Direct Costing Explained

TECHNICAL UNIVERSITY DEGGENDORF
Investment Calculation and Technical Controlling
5.4. Direct Costing
● Problems with full cost accounting

● Turnover - Profit - Contribution margin
● Direct costing
● Contribution margin
Prof. Dr.-Ing. Stefan Scherbarth www. t h - d e g . d e 1

Comparison of Full Costs and Marginal Costing
cost accounting system
full costing marginal costing
is based on the split is based on the split

between between
direct costs overhead variable costs fixed costs
What are the costs? What are the costs?

Problems with Full Cost Accounting
Full costing has the following disadvantages:

● Fixed costs are proportionalized in the form of overhead rates and
allocated to the activity units.
● Overhead costs are assigned proportionally to the direct costs.
● Overhead costs incurred for several activity types jointly are broken down
to the individual activity types.
● Contexts are not reproduced correctly.

Risk of Proportionalization of Fixed Overhead Costs

The overheads of an industrial plant are predominantly to be seen as fixed costs.
They amounted to €600.000 in the 3rd quarter payroll period and the operating rate
in this period was 2.000 units. This results in an overhead surcharge of 300 € per
unit.
For the next two quarters, the company expect a capacity utilisation levels of
1.000 and 4.000 units.
I ftraditional full cost accounting would be used for planning the result is:
1.000 x 300 € = 300.000 € resp. 4.000 x 300 € = 1.200.000 €.
In fact, however, due to the fixed cost nature, the following always occur
overhead costs of 600.000 €.
Low levels of capacity utilisation , on the other hand, lead to a cost shortfall,
high levels of capacity utilisation thus lead to cost overcoverage.
The proportionalisation of fixed costs thus leads to a false signal effect,
for entrepreneurial decisions:
● costs are too high with increasing capacity utilisation ,
● lower costs in the event of declining capacity utilisation.
than is actually not the case.

Problems with Full Cost Accounting
One can calculate oneself out of the market

● Somebody's offering a bus trip to Rome.
● Driver and bus cost for 3 days 2.000 €.
● Per passenger there will be an overnight charge of 80 €/person.
● The bus can carry up to 75 people.
● A workload of 50 persons is expected.
● Requested cost price of 120€/pers.= 2000€/50pers.+ 80€/person.
● But only 40 people book the trip.
● For the next trip the price rises accordingly to 130 €/persons.
There are only 20 persons left that book the trip.
● The price on the third trip rises to 180 €/person.
No one's coming…

Alternative to Full Cost Accounting
● At a price of 120 €/person only 40 persons were interested.

● If one had planned on full utilization (75 persons), one would have got
along with a cost price of 107 €/pers.
● So the question is whether, if loss is to be avoided,
prices should be increased or even reduced.
The decision on this can only be made with the help of knowledge of the
split of the total costs into variable and fixed components.

Decision on Acceptance or Rejection of an Application for a

Additional Order for Unused Capacities
production fixed variable total turnover outcome

cost expenses expenses
1.000 pieces 30.000 € 80.000 € 110.000 € 100.000 € -10.000 €
Calculation of an additional order for 100 pieces at one price

of 100 €/piece and variable costs of 80 €/piece
A B
Preliminary costing: Contribution margin calculation:
Rejection of the Variable costs 80 €/piece
additional order; Fixed costs 30 €/piece
Total cost 110 €/piece Revenue 100 €/piece
old operating Variable costs 80 €/piece
Revenue 100 €/piece
result remains. Loss 10 €/piece Contribution margin 20 €/piece
Acceptance of the additional

order; new operating result
shows reduced losses
production fixed variable total turnover outcome

cost expenses expenses
1.100 pieces 30.000 € 88.000 € 118.000 € 110.000 € -8.000 €

