The document discusses cost-benefit analysis focusing on fixed, variable, and sunk costs, and the concept of contribution, which aids decision-making in contexts such as pricing and profitability. It explains marginal costing, its application in short-term decisions, and break-even analysis to determine output levels required to cover costs and achieve profit. Examples illustrate how businesses should evaluate special orders and make-or-buy decisions based on costs and contributions.

1. COST-BENEFIT
COST-BENEFIT
ANALYSIS (CBA)
ANALYSIS (CBA)
CPA Dr. Amos J. Nsanganzelu (PhD, Business Mgt,
CPA Dr. Amos J. Nsanganzelu (PhD, Business Mgt,
Finance & Accounting); MBA (F
Finance & Accounting); MBA (Fi
inance & Strategic Mgt)
nance & Strategic Mgt)
(Maastricht), CPA (T)-ACPA 2471; BCom (Accounting)
(Maastricht), CPA (T)-ACPA 2471; BCom (Accounting)
(Hons) (UDSM); Adv. Dipl in Transport and Logistics
(Hons) (UDSM); Adv. Dipl in Transport and Logistics
Mgt (ADLTM) (Dar); Adv. Cert SCM (DIU, Germany);
Mgt (ADLTM) (Dar); Adv. Cert SCM (DIU, Germany);
Fellow of the Chartered Institute of Logistics and
Fellow of the Chartered Institute of Logistics and
Transport Management (FCILT) (UK)
Transport Management (FCILT) (UK)

2. Costs Terminology
Costs Terminology
• Fixed Costs
 These are costs that remain relatively fixed ( in total )
irrespective of changes in volume of activity/ output
within the relevant planning horizon
• Variable Costs
 These costs vary in relation to unit of output
• Sunk Costs
 These are costs already incurred which cannot be altered
with a current decisions ( e.g., exploration costs can be a
sunk costs if there no results.)
• Relevant Costs
These are costs which will be incurred in a current future
decisions

3. Definition of Contribution
Definition of Contribution
• Contribution is the difference between sales
Revenue and Variable Costs
• It is the amount remaining after variable costs
have been deducted from sales revenue
• It is not the same as profit since we reach a
figure for contribution after deducting variable
costs and not fixed costs
• Total contribution = Sales Revenue - Variable
Costs

4. Contribution per Unit
Contribution per Unit
• As well as total contribution it is also useful
to calculate the contribution that each unit
of sales produces
• Contribution per unit is revenue per unit
( Price) minus variable costs per unit.

5. Contribution to What
Contribution to What
• In the first instance it is contribution to
fixed costs
• Once fixed costs have been covered it is a
contribution to profits
• Total contribution= Total Fixed Costs +
Profits
• Profit= Total Contribution- Total Fixed
Costs

6. Strengths of the Concept
Strengths of the Concept
• It is useful in decision making
• It avoids the need for arbitrary divisions of
the fixed costs
• It provides a flexible basis for pricing
decisions

7. Weaknesses of the Concept
Weaknesses of the Concept
• Ignores fixed costs
• Some costs are difficulty to classify as
fixed or variable
• In the longer-term fixed costs can always
change thus invalidating earlier decisions
based on contribution

8. Marginal Costing
Marginal Costing
• An accounting system in which variable
costs are charged to cost units and fixed
costs of the period are written in full
against aggregate contribution
• The valuation of a product solely on the
basis of variable costs
• Fixed costs are excluded
• Marginal Costing focuses on sales ,
variable costs and contribution

9. Marginal Costing Contd…
Marginal Costing Contd…
• Fixed costs are considered irrelevant for
short run decisions because they are fixed
regardless of the level of output within the
relevant range
• Fixed costs are difficult to allocate
especially in the case of multiproduct firms

10. Marginal Cost Statement
Marginal Cost Statement
Sales xxxx
Less: Variable Costs ( xxx)
Contribution xxx
Less : Fixed Costs ( xxx)
Net Profit Before Tax xxx

11. Example
Example
Product
A B C Total
Sales 100 70 30 200
Less : VC 60 40 10 110
Contribution 40 30 20 90
Less : FC 40
Profit 50

12. WHAT IS SPECIAL IN THIS
WHAT IS SPECIAL IN THIS
EXAMPLE
EXAMPLE
• Fixed costs are not apportioned
• They are not divided up between the three
products
• This is because any sharing out of fixed costs is
arbitrary and often unfair
• Contribution of each identified
• Fixed costs are deducted from total contribution
• This focus on contribution is useful in short term
decision making

