suppose only £50,000 of the fixed costs would disappear if the unit closed.
If the unit remains open
Loss = £20,000
If the unit closes
Lost contribution = £60,000
Fixed costs saved = £50,000
Net effect:
£50,000 − £60,000
= £10,000 decrease in overall profit
Interpretation
Although the unit reports a £20,000 accounting loss, closing it would reduce overall profit by £10,000 if the assumptions remain unchanged.
This demonstrates why management should examine the behaviour of costs rather than relying only on reported profit or loss.
LIMITING FACTORS
A limiting factor is a resource that restricts the level of production or sales.
Examples may include:
- Labour hours
- Machine hours
- Raw materials
- Production capacity
- Skilled labour availability
When a limiting factor exists, management may need to determine which product generates the greatest contribution per unit of the scarce resource.
Formula
Contribution per unit of limiting factor = Contribution per unit ÷ Limiting factor required per unit
WORKED EXAMPLE — LIMITING FACTOR
A business produces Products A and B.
| Product A | Product B | |
|---|---|---|
| Selling price | £50 | £60 |
| Variable cost | £30 | £42 |
| Contribution per unit | £20 | £18 |
| Machine hours per unit | 2 | 1 |
Contribution per machine hour
Product A:
£20 ÷ 2
= £10 per machine hour
Product B:
£18 ÷ 1
= £18 per machine hour
Although Product A has the higher contribution per unit, Product B generates more contribution per machine hour.
Therefore, where machine hours are the limiting factor, contribution per machine hour is the relevant comparison.
TARGET PROFIT
CVP analysis can also be used to determine the sales required to achieve a target profit.
Target sales volume (units)
Target sales volume (units) = (Fixed costs + Target profit) ÷ Contribution per unit
Target sales revenue (£)
Target sales revenue (£) = (Fixed costs + Target profit) ÷ C/S ratio
The total contribution required is:
Fixed costs + Target profit
Worked Example 5 — Target Profit
Fixed costs = £50,000
Target profit = £20,000
Contribution per unit = £10
Target sales volume
(£50,000 + £20,000) ÷ £10
= 7,000 units
Therefore, the business needs to sell 7,000 units to achieve a target profit of £20,000.
Target sales revenue
If the C/S ratio is 40%:
(£50,000 + £20,000) ÷ 0.40
= £175,000
Therefore, target sales revenue is £175,000
CVP AND SELLING PRICE CHANGES
A change in selling price changes contribution per unit if variable cost remains unchanged.
Example
Original:
Selling price = £100
Variable cost = £60
Contribution = £40
If selling price falls to £90:
New contribution:
£90 − £60
= £30
The lower contribution means more units must be sold to achieve the same profit.
Management must therefore consider whether the expected increase in sales volume justifies the reduction in selling price.
CVP AND VARIABLE COST CHANGES
An increase in variable cost reduces contribution if selling price remains unchanged.
Example
Selling price = £80
Original variable cost = £50
Contribution = £30
If variable cost increases to £55:
New contribution:
£80 − £55
= £25
The business now needs more sales volume to generate the same total contribution.
CVP AND FIXED COST CHANGES
An increase in fixed costs does not change contribution per unit.
However, it increases the amount of contribution required before profit is earned.
Example
Contribution per unit = £20
Original fixed costs = £60,000
Original break-even output:
£60,000 ÷ £20
= 3,000 units
If fixed costs increase to £80,000:
New break-even output:
£80,000 ÷ £20
= 4,000 units
Therefore, an increase in fixed costs increases the break-even output when contribution per unit remains unchanged.
FINANCIAL VS NON-FINANCIAL FACTORS
Financial information is important, but it should not be the only consideration.
Financial factors
- Contribution
- Relevant costs
- Fixed costs
- Variable costs
- Profit
- Cash-flow effects
- Opportunity costs
Non-financial factors
- Product quality
- Customer satisfaction
- Supplier reliability
- Employee morale
- Reputation
- Environmental impact
- Capacity
- Long-term strategy
- Legal or contractual considerations
A strong management decision considers both.