Contribution Margin in Case of Profit and Loss
Profit
Revenue
Loss = uncovered
CM fixed costs
Fixed costs
Revenue
Covered fixed costs CM
Variable costs Variable costs
Contribution margin Contribution margin

in case of profit in case of loss

Partial Costing - Contribution Margin
Turnover - Profit contribution margin
Profit
contribution margin
Fixed costs contribution margin
Variable costs Variable costs Variable costs
full-cost analysis Contribution margin Contribution margin

with full coverage of for cover only
fixed costs and profit and the fixed costs
without a profit

Separation into Variable and Fixed Costs
● Objective: Allocation of the cost elements in:

● Fixed costs
● Variable costs
● Mixed costs
● Possibilities for cost separation:

● Experience knowledge or expert knowledge
● Technical analysis:
Assessment of physical characteristics by engineers,
very time- and cost-intensive
● Expert judgment:
Specialists with empirical knowledge are interviewed,
quick practical results and learning curve but subjective
● Quantitative methods:
● Mini-Max method (shift cost method)
● Compensation line (graphical or mathematical)
● S curve (graphical or mathematical)

Partial Costing Definition: Contribution Margin
Contribution margin (CM):

● CM = Revenues - performance-related (allocable / variable) costs
● Company result = CM - time-dependent (fixed) costs
Fixed costs in the contribution margin calculation:

● The fixed costs are no longer calculated per unit,
but as a complete block.
● Operating result = contribution margin - fixed costs
● Operating result = revenue - variable costs - fixed costs

Partial costing - contribution margin CM1, CM2, CM3, CM4
Definition of the contribution margin:

CM 1 = Gross_revenues - sales deductions - directly attributable
production costs
CM 2 = CM 1 - direct sales and marketing costs
Cm 3 = CM 2 - other direct variable costs
CM 4 = CM 3 - directly attributable fixed costs
Profit = sum of all CM 4 - non-assignable fixed costs
Sales deductions e.g. (bonuses, discounts)

Single- and Multi-Level Contribution Margin Accounting

Single-level Product group A Product B
contribution margin accounting A1 A2 Sum A B sum
Net revenues 3.900 1.365 5.265 1.950 7.215
- Variable costs 3.000 1.050 4.050 1.700 5.750
= Contribution margin 900 315 1.215 250 1.465
- Fixed costs 1.540
= Operating success -75
Multilevel Product group A Product B

contribution margin accounting A1 A2 Sum A B sum
Net revenues 3.900 1.365 5.265 1.950 7.215
- Variable costs 3.000 1.050 4.050 1.700 5.750
= Contribution margin (I) 900 315 1.215 250 1.465
- The products
400 260 660 280 940
attributable fixed costs
= Contribution margin (II) 500 55 555 -30 525
- Fixed costs attributable to the
378 102 480
product groups
= Contribution margin (III) 177 -132 45
- Not allocable fixed costs 120
= Operating result -75

Allocation of Fixed Cost Blocks for CM1 - CM4
● Fixed costs that can be allocated to the individual product type

e.g. R&D costs, costs of a marketing for a dedicated product type, costs
of special tools for the production of this product type, depreciation on a
single-product machine,
● Fixed costs incurred by individual product groups:
for example, rent for a building in which different product types are
manufactured,
● Fixed costs associated with individual cost centers:
for example, the salary of the head of a cost center in which individual
product types are processed,
● Fixed costs of individual operating areas:
e.g. salary of the area manager (division manager),
● Fixed costs of the entire company:
e.g. salary of the accountant of the company, salaries of the board of
directors, costs of an image-building actions of the company.

