Business – 5.4 Costs – Uses of cost information | e-Consult
5.4 Costs – Uses of cost information (1 questions)
Login to see all questions.
Click on a question to view the answer
Model Answer:
- Contribution costing separates costs into variable and fixed components.
- For a one‑off special order, the fixed costs (e.g., rent, salaries, depreciation) are incurred regardless of whether the order is accepted; they do not change with the level of output in the short run.
- Therefore, only the additional variable costs that are directly attributable to producing the special order affect the decision. The relevant figure is the contribution margin (selling price – variable cost).
- Under absorption costing, fixed manufacturing overhead is allocated to each unit produced. When evaluating a special order, the allocated fixed overhead would be added to the cost of the order, potentially making the order appear unprofitable even though the fixed overhead would be incurred anyway.
- Consequently, contribution costing provides a clearer picture of the incremental profitability of a special order by ignoring fixed costs that are sunk in the short term.