DECISION-MAKING FRAMEWORK
When answering a management-decision question:
Step 1 — Identify the decision
What are the alternatives?
Step 2 — Identify relevant financial information
Which costs and revenues actually change?
Step 3 — Calculate
Determine:
- Contribution
- Relevant cost
- Profit impact
- Contribution per limiting factor
- Other required figures
Step 4 — Compare alternatives
Identify the financial effect of each option.
Step 5 — Consider non-financial factors
Ask what other consequences could affect the decision.
Step 6 — Reach a supported conclusion
State which option the calculations support under the assumptions given, then explain the conditions or non-financial factors that management should consider.
COMMON EXAMINATION ERRORS
Error 1 — Using total cost automatically
Not every cost is relevant to every decision.
Error 2 — Ignoring fixed-cost behaviour
Ask whether the fixed cost will actually change as a result of the decision.
Error 3 — Looking only at contribution per unit
For limiting-factor decisions, calculate:
Contribution per unit of scarce resource
Error 4 — Closing a loss-making department automatically
A reported loss does not necessarily mean closure will improve overall profit.
Error 5 — Accepting every special order above variable cost
The business must consider capacity, additional costs and opportunity costs.
Error 6 — Ignoring non-financial factors
A financially attractive option may create operational, employee, customer or strategic problems.
Error 7 — Giving a calculation without a conclusion
Management-decision questions often require interpretation.
Always explain what the calculation means for the decision.
Structured Practice
Question 1 — Make or Buy
Question 1 — Make or Buy
A component costs £7 in variable production costs.
An external supplier offers to supply it for £8.
The business has spare production capacity.
Calculate the financial difference per unit and explain the initial implication.
(3 marks)
Question 2 — Special Order
Question 2 — Special Order
A business normally sells a product for £60.
Variable cost = £38.
A customer offers to purchase 2,000 units for £45 each.
There is sufficient spare capacity and no additional fixed costs.
Calculate the additional contribution from the order.
(3 marks)
Question 3 — Closure
Question 3 — Closure
A department generates contribution of £70,000.
If the department closes, only £50,000 of its fixed costs will be saved.
Calculate the financial effect of closure.
(3 marks)
Question 4 — Limiting Factor
Question 4 — Limiting Factor
Product A generates contribution of £24 and requires 3 machine hours.
Product B generates contribution of £20 and requires 2 machine hours.
Calculate contribution per machine hour for each product.
(4 marks)
Question 5 — Target Profit
Question 5 — Target Profit
Fixed costs = £75,000
Target profit = £25,000
Contribution per unit = £20
Calculate the required output.
(2 marks)
Question 6 — Evaluation
Question 6 — Evaluation
Explain two non-financial factors that management should consider before making a make-or-buy decision.
(4 marks)
Proficiency Check
LEARN → UNLEARN → RELEARN
LEARN
Complete:
- Profit = __________ − __________.
- Relevant costs are costs that __________ as a result of the decision.
- Limiting-factor analysis compares contribution per __________.
- A special order should be assessed using relevant __________ and revenues.
- A loss-making department should not automatically be __________.
- Management decisions should consider both financial and __________ factors.
UNLEARN
Correct these statements:
Statement A
“Every fixed cost is relevant to every management decision.”
Statement B
“The product with the highest contribution per unit should always be produced first when there is a limiting factor.”
Statement C
“A department making an accounting loss should always be closed.”
Statement D
“Any special order priced above the normal selling price should be accepted.”
Statement E
“Financial calculations are sufficient for making every management decision.”
RELEARN
Explain:
- Why are relevant costs important in decision-making?
- Why can a loss-making department still contribute to overall profit?
- Why is contribution per limiting factor important?
- Why might a business reject a special order that provides positive contribution?