Multilevel Contribution Margin Accounting

Division/Area Division 1 Division 2
Product group 11 12 21 22
Product type 111 112 113 121 122 211 212 221 222 223
Net revenues 100 87 59 86 120 95 43 76 32 52
- Variable costs 56 42 22 61 65 66 11 43 12 25
= Contribution margin 1 44 45 37 25 55 29 32 33 20 27
- Product type fixed costs 15 30 25 10 32 11 16 21 8 E
= Contribution margin 2 29 15 12 15 23 18 16 12 12 22
Sum CM 2 56 38 34 46
- Product group fixed costs 22 13 16 32
= Contribution margin 3 34 25 18 14
Sum CM 3 59 32
- Range fixed costs 12 6
= Contribution margin 4 47 26
Sum CM 4 73
- Fixed company costs 20
= Operating result 53
Partial Cost Accounting - Cost Accounting Procedure
Importance of cost accounting procedures:

Earlier: primarily calculation, pricing (preliminary and final calculation)
Today: primarily decision preparation and control
Today with the main use of direct costing applies:

● Direct costing does not allocate all costs to the cost objects.
● The remaining unallocated costs must be coverd by the revenues of all
products.
● The central parameter is the contribution margin of each individual
product or cost unit.
● As long as a cost unit has a positive CM, it contributes to covering fixed
costs and thus to improving the operating result.

A B C D E sum
net revenues 50.000 85.000 165.000 80.000 50.000 430.000
- variable distribution costs 1.000 3.000 9.000 2.000 2.000 17.000
- variable manufact. costs 52.000 36.000 80.000 40.000 38.000 246.000
contribution margin CM1 -3.000 46.000 76.000 38.000 10.000 167.000
- fixed product costs 4.000 14.000 50.000 24.000 10.000 102.000
Contribution margin DB2 -7.000 32.000 26.000 14.000 0 65.000
Total product group 25.000 26.000 14.000 65.000
- Product group fixed costs 4.000 15.000 12.000 31.000
Contribution margin DB3 21.000 11.000 2.000 34.000
Sum ranges 32.000 2.000 34.000
- Range fixed costs 15.000 4.000 19.000
Contribution margin DB4 17.000 -2.000 15.000
Total companies 15.000 15.000
- fixed company costs 10.000 10.000
corporate success 5.000 5.000

A B C D E sum
net revenues 50.000 85.000 165.000 80.000 50.000 430.000
contribution margin CM2 -7.000 32.000 26.000 14.000 0 65.000
Total product group 25.000 26.000 14.000 65.000
- Product group fixed costs 4.000 15.000 12.000 31.000
Contribution margin DB3 21.000 11.000 2.000 34.000
Sum ranges 32.000 2.000 34.000

A B C D E sum
net revenues 50.000 85.000 165.000 80.000 50.000 430.000
total product group 25.000 26.000 14.000 65.000
- product group fixed costs 4.000 15.000 12.000 31.000
contribution margin CM3 21.000 11.000 2.000 34.000
Sum ranges 32.000 2.000 34.000

A B C D E sum
net revenues 50.000 85.000 165.000 80.000 50.000 430.000
sum division 32.000 2.000 34.000
- division fixed costs 15.000 4.000 19.000
contribution margin CM4 17.000 -2.000 15.000

A B C D E sum
net revenues 50.000 85.000 165.000 80.000 50.000 430.000
sum division 32.000 2.000 34.000
- division fixed costs 15.000 4.000 19.000
contribution margin CM4 17.000 -2.000 15.000
total companies 15.000 15.000
corporate result 5.000 5.000

Relative Contribution Margin
A B C D E sum
net revenues 12% 20% 38% 19% 12% 100%
contribution margin CM1 -6% 54% 46% 48% 20% 39%
contribution margin CM2 -14% 38% 16% 18% 0% 15%
contribution margin CM3 16% 7% 2% 8%
contribution margin CM4 6% -2% 3%
corporate result 1% 1%
CM
CM factor or relative CM =
turnover

Calculation as Full Cost Accounting

Which product is particularly worthy of promotion?
on the condition that production capacities are not exhausted?
EXAMPLE: A company produces toasters in three variants. The following data from
the previous months is available for the three models (the quantity produced is equal
to the quantity sold):
Single Family Luxury Total

quantity in pcs. 5.000 8.000 4.000 17.000
turnover in € 90.000 192.000 128.000 410.000
– variable costs 25.000 64.000 40.000 129.000
– fixed costs 50.000 102.000 105.000 257.000
= operating result + 15.000 + 26.000 – 17.000 + 24.000
unit profit + 3,00 + 3,25 – 4,25

