Three products, one afternoon oven: Every afternoon, once the bread for the shops is out, Priti's team at Mill Lane bakes for the cafés: crackers, cheese straws and small fruit loaves.
Each product has its own ingredients. But the afternoon shift, the oven and the van round are shared, and they cost $600 a week however the three split the work.
Lena wants to know which of the three pays its way. First she has to decide who pays for the $600.
Some costs belong to one product: the cheese, flour and packet in a pack of cheese straws. Bake one pack fewer and that money is not spent. These are the product's direct costs; here they are its variable costs (5.5.1).
Other costs are shared by all three and caused by none of them alone: the shift, the oven, the van. These are indirect costs, also called overheads.
| A normal week | Crackers | Cheese straws | Fruit loaves |
|---|---|---|---|
| Sold to the cafés | 350 packets | 320 packs | 150 loaves |
| Price | $2.50 | $2.00 | $3.00 |
| Direct cost per unit | $0.60 | $0.70 | $1.20 |
| Oven hours | 7 | 8 | 15 |
One way to answer Lena is to share the $600 out, so that every product carries a part of it on top of its own direct costs. This is absorption costing (full costing): all costs, direct and indirect, are absorbed into the cost of the products.
The $600 has to be split on some basis. The fruit loaves fill the oven for longest, so Lena's accountant splits it by oven hours: $600 ÷ 30 hours = $20 for every hour a product is in the oven.
The fruit loaves under absorption costing
Their share of the $600
15 oven hours × $20 = $300 a week.
Full cost per loaf
Direct cost + share per loaf: $1.20 + $300 ÷ 150 = $1.20 + $2.00 = $3.20 a loaf.
Against the price
The cafés pay $3.00. On this split each loaf loses $0.20.
Profit or loss for the week
Revenue 150 × $3.00 = $450, minus direct costs 150 × $1.20 = $180, minus the $300 share: $450 − $180 − $300 = −$30. A loss of $30 a week.
| Absorption costing, one week | Crackers | Cheese straws | Fruit loaves | Café range |
|---|---|---|---|---|
| Revenue | $875 | $640 | $450 | $1,965 |
| Direct costs | $210 | $224 | $180 | $614 |
| Share of the $600 (oven hours) | $140 | $160 | $300 | $600 |
| Profit or loss | $525 | $256 | −$30 | $751 |
You have met this split before: The crackers' fixed costs of $140 a week (5.5.1) were their share of the $600: 7 oven hours × $20.
And the $1.00 a packet that Lena marked up to $2.50 (4.5.2) was the crackers' full cost: $0.60 + $140 ÷ 350 = $1.00. That price was built on absorption costing.
Free preview
This is the free notes preview
You're reading the free notes. Aimnova Pro unlocks the full study experience — and you can try it with your first topic free to keep:
- FlashcardsLock in vocabulary and key terms with spaced repetition.
- Practice questionsAnswer exam-style questions and get instant AI marking.
- Mock exams & past-paper vaultSit full mocks and see exactly how examiners award marks.
- Personalised study planA daily plan built around your exam date and weak areas.
The same week, drawn again: Lena's accountant draws the table a second time. This time the $600 is not split at all.
Each product is charged only with what it costs to make. What is left of its revenue goes into one pot, and the pot pays the $600.
This is contribution costing: each product is judged by its contribution, its revenue minus its direct (variable) costs (5.5.1). The shared fixed costs stay as one total and come off at the end.
Profit = total contribution − fixed costs
| Contribution costing, one week | Crackers | Cheese straws | Fruit loaves | Café range |
|---|---|---|---|---|
| Revenue | $875 | $640 | $450 | $1,965 |
| Direct costs | $210 | $224 | $180 | $614 |
| Contribution | $665 | $416 | $270 | $1,351 |
| Shared costs | not split | not split | not split | $600 |
| Profit | $1,351 − $600 = $751 |
The café range makes $751 a week either way. The two methods do not change how much the bakery makes. They change what each product appears to make.
Under absorption costing the fruit loaves lose $30. Under contribution costing they add $270 a week towards the $600.