- Why should non-financial factors be considered alongside financial calculations?
Detailed Activity Solutions
Question 1, 2, 3, 4, 5,6
Question 1 — Make or Buy
Make:
£7 per unit
Buy:
£8 per unit
Difference:
£8 − £7
= £1 per unit
Based on the relevant costs given, making the component costs £1 less per unit.
However, management should also consider quality, supplier reliability, capacity and other relevant factors.
Question 2 — Special Order
Special-order selling price = £45
Variable cost = £38
Contribution:
£45 − £38
= £7 per unit
Total additional contribution:
2,000 × £7
= £14,000
Therefore, the order would generate £14,000 additional contribution if there are no other relevant costs and sufficient spare capacity exists.
Question 3 — Closure
Contribution lost:
£70,000
Fixed costs saved:
£50,000
Net effect:
£50,000 − £70,000
= £20,000 decrease in overall profit
Therefore, based on the information given, closure would reduce overall profit by £20,000.
Question 4 — Limiting Factor
Product A
£24 ÷ 3
= £8 per machine hour
Product B
£20 ÷ 2
= £10 per machine hour
Product B generates the higher contribution per machine hour.
Question 5 — Target Profit
Target output:
(£75,000 + £25,000) ÷ £20
= £100,000 ÷ £20
= 5,000 units
Question 6 — Evaluation
Possible non-financial factors include:
- Quality: An external supplier may provide different or less consistent quality.
- Reliability: Delays from an external supplier could disrupt production.
- Capacity: Using internal production capacity may prevent the business from producing other profitable products.
- Employee impact: Outsourcing may affect employees and staff morale.
- Strategic control: Producing internally may protect important skills or knowledge.
A strong answer should explain how the factor could affect the decision.
Answers for proficiency test
PROFICIENCY CHECK — FULL ANSWER KEY
LEARN — Answers
1.
Profit = Contribution − Fixed costs.
Contribution is the amount available to cover fixed costs and then generate profit.
2.
Relevant costs are costs that change as a result of the decision.
A relevant cost must be future and must differ between the alternatives being considered.
3.
Limiting-factor analysis compares contribution per unit of the scarce resource / limiting factor.
For example:
Contribution per machine hour = Contribution per unit ÷ Machine hours per unit
4.
A special order should be assessed using relevant costs and revenues.
The business should consider the additional revenue and additional costs caused by accepting the order.
5.
A loss-making department should not automatically be closed.
Management must determine which costs would actually be saved and how much contribution would be lost.
6.
Management decisions should consider both financial and non-financial factors.
Examples include quality, reliability, employee effects, reputation and strategic considerations.
UNLEARN — Answers
Statement A
Incorrect.
Not every fixed cost is relevant to every management decision.
A fixed cost is relevant only if it changes as a result of the decision.
For example, an allocated fixed cost that will continue regardless of whether a component is made or bought is not relevant to that decision.
Statement B
Incorrect.
When a limiting factor exists, the business should compare:
Contribution per unit of the limiting factor
rather than simply contribution per unit.
A product with lower contribution per unit may generate higher contribution per machine hour, labour hour or other scarce resource.
Statement C
Incorrect.
A department making an accounting loss should not automatically be closed.
Management must consider:
- Contribution that would be lost
- Fixed costs that would actually be saved
- Any alternative use of resources
- Relevant non-financial factors
Closure may reduce overall profit if the contribution lost is greater than the costs saved.
Statement D
Incorrect.
A special order should not be accepted simply because its price is above the normal selling price.
Management should consider:
- Relevant costs
- Spare capacity
- Opportunity costs
- Additional fixed costs
- Effects on existing customers
- Other strategic factors
A special order priced below the normal selling price may still provide useful contribution if sufficient spare capacity exists and no other relevant problems arise.
Statement E
Incorrect.
Financial calculations are important but may not be sufficient.