Contribution Margin Accounting
Single Family Luxury

Quantity in pcs. 5.000 8.000 4.000
turnover in € 90.000 192.000 128.000
– variable costs 25.000 64.000 40.000
= contribution margin + 65.000 + 128.000 + 88.000
cm (CM per item) + 13,00 + 16,00 + 22,00
or:
Single Family Luxury
revenues per item 18,00 24,00 32,00
– variable costs/pcs. 5,00 8,00 10,00
cm (CM per item) + 13,00 + 16,00 + 22,00
or piece_CM
With a sales increase of 1000 pcs.
the profit would increase by 22.000 €.

Contribution Margin for Product Evaluation
Which product would be preferable,

if a (fixed) additional turnover could be realized in €.
(at constant unit sales and without capacity bottlenecks)
EXAMPLE: The toaster manufacturer could sale more due to an

increased demand, an additional turnover of € 36,000 is
created. One model is produced and sold more intensively in
this case. The following alternatives result:
Additional turnover / unit additional

model
revenue = quantity
Single 36.000 € / 18,00 €/pcs. = 2.000 pcs.
Family 36.000 € / 24,00 €/pcs. = 1.500 pcs.
Luxury 36.000 € / 32,00 €/pcs. = 1.125 pcs.

Contribution Margin for Product Evaluation
model Number of items - piece_CM = Total CM

Single 2,000 pcs. - 13,00 €/piece = 26.000 €
Family 1,500 pcs. - 16,00 €/piece = 24.000 €
Luxury 1.125 pcs. - 22,00 €/piece = 24.750 €
model piece_CM / piece revenue = CM_Intensity

Single 13,00 € / 18,00 € = 72,22%
Family 16,00 € / 24,00 € = 66,67%
Luxury 22,00 € / 32,00 € = 68,75%

Selection of a Product in Case of a Bottleneck
Which product is particularly worthy of promotion?

when there's a bottleneck machine?
EXAMPLE: The machines that form bottlenecks are used by the individual
products as follows:
Utilization per unit in

model
minutes
Single 6 minutes per item
Family 8 minutes per item
Luxury 10 minutes per item

Piece_CM / minute Total_CM per

model
requirement = minute
Single 13 € / 6 minutes = 2,17 €/minute
Family 16 € / 8 minutes = 2,00 €/minute
Luxury 22 € / 10 minutes = 2,20 €/minute


From model luxury in the future 30% more thus instead of 4.000 pcs. now
5.200 pcs. will be produced.
This production increase of 1.200 pcs. requires a minute requirement of the
bottleneck unit of 1.200 pcs. x 10 min/pcs. = 12.000 min.
For the 'Family' model, this results in a production reduction of 1.500 pcs.
12.000 min / 8 min / pcs. = 1.500 pcs.
After the program restructuring, the following screen appears:
Model Items Minutes CM

Single 5.000 30.000 65.000
Family 6.500 52.000 104.000
Luxury 5.200 52.000 114.000
Sum 16.700 134.000 283.400
– Fixed costs 257.000
= Operating result + 26.400

Determination of the Optimal Product Mix
Example: An MP3 player manufacturer produces three different models: The

newly introduced 'Easy' model is currently still producing a negative
piece_CM (cm).
A grocery discounter was to buy a delivery of 12.000 units for the
coming month. The total capacity is 78.000 units per month, the
fixed costs per month amount to € 1.9 million:
Variable minimum maximum

Model Price
costs per CM per piece sales sales
unit volume volume
Easy 19,00 € 22,00 €/pcs. – 3,00 €/pce. 12.000 pcs. 70.000 pcs.
Sonic 72,00 € 32,00 €/pcs. + 40,00 €/pce. 36.000 pcs.
Future 58,00 € 28,00 €/pcs. + 30,00 €/pce. 45.000 pcs.

