Approaches to costing: full, contribution

Need to know

What you need to know

• **Special order:** Accept if the order price exceeds the variable cost, as it will generate a positive contribution towards fixed costs (assuming spare capacity exists).
• **Limiting factor:** When a resource is scarce, rank products by **contribution per unit of the scarce resource** (e.g., contribution per machine hour) to maximise profit.
• **Decision Rule:** Do not use the full unit cost to reject a special order that earns a positive contribution. The allocated fixed costs are irrelevant for this short-term decision.

Explanation

Approaches to costing: full, contribution

1. **Special order:** Accept if the order price exceeds the variable cost, as it will generate a positive contribution towards fixed costs (assuming spare capacity exists).
2. **Limiting factor:** When a resource is scarce, rank products by **contribution per unit of the scarce resource** (e.g., contribution per machine hour) to maximise profit.
3. **Decision Rule:** Do not use the full unit cost to reject a special order that earns a positive contribution. The allocated fixed costs are irrelevant for this short-term decision.