A level-readyAll subjects · Accounting · WAC12 Corporate and Management Accounting
Marginal costing decisions: make or buy, and continuing or discontinuing
Edexcel IAL Accounting · WAC12 Corporate and Management Accounting
Should a business make a component itself or buy it in? Should it close a product that shows a loss? Both decisions turn on which costs actually change: usually variable costs and any avoidable fixed costs.
Make or buy
Compare the buy price with the relevant cost of making:
- variable cost of making
- plus any fixed costs that would be avoided if the item were bought (for example a supervisor who would be made redundant)
- plus any opportunity cost: contribution from other work that the freed capacity could do
Apportioned fixed costs that continue anyway are irrelevant.
Non-financial factors: quality and reliability of the supplier, control over supply, confidentiality, effect on the workforce, the supplier's price in future.
Continuing or discontinuing
A product or department that shows a 'loss' after apportioned fixed costs may still be making a positive contribution towards fixed costs that would continue after closure. Closing it would reduce total profit.
Rule: continue if contribution > fixed costs that would be avoided by closing. Also consider: knock-on effects on sales of other products, redundancies and morale, using the space for something more profitable, and whether the product is new and growing.
| £ | A | B | C | Total |
|---|---|---|---|---|
| Sales | 120,000 | 80,000 | 100,000 | 300,000 |
| Variable costs | (70,000) | (65,000) | (55,000) | (190,000) |
| Contribution | 50,000 | 15,000 | 45,000 | 110,000 |
| Apportioned fixed costs | (30,000) | (25,000) | (30,000) | (85,000) |
| Profit (loss) | 20,000 | (10,000) | 15,000 | 25,000 |
Fixed costs are apportioned and would continue if a product closed
Reading the table
Product B shows a loss of £10,000, but it contributes £15,000. If it closes, the £25,000 of fixed costs is shared by A and C, and total profit falls from £25,000 to £10,000. Keep B.
Worked example
A component costs £4 materials, £5 labour and £2 variable overhead to make, plus £3 of apportioned fixed overhead. A supplier offers it at £12. 10,000 are needed a year. Should the firm buy it? What if buying also saves a supervisor costing £15,000?
- Variable cost of making = £11; buy price £12: making is cheaper by £1 per unit (the £3 apportioned overhead continues anyway)
- With the supervisor saved: relevant cost of making = 11 + 15,000/10,000 = £12.50 per unit
- Now buying at £12 saves £0.50 per unit = £5,000 a year
Answer: Without the saving, make; with the supervisor's salary avoided, buy (saving £5,000)
Check yourself
- Making a part costs £7.40 variable cost per unit plus £2.60 apportioned fixed overhead. A supplier charges £8.50. 6,000 parts are needed and fixed costs would not change. How much more would buying cost than making?
Show answer
£6600. (8.50 - 7.40) x 6,000 = £6,600 extra if bought.
- Variable cost of making a part is £15. Buying would avoid fixed costs of £24,000 a year. 8,000 parts are needed. What is the maximum price per part worth paying a supplier?
Show answer
£18.00. 15 + 3 = £18 per part.
- A product has sales of £90,000, variable costs of £72,000 and apportioned fixed costs of £25,000. If it is dropped, none of the fixed costs is saved. By how much would total profit change? Give a fall as a negative number.
Show answer
£-18000. Contribution lost = 18,000, so profit falls by £18,000.
- A department has contribution of £40,000 and apportioned fixed costs of £55,000. Closing it would save £30,000 of those fixed costs. By how much would total profit change? Give a fall as a negative number.
Show answer
£-10000. Lose 40,000 contribution, save 30,000: profit falls by £10,000.
- A product shows a loss after apportioned fixed costs but has a positive contribution. The fixed costs would continue if it were dropped. What should happen?
- Keep it, because it contributes towards fixed costs
- Drop it immediately
- Raise the apportioned fixed costs
- Value its inventory at selling price
Show answer
Keep it, because it contributes towards fixed costs. Dropping it would lose the contribution while the fixed costs remain.
- Which is a non-financial reason to keep making a component rather than buying it?
- The supplier's price is lower than variable cost
- Apportioned overheads are high
- Control over quality and reliability of supply
- It increases the C/S ratio
Show answer
Control over quality and reliability of supply. Relying on a supplier risks late or poor-quality deliveries.
- Spare capacity freed by buying a component could make another product with a contribution of £20,000. How should this be treated in a make-or-buy decision?
- As an opportunity cost of making the component
- It should be ignored
- As an apportioned fixed cost
- As part of the buy price
Show answer
As an opportunity cost of making the component. Making the component means giving up that contribution.
Sources
Last updated 8 November 2026. Spotted a mistake? Tell us.