Determination of the Optimal Product Mix
Type of
model quantity CM per piece CM
restriction
Easy 12.000 pcs. – 3,00 €/pce. – 36.000 € minimum quantity
Sonic 36.000 pcs. + 40,00 €/pce. + 1.440.000 € maximum
Future 30.000 pcs. + 30,00 €/pce. + 900.000 € total capacity
Sum 78.000 pcs. + 2.304.000 €
The operating result therefore amounts to

Operating result = CM - fixed costs
Operating result = 2,304,000 € - 1,900,000 €
Operating result = 404,000 €.

Determination of the Optimal Product Mix for Bottlenecks
EXAMPLE: A manufacturer of board games has three different board

games in its program, each containing different amounts of the
same wooden sticks. The following data applies:
Wooden
Minimum Maximum sales
model piece_CM sticks per
sales volume volume
game
The Clan 6 €/pcs. 90 800 pcs. 6.000 pcs.
Hinz & Kunz 7 €/pcs. 150 500 pcs. 4.000 pcs.
Fantasia 5 €/pcs. 100 300 pcs. 2.000 pcs.
Due to acute procurement difficulties, the number of available wooden
sticks is limited to 950.000 per month.

Step one:
The bottleneck load for the production of the minimum quantities is
determined
Number of wooden sticks Number of

model
games per game wooden sticks
The Clan 800 games - 90 sticks = 72.000 sticks
Hinz & Kunz 500 games - 150 sticks = 75.000 sticks
Fantasia 300 games - 100 sticks = 30.000 sticks
Sum 177.000 sticks
Step two:
Determine the freely available congestion capacity:
Free available quantity: 950.000 - 177.000 = 773.000 sticks

Step 3: The remaining congestion capacity is determined in order of

relative CM and taking into account the maximum sales volumes:
wooden sticks order of

model Number of games
per game precedence
6,00 €/game
The Clan = 0,0667 €/stick 1
90 sticks/game
7,00 €/game
Hinz & Kunz = 0,0467 €/stick 3
150 sticks/game
5,00 €/game
Fantasia = 0,05 €/stick 2
100 rods/game


Distribution of the "free remaining quantity" according to CM ranking
Need for wooden
additional Free remaining
sticks for
model production
additional
quantity (sticks
(games/month) per month)
production
The Clan 5.200 468.000 305.000
fantasia 1.700 170.000 135.000
Hinz & Kunz 900 135.000 0
Calculation total piece rate from minimum quantity + additional production

CM-oriented
Production from
model minimum quantity
additional Total production
production
The Clan 800 5.200 6.000

Hinz & Kunz 500 900 1.400
fantasia 300 1.700 2.000
Contribution Margin Accounting Exercise
innovativ & lebendig – Bildungsregion DonauWald

Contribution Margin Accounting Task 1
● A series manufacturer has a weekly production capacity of 3.000 min in

total and weekly fixed costs of 90.000 €. The following data is available for
the current week:
Sales price per variable unit Processing time Maximum sales

Product
piece costs per piece volume
Super 20,00 € 15,00 € 5 sec 6,000 pcs.

Mega 18,00 € 12,00 € 8 sec 10.000 pcs.
Hyper 15,00 € 12,00 € 2 sec 5,000 pcs.
a. Calculate the expected weekly operating result.

b. In order to increase capacity utilisation to 90%, the company is planning
an advertising campaign that will incur additional costs of 50.000€. Only
one additional product is to be advertised. Assume that the additional
quantity produced can also be sold, and check whether this promotion
makes sense for one of these products.
Prof. Dr.-Ing. Stefan Scherbarth www. t h - d e g . d e

Contribution Margin Accounting Task 2
A company produces 4 different mechanical parts.

