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Chapter 8
Marginal costing
The marginal cost of a product is the additional cost incurred in
producing one additional unit of the product. This will include the total of
the variable costs, including direct materials, direct labour, direct
expenses and variable overheads.
Note that fixed overheads are not included as the total fixed production overhead will
not increase as a result of making one additional unit. Fixed overheads are treated as
a period cost and deducted in full within the statement of profit or loss
2.1 Contribution
The contribution concept lies at the heart of marginal costing. Contribution can be
calculated as follows:
CONTRIBUTION = SALES VALUE – VARIABLE COSTS
Once the contribution from a product or service has been calculated, the fixed costs
associated with the product or service can be deducted to determine the profit for the
period.
Contribution gives an idea of how much ‘money’ there is available to ‘contribute’
towards paying for the fixed costs of the organisation and generating profit.
At varying levels of output and sales, contribution per unit is constant (while
profit varies).
Can be used to calculate profit:
Total contribution = Contribution per unit × Sales volume.
Profit = Total contribution – Fixed costs.
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