Management should also consider non-financial factors such as:
- Quality
- Supplier reliability
- Customer satisfaction
- Employee effects
- Reputation
- Environmental considerations
- Long-term strategy
A strong decision considers both financial and non-financial information.
RELEARN — Full Answers
1. Why are relevant costs important in decision-making?
Relevant costs help management identify the financial consequences that actually change between alternatives.
A relevant cost is normally a future cost that differs depending on the decision.
Including costs that will remain unchanged can distort the comparison and lead to an inappropriate decision.
2. Why can a loss-making department still contribute to overall profit?
A department may make an accounting loss because its allocated fixed costs are greater than its contribution.
However, some of those fixed costs may continue even if the department closes.
If the department is closed, its contribution may be lost while only part of its fixed costs are saved.
Therefore, a loss-making department may still make a positive contribution towards the business’s overall fixed costs.
3. Why is contribution per limiting factor important?
When a resource is scarce, the business cannot necessarily produce unlimited quantities of every product.
Contribution per limiting factor shows how much contribution is generated from each unit of the scarce resource.
For example:
Contribution per machine hour = Contribution per unit ÷ Machine hours required per unit
This helps management compare products using the resource that restricts production.
4. Why might a business reject a special order that provides positive contribution?
Positive contribution alone does not guarantee that accepting the order is appropriate.
The business may reject the order if:
- it does not have sufficient spare capacity;
- accepting it would reduce normal sales;
- overtime or additional fixed costs would arise;
- another product would have to be sacrificed;
- the opportunity cost is too high;
- quality or delivery requirements create additional problems;
- accepting the order could damage existing customer relationships or the normal market.
Therefore, the full decision must consider all relevant financial and non-financial factors.
5. Why should non-financial factors be considered alongside financial calculations?
Financial calculations show the measurable financial effect of alternatives, but they may not capture every consequence of a decision.
For example, choosing a cheaper supplier could create quality or delivery problems.
Similarly, outsourcing may reduce costs but affect employees, supplier dependence or strategic control.
Therefore, management should use financial calculations together with relevant non-financial information before reaching a decisi
How This Topic Appears in the Examination
Questions may require you to:
- calculate and interpret contribution;
- apply marginal costing to management decisions;
- evaluate make-or-buy decisions;
- analyse special orders;
- assess closure of a business unit;
- calculate contribution per limiting factor;
- use target-profit calculations;
- analyse changes in selling price or costs;
- distinguish relevant and irrelevant information;
- evaluate financial and non-financial factors;
- support a management decision with calculations and explanation.
The Cambridge 9706 syllabus specifically identifies make-or-buy, special orders, closure of a business unit, limiting factors and target profit as management-decision applications of marginal-costing information. It also requires consideration of non-financial factors.
🎯 Question Papers + YouTube Explanation
Practise this topic using examination-style questions and review the corresponding explanations before moving to the premium revision simulations.
For enrolled students: Use the student doubt-support facility for difficult calculations, interpretations or examination questions.
Self-Assessment Checklist
☐ Explain CVP analysis.
☐ Explain the importance of contribution.
☐ Identify relevant financial information.
☐ Apply contribution to make-or-buy decisions.
☐ Analyse special orders.
☐ Evaluate closure decisions.
☐ Calculate contribution per limiting factor.
☐ Apply target-profit calculations.
☐ Analyse changes in selling price.
☐ Analyse changes in variable costs.
☐ Analyse changes in fixed costs.
☐ Consider opportunity costs where relevant.
☐ Consider non-financial factors.
☐ Support a management decision with calculations.
☐ Explain the limitations of marginal-costing information.
Continue Your Preparation
Go beyond the lesson with curated resources, examination practice and video learning.
PREMIUM RESOURCES
Master the topic with curated learning, revision and assessment resources
GUESS PAPERS
Prepare for the examination with complete Guess Paper packages and Mark Schemes.
VIDEO ON DEMAND
Watch, revise and strengthen your understanding with Shasha Academy videos.