With the current production volume, the capacity limit has been reached.
The following data was compiled by the controlling:
Product Alpha Beta Gamma Delta
maximum sales volume 10.000 pcs. 7.500 pcs. 9.000 pcs. 7.500 pcs.
current sales volume 9.000 pcs. 6.000 pcs. 8.000 pcs. 6.000 pcs.
Minimum sales quantity
7.000 pcs. 5.000 pcs. 6.500 pcs. 4.500 pcs.
(contractually bound)
Machine time in seconds 2,0 sec 2,5 sec 3,0 sec 5,0 sec
Selling price per unit 125 € 110 € 120 € 140 €
variable unit costs 100 € 95 € 90 € 120 €

The monthly fixed costs amount to 455.000 €.
Determine the optimum operating result.
Prof. Dr.-Ing. Stefan Scherbarth www. t h - d e g . d e

5.5. Break Even Analysis

Break Even Analyses
Problem:
Partial costing shows relationships between sales, costs and profit.
Of particular interest here is the question of the activity quantity
(= critical quantity) from which the costs incurred are covered
from the profit which is achieved. (= break-even point).
The break even analysis provides this information.
In the single-product company, the (planned) total costs and revenues are
compared.
The formula for determining of the Break Even Point (BEP) is:
With C : fixed costs

cm: piece contribution margin
r : piece revenue
c : unit costs

Break Even Analyses
R Total revenue
Cost,
revenue
profit
zone
C Total costs
C = Cf + Cv
Cv variable costs
Cf fixed costs
loss-
zone
x Volume
xBEP capacitive
break even volume border
Break Even Analyses
R Total revenue
Cost,
revenue
profit
zone
C Total costs
C = Cf + Cv
Accumulated
contribution margins
Cv variable costs
Cf fixed costs
loss-
zone
x Volume
xBEP capacitive
break even volume border
Example
EXAMPLE: For a (planned) period, the fixed costs are 30.000 €, and
the variable unit costs 40 €.
The piece revenue amount is 70 €.
The critical quantity is calculated:
xBEP = 30.000€ / (70€/piece - 40€/piece) = 30.000€ / 30€/piece = 1.000 pcs.
With 1.000 pieces, the costs are covered and a profit is made.
Graphically, the break-even point is at the intersection of the revenue and cost
curves or the fixed cost and contribution margin curves.

Addition of Minimum Profit
If necessary, the break-even analysis can be supplemented with a desired

minimum profit, for example.
This should amount to 6.000 €, for example, and is added to the fixed
costs in the formula.
The break-even point is therefore 1.200 units:
XBEP = (30.000€ + 6.000€) / (70€/piece - 40€/piece)

XBEP = 36.000€ / 30€/piece
XBEP = 1.200 pcs.

Break-even Analyses with Minimum Profit
R Total revenue
Cost,
revenue C + Pmin
Total costs +
minimum profit
Accumulated
Cf + Pmin
fixed c. + minimum.
Pmin Minimum
Cv variable costs
profit
Cf fixed costs
x Volume
xBEP
break even volume
Consideration of Production Capacities
Other parameters that can be included in the break-even analysis are

production capacity or total capacity and a planned or usual sales quantity
(specifies the safety margin):
break−even−point
Capacity utilization in % =
production capacityät
normal quantity — BEP

Safety distance in % =
normal quantity

Example:
In addition to the initial case (without minimum profit), the BEP is 1.000 pieces, the
total capacity is 2.000 pieces per period, the usual sales volume is 1.250 pieces.
Capacity utilization is therefore at a high level:
1.000 pcs. / 2.000 pcs. = 50 %
The safety distance is:
(1.250 pcs. – 1.000 pcs) / 1.250 pcs. = 20 %
If beyond that a minimum profit of 6.000 € is to be gained
(BEP = 1.200 pieces), the following values result instead:
Capacity utilization = 1.200 pcs./ 2.000 pcs. = 60%.

