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How does marginal costing treat fixed costs as period costs, and how is contribution used?

Prepare a marginal costing statement and explain the role of contribution in short-run decisions

A focused answer to the H2 Principles of Accounting outcome on marginal costing. Variable cost of production, contribution as sales less variable cost, treating fixed costs as period costs, and the marginal costing profit statement.

Generated by Claude Opus 4.810 min answerUpdated 2026-06-06

Reviewed by: AI editorial process; not yet individually human-reviewed

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What this dot point is asking
The answer
Examples in context
Try this

What this dot point is asking

SEAB wants you to prepare a marginal costing profit statement and to explain the central role of contribution in short-run decisions. Marginal costing is the costing method built directly on cost behaviour: it values output at variable cost only and treats fixed costs as a lump charged against the period. The central insight is that contribution, sales less variable cost, is the figure that matters for short-run choices, because fixed costs do not change with the decision.

The answer

The marginal costing approach

Marginal costing distinguishes sharply between variable and fixed costs:

Variable cost of production (direct materials, direct labour, variable overhead) is attached to each unit. This is the cost of making one more unit, the marginal cost.
Fixed costs are treated as period costs: charged in full against the period's contribution, not spread over units.

This means inventory is valued at variable cost only, a key difference from absorption costing.

Contribution

Contribution is the engine of marginal costing:

\text{Contribution per unit} = \text{selling price} - \text{variable cost per unit}

\text{Total contribution} = \text{sales} - \text{total variable costs}

Each unit's contribution first covers fixed costs; once those are covered, every further unit's contribution becomes profit. Hence:

\text{Profit} = \text{total contribution} - \text{fixed costs}

The profit statement layout

A marginal costing statement runs:

Line
Sales	$X$
Less variable costs	$(X)$
Contribution	$X$
Less fixed costs	$(X)$
Profit	$X$

Because fixed costs are deducted as a single period figure, profit under marginal costing depends only on sales volume (given prices and costs), not on how many units were produced and stored. This makes it the natural tool for decisions about pricing, special orders and product mix.

Worked example

A company makes one product selling at $\$ 80 $. Variable costs per unit are materials$ \ $30$ , labour $\$ 20 $and variable overhead$ \ $10$ . Fixed costs are $\$ 150,000 $per period. It produces$ 12,000 $units and sells$ 10,000$. Prepare the marginal costing statement.

Step 1: Variable cost and contribution per unit

Variable cost per unit $= 30 + 20 + 10 = \$ 60 $. Contribution per unit$ = 80 - 60 = \ $20$ .

Step 2: Value inventory at variable cost

Closing inventory $= 12\,000 - 10\,000 = 2\,000$ units, valued at variable cost $= 2\,000 \times 60 = \$ 120,000$. (This affects the cost of sales but not the contribution, which is based on units sold.)

Step 3: Build the statement on units sold

Marginal costing statement	$\$ $
Sales ( $10\,000 \times 80$ )	800,000
Less variable cost of sales ( $10\,000 \times 60$ )	(600,000)
Contribution	200,000
Less fixed costs	(150,000)
Profit	50,000

Step 4: Interpret

Profit is $\$ 50,000 $. Note that the$ 2,000 $unsold units are carried in inventory at variable cost ($ \ $120\,000$ ), and all fixed costs ( $\$ 150,000 $) are charged this period regardless of the units stored. Profit therefore reflects the$ 10,000 $units sold, not the$ 12,000$ made.

Examples in context

Example 1. A special order. A factory with spare capacity is offered $1\,000$ units at $\$ 45 $each, below the normal$ \ $80$ price, when the variable cost is $\$ 38 $per unit. Contribution per unit is$ 45 - 38 = \ $7$ , so the order adds $1\,000 \times 7 = \$ 7,000$ to profit because fixed costs are already covered by normal sales. Marginal costing shows that any price above variable cost makes a positive contribution in the short run, the basis for accepting such orders.

Example 2. Comparing two products. A firm makes two products with contributions of $\$ 12 $and$ \ $18$ per unit. When deciding which to push with limited demand, it favours the higher-contribution product, because fixed costs are common to both and unaffected by the choice. Marginal costing focuses management on contribution, the only figure that changes with the decision, rather than on full unit cost.

Try this

Q1. A product sells for $\$ 40 $with variable cost$ \ $25$ . Find the contribution per unit. [2 marks]

Cue. Contribution $= 40 - 25 = \$ 15$ per unit.

Q2. Total contribution is $\$ 240,000 $and fixed costs are$ \ $160\,000$ . Find the profit. [2 marks]

Cue. Profit $= \text{contribution} - \text{fixed costs} = 240\,000 - 160\,000 = \$ 80,000$.

Q3. Explain why marginal costing values closing inventory at variable cost only. [3 marks]

Cue. Fixed costs are treated as period costs charged in full against the period, so they are not attached to units; only the variable cost of making each unit is carried in inventory.

Exam-style practice questions

Practice questions written in the style of SEAB exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.

Original7 marksA product sells for

\

. Variable costs are: direct materials

18

, direct labour

\

, variable overhead

5

. Fixed costs are

\

120\,000

for the period and

20\,000$ units are sold. (a) Calculate the contribution per unit. (b) Prepare a marginal costing profit statement. (c) State the profit.

Show worked answer →

(a) Variable cost per unit $= 18 + 12 + 5 = \$ 35 $. Contribution per unit$ = $selling price$ - $variable cost$ = 50 - 35 = \ $15$ .

(b) Marginal costing profit statement:

Marginal costing statement	$\$ $
Sales ( $20\,000 \times 50$ )	1,000,000
Less variable costs ( $20\,000 \times 35$ )	(700,000)
Contribution ( $20\,000 \times 15$ )	300,000
Less fixed costs	(120,000)
Profit	180,000

Markers reward contribution per unit of $\$ 15 $, total contribution of$ \ $300\,000$ , deducting fixed costs as a period cost, and a profit of $\$ 180,000$.

Original5 marksExplain what contribution means in marginal costing and why fixed costs are treated as period costs rather than being charged to each unit.

Show worked answer →

Contribution is selling price less variable cost, per unit or in total. It is the amount each unit contributes first toward covering the fixed costs and then, once fixed costs are covered, toward profit. In symbols, contribution per unit $=$ selling price $-$ variable cost per unit, and profit $=$ total contribution $-$ fixed costs.

Fixed costs are treated as period costs (charged in full against the period's contribution) rather than per unit because, in marginal costing, fixed costs do not change with the number of units made; they relate to the period, not to individual units. Charging them per unit would make the unit cost depend on the volume produced, which complicates short-run decisions. By keeping fixed costs separate, marginal costing isolates the variable cost that actually changes with each decision.

Markers reward defining contribution as sales less variable cost, its role in covering fixed costs then profit, and the reasoning that fixed costs relate to the period and so are not unitised.