13. USES OF MARGINAL COSTING
USES OF MARGINAL COSTING
IN DECISION MAKING
IN DECISION MAKING
• Marginal Costing is called contribution an
analysis when used for decision making
• It is useful in short term decision making in
the following areas
 Break- Even Analysis
 Special Order Contract
 Make or Buy decisions
 Deletion of unprofitable product

14. BREAK EVEN ANALYSIS
BREAK EVEN ANALYSIS
• At Break –even point level of output , total costs are covered by the
total revenue so that the firm makes neither profit or loss.
• Contribution can be used to calculate the B.E.P
Break-even analysis depends on the following variables:
– Selling Price per Unit: The amount of money charged to the customer
for each unit of a product or service
– Total Fixed Costs: The sum of all costs required to produce the first
unit of a product. This amount does not vary as production increases or
decreases, until new capital expenditures are needed
– Variable Unit Cost: Costs that vary directly with the production of one
additional unit.
– Total Variable Cost The product of expected unit sales and variable
unit cost, i.e., expected unit sales times the variable unit cost

15. B.E ANALYSIS Contd…
B.E ANALYSIS Contd…
– Forecasted Net Profit: Total revenue minus total cost. Enter Zero (0) if
you wish to find out the number of units that must be sold in order to
produce a profit of zero (but will recover all associated costs)
• Each of these variables is interdependent on the break-even point
analysis. If any of the variables changes, the results may change
Total Cost: The sum of the fixed cost and total variable cost for any
given level of production, i.e., fixed cost plus total variable cost
• Total Revenue: The product of forecasted unit sales and unit price,
i.e., forecasted unit sales times unit price
• Break-Even Point: Number of units that must be sold in order to
produce a profit of zero (but will recover all associated costs). In
other words, the break-even point is the point at which your product
stops costing you money to produce and sell, and starts to generate
a profit for your company

16. Break Even Output
Break Even Output
• Break-even is calculated by Dividing fixed costs by
contribution per unit
• Given
Fixed Costs= Shs 5, 000,000
Selling Price per unit= Shs 5 per unit
Variable costs per unit= Shs 3 per unit
Therefore
B.E.P = Fixed Costs
Contribution per unit
= 5,000,000 Shs
( 5-3 ) Shs
= 2,500,000 units

17. Break- Even with Profits
Break- Even with Profits
• Suppose the firm wants to achieve a
specific target level of profits from the
product , what level of output and sales
are needed to achieve the target profits?
• The Formula changes to
B.E.P = Fixed Costs + Desired Profit
Contribution margin per unit

18. Example
Example
• Let us use the previous example but
impose a target profit of Shs 4,000,000
what will be the B.E.P?
• Solution
B.E.P = 5M + 4M/2
= 4,500,000 units

19. B.E.P After Tax
B.E.P After Tax
• Given
FC = 60,000/= shs, SP= 12/-SHS
VC = 7.50/- Desired Profit= Shs 15,000
Tax Rate = 20%
Determine B.E.P

20. Solution
Solution
B.E.P = FC + Profit ( 1- T)
Contribution Margin per unit
Where T= Rate of Tax
OR
B.E.P = FC + ATP
1- t
= 60,000 + 15,000/0.8
= 17,500 Units

21. Special Order
Special Order
• Typically this involves a supplier receiving
large order placed by a customer
• The offer price exceeds variable costs but
it is insufficient to cover the full costs of
production
• As the result the contract is apparently
unprofitable
• Should the supplier accept the contract?

22. EXAMPLE
EXAMPLE
• VC per unit – 100shs
• Fixed Costs per unit : 150 shs at current output
• Usual Selling Price : 300 Shs
• Current Output : 500,000 Units
• Full Capacity Output: 750,000 Units
• Special Order Contract offer
100,000 Units at a price of shs 140
Should the contract be accepted?

23. REJECT
REJECT
• It is unprofitable
• It will make a loss of Tshs 250-140= 110
shs per unit
• But this ignores some important points
 Break – even has already been achieved
The firm has spare capacity
The product does make a contribution

24. Make or Buy Decisions
Make or Buy Decisions
• A firm is faced with a decision
 Should it continue produce the component itself or
Should it buy in the component from outside firm?
• It will depend on the relative costs

25. Example
Example
• Cost of Making : 50/- per unit
• Purchase Price when buying in : 70/- per
unit
• Quantity Required – 200,000 units
• Saving in terms of fixed costs when the
component is bought – Tshs 6,000,000
• Decision- The extra Costs when buying in
Shs 70- Shs 50 = 20/- per unit

26. Solution
Solution
• Lost Contribution
20* 200,000 = Tshs 4,000,000
Buying in adds 4,000,000 /= to variable
costs but saves Tshs 6,000,000 on fixed
costs
It is advantageous to buy in