Safety distance = (1.250 pcs. – 1.200 pcs.) / 1.250 pcs. = 4 %
In the latter case, the safety margin is extremely small as the actual sales volume of
4 % is only slightly above the BEP. If the sales volume decreases by this amount, the
desired minimum profit is just achieved, a further decrease reduces the profit and can
possibly lead to a loss.

Cash Point – Point of Noncash
A variant of a break-even calculation results from the following situation: In the

short term, part of the fixed costs do not lead to outflows of payments and therefore
do not have to be covered.
The cash point coverage specifies the sales quantity that is required to cover the
fixed costs affecting cash payments. To do this, the noncash fixed costs (especially
calculatory depreciation) are subtracted from the total fixed costs. The remaining
non-cash fixed costs are divided by the unit cm:
"# "# %&%'()*
cash point = !
+,
Example:
The €30.000 fixed costs of the initial case include €9.000 depreciation (as short-
term non-cash costs).
The cash point is therefore enclosed:
(30.000€ - 9.000€) / 30 €/piece = 700 pcs.
In the graphic display, the fixed cost line is shifted downwards by the amount of the
non-cash fixed costs.

Cash Point - Break Even Analyses
R Total revenue
Cost,
revenue
C Total costs
C = Cf + Cv
Accumulated
Cv variable costs
Cf fixed costs
Cf noncash
Cf noncash
- ./01 non-cash
! fixed costs
x Volume
xCP capacitive
cash point border
Multi-Product Manufacturing
In multiproduct production, a separate variable must be used for each product type.
In two-product production, for example, this results in a three-dimensional
representation.
Instead, the break-even point can also be determined in the way shown above,
whereby the fixed costs that cannot be directly allocated are then added
proportionately to the fixed costs that can be allocated in each case. This value can
be distributed in proportion to the contribution margins per unit of the individual
products.

Break-even Analysis for Decision: External or In-house Production
A particular problem that can be solved with the help of a break-even analysis is the
question of whether certain services (e.g. as external components) should be
procured from external suppliers or whether they should be produced themselves
(make-or-buy decision).
This problem of in-house production or external procurement concerns not only
preliminary products (and thus the material and production area), but also the
indirect area, such as the production of posters by the in-house print shop or by
external parties, the development of an advertising campaign by the in-house
advertising department or an external advertising agency, etc.
A necessary comparison of economic efficiency is carried out on the basis of the
costs relevant to the decision. If unused capacity is available for in-house production
(i.e. no additional fixed costs are incurred), only the marginal costs are decisive: in-
house production is advantageous if the marginal costs are lower than the cost price
for external procurement.

Break Even Analysis for Decision: External or In-house Production
For comparison purposes, the variable direct material and production costs as well
as the proportional material and production overhead costs are determined for in-
house production and the purchase prices (including procurement costs) are
determined for external procurement.
in-house production Cv external
external production
expenses
If, on the other hand, additional beneficial
fixed costs are incurred with in- Cv own + Cf own
house production, in-house fixed + variable costs
production is only cheaper if its for in-house
production
sum of fixed costs and external procurement
proportional costs is lower than beneficial
the sum of the proportional cost
prices for external procurement; Cf own
therefore, this applies to a unit fixed costs
approach: in-house production
x Volume
In-house production is cheaper, xBEP capacitive
if cf own + cv own < cv external break even volume border
-2
3 4 546 /7 3 -2
Example:
A company is faced with the decision to produce an external component itself or to

purchase it from a supplier.
In the case of external procurement, the cost price is 0,6923 €/piece,
for in-house production, fixed costs of € 9.000 per month are incurred, and
0,3173 €/piece variable unit costs.
Make or buy?
The break-even point is the quantity at which the fixed costs for in-house production
are offset by the lower variable unit costs (€ 0,375/piece):
XBEP = Cf Own /(cv external – cv own)

XBEP = 9.000 / (0,6923 – 0,3173) = 9.000 / 0,375 = 24.000 [pieces]
With 24.000 pcs. both alternatives cause costs in the same amount, with a higher
need the own production is more advantageous, with a lower one the external
procurement.

