Marginal costing decisions: accepting or refusing orders

The decision rule

With spare capacity:

• Accept if the price per unit is above the variable (marginal) cost per unit, so the order makes a positive contribution.
• Deduct any extra fixed costs caused by the order (special tooling, extra supervisor).
• Ignore existing fixed costs and the full (absorption) cost: they are paid whether or not the order is accepted.

Without spare capacity, accepting means giving up existing sales: compare the order's contribution with the contribution lost.

Non-financial and other factors

• Will existing customers find out and demand the lower price?
• Is the order a one-off, or could it lead to regular profitable work?
• Does it use capacity that might be needed for full-price orders later?
• Effect on brand image if the goods are sold cheaply elsewhere.
• Can the workforce cope (overtime costs, quality)?
• Reliability of the new customer (credit risk).

Worked decision

A firm can make 12,000 units and sells 10,000 at £30. Variable cost £12; fixed costs £80,000 (full cost £20 per unit). A new customer offers £16 each for 1,500 units, needing special packaging costing £2,000.

Extra contribution = 1,500 x (16 - 12) = £6,000; less packaging £2,000 = £4,000 increase in profit. Accept on financial grounds, even though £16 is below the full cost of £20.

Worked example

Same firm, but the customer wants 3,000 units at £16 and the extra packaging still costs £2,000. Capacity is only 12,000, so 1,000 normal sales at £30 would be lost. Should it accept?

1. Contribution from the order = 3,000 x (16 - 12) = £12,000
2. Less packaging £2,000
3. Contribution lost on 1,000 normal sales = 1,000 x (30 - 12) = £18,000
4. Net effect = 12,000 - 2,000 - 18,000 = (£8,000)

Answer: Profit would fall by £8,000: reject (or negotiate a smaller order)

Check yourself

1. Variable cost £22 per unit. A customer offers £27 per unit for 800 units. There is spare capacity and no extra fixed costs. By how much would profit change?
   Show answer

   £4000. 800 x 5 = £4,000 increase.

2. Variable cost £9.50 per unit. A one-off order for 2,000 units at £11 needs an extra machine hire of £1,800. Calculate the change in profit.
   Show answer

   £1200. 2,000 x 1.50 - 1,800 = £1,200.

3. Variable cost is £14 per unit. An order of 500 units needs extra fixed costs of £1,000. What is the minimum price per unit to avoid reducing profit?
   Show answer

   £16.00. 14 + 1,000 / 500 = £16 per unit.

4. Why are existing fixed costs ignored when deciding whether to accept a special order with spare capacity?
   • They are always zero
   • They are included in the selling price
   • They are paid by the customer
   • They will be paid whether or not the order is accepted
   Show answer

   They will be paid whether or not the order is accepted. Only costs that change because of the decision are relevant.

5. Which is a valid non-financial reason to refuse a profitable low-price order?
   • The order has a positive contribution
   • Regular customers may demand the same lower price
   • Fixed costs are already covered
   • The firm has spare capacity
   Show answer

   Regular customers may demand the same lower price. Undercutting your own prices can damage relationships with existing customers.

6. An order price is above variable cost but below full absorption cost. With spare capacity and no extra costs, what happens to profit if the order is accepted?
   • Profit decreases
   • Profit is unchanged
   • The firm makes a loss on all its sales
   • Profit increases
   Show answer

   Profit increases. Positive contribution adds to profit because fixed costs are unchanged.

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Accounting specification (XAC11/YAC11), Issue 2

Last updated 8 November 2026. Spotted a mistake? Tell us.