Absorption costing
- Each product carries its direct costs plus a share of the overheads
- The share depends on the basis chosen: oven hours, units made, floor space
- Fruit loaves: a loss of $30 a week
- Asks: does each product cover its full cost?
Contribution costing
- Each product carries only its own direct costs
- The overheads stay as one total, paid from all the contributions together
- Fruit loaves: $270 a week towards the $600
- Asks: what does each product add to the pot?
A positive contribution is not a profit: All three products have a positive contribution. That alone does not mean the range makes money: together the three must cover the $600 first (5.5.1).
If the cafés cut their orders and the three contributions added up to less than $600, every product would still show a positive contribution while the range made a loss.
Memorize terms 3x faster
Smart flashcards show you cards right before you forget them. Perfect for definitions and key concepts.
Lena reads the first table: The absorption table says the fruit loaves lose $30 a week. Lena asks Priti to stop baking them from Monday.
Priti asks one question back: if we stop, which part of the $600 do we stop paying?
A week without the fruit loaves
Contribution lost
The loaves' $270 goes: $450 of revenue less $180 of direct costs.
Shared costs saved
None. The shift, the oven and the van still cost $600, because the crackers and cheese straws still need them.
The new profit
$665 + $416 = $1,081 of contribution, minus $600 = $481 a week.
The change
From $751 to $481: $270 a week less. Dropping the product that 'lost' $30 cut profit by its whole contribution.
The $30 loss came from the split, not from the loaves. Share the $600 equally instead, $200 each, and the same loaves in the same week make a profit: $270 − $200 = $70.
One basis says loss, another says profit, and the loaves have not changed. This is the main weakness of absorption costing: the way the overheads are split is a choice (it is arbitrary), and a decision can hang on it.
Absorption: strengths
- Every cost is counted, so prices can be set to cover the overheads too (cost-plus, 4.5.2)
- Shows whether each product covers its full cost over time
- Useful where overheads are a large part of the costs
Absorption: weaknesses
- The basis of the split is a choice, and a different basis gives a different answer
- Can make a product that contributes look like a loss
- Takes time to measure the oven hours, floor space or labour each product uses
Contribution: strengths
- No split to argue about: it shows exactly what each product adds
- The right figure for short-run choices: drop a product, take an extra order (4.5.7)
- Simple to work out from the price and the variable cost
Contribution: weaknesses
- Every product can contribute while the range still loses money
- Prices set just above variable cost may never pay the overheads (4.5.7)
- It assumes the overheads stay the same when a product goes
When dropping a product does save money: Contribution costing assumes the $600 stays. Check that before you trust it.
If stopping the fruit loaves let Priti end an afternoon shift costing $300 a week, the saving would beat the $270 lost and profit would rise by $30: exactly the absorption answer, because now the loaves' share really would go with them. The 15 free oven hours could also bake more crackers, if the cafés wanted them.
So the question for any product is: what would really change if it went?
How this comes up: Costing questions give a table: each product's sales, price and direct costs, and one figure for the shared overheads with the basis for splitting them.
You may be asked to calculate one product's profit or loss with absorption costing, or its contribution; to explain an advantage or disadvantage of either method; or to recommend whether a business should keep a product that seems to make a loss.
The two-mark calculation
- Find the product's share of the overheads. Use the basis the question gives: hours, units, floor space, or an equal split.
- Take its direct costs off its revenue. Units × price, minus units × direct cost per unit.
- Take the share off as well. What is left is its profit; a negative figure is a loss.
- Write every step, then the answer with a $ sign: $216, or −$30 for a loss.
Two traps: The wrong basis. Split the overheads on the basis the question gives, even if another seems fairer.
A loss is not a reason to drop. A loss under absorption costing says nothing about what dropping the product would do. For that, compare its contribution with the overheads that would really stop.
Using absorption costing, with the shared costs split equally between the three products, calculate the weekly profit or loss of the cheese straws (show all your working).
Model answer plan
See the mark-by-mark plan — for / against / judgement, with marking guidance — in study mode.