Determination of Lower Price Limits
The long-term lower price limit of a product is determined by its full cost price per
unit - i.e. including the proportionate fixed costs.
This must be at least on average all products fixed costs.
In the short term, it is possible to dispense with the coverage of fixed costs, which is
why they are irrelevant for short-term decisions (e.g. acceptance of an additional
order). Rather, it is essential here whether the operational capacities are fully
utilised (full employment) or not (underemployment).
Situation 1: Short-term lower price limit in the case of unused capasity.

In the event of unused capacity, the short-term lower price limit corresponds to the
variable unit costs. Each additional order whose unit revenue exceeds the variable
unit costs improves the operating result.

Example: Open Capacities
A manufacturer of footballs produces 5.000 footballs per month, which are sold for
30 € each. This costs 9 € variable unit costs (= 45.000 €) and 96.000 € fixed costs.
An event agency would like to purchase 800 pieces of the same model at a price of
20 € per football; for a special imprint, further variable costs of 0,50 €/piece would
be incurred. The existing capacities are sufficient for the order.
On the basis of full costs, the order would have to be rejected, since the average
cost price per unit would be
(5.000 • 9,00 € + 800 • 9,50 € + 96.000 €) / 5.800 pcs. = 25,62 €/piece
and would therefore be higher than the price offered (20 €).
The variable costs per football are only 9,50 €. At a price of € 20, this would result
in a unit cm of € 10,50, which would contribute to covering the fixed costs and
improving earnings.

Capacities Fully Utilised
Situation 2: Short-term lower price limit for fully occupied capasity.

If an additional order is to be accepted or a new product is to be included in the
programme, this is only possible in the case of fully utilised capasity if the
production quantities of other products are reduced accordingly at the same time.
By opting for a new product or an additional order, the company foregoes a portion
of the contribution margins generated with the previous production, which results in
opportunity costs.
These must be taken into account to determine the short-term lower price limit,
which is therefore the variable unit cost plus the opportunity cost of the capacity
utilization.

Example: Capacities Utilized
A manufacturer of toasters offers three models.

The capacities are fully utilised.
A customer asks at which price a new toaster model "Joy" can be offered, whose
variable unit costs were calculated with 7,50€.
There is a bottleneck in one production area, so that the production of "Joy" would
have to reduce that of another toaster.
The minute requirement in the bottleneck area for "Joy" is 7 minutes.
Further information is available:
single family luxury
cm 13,00 € 16,00 € 22,00 €
minute requirement 6 min 8 min 10 min
This makes it possible to determine which of the previous products makes the worst
use of the capacity bottleneck, i.e. where the lowest contribution margin per minute
is achieved:
single family luxury
cm / minute requirement 13,00 € / 6min 16,00€ / 8min 22,00€ / 10min
cm / minute requirement 2.167 €/min 2,00 €/min 2,20 €/min

Example: Capacities Utilized
The "Family" model generates the lowest contribution margin per minute of capacity
utilization of the bottleneck factor at 2 €/min.
If the "Joys" model were included in the programme, the production volume of
"Family" would therefore have to be reduced, as "Joy" would reduce the bottleneck
area
7 minutes, the opportunity costs amount to:
CostOpp. = minute requirementProduct new Piece_CM per minuteProduct old
Example:
7 min 2 €/min = 14 €
The lower price limit for "Joy" is therefore:
cv + cOpp = 7,50 €/piece + 14,00 €/piece = 21,50 €/piece
If the replacement of "Family" by "Joy" would result in the minimum sales volume of
"Family" being undercut, the product with the next lower cm/min must be replaced
from this point onwards.

Carrying out Process Comparisons
A comparison of different production processes is carried out in various situations:

a. If a product can be manufactured using different production systems and there is
free capacity in these facilities, or
b. When deciding on the acquisition of new equipment.
In case a. the production system do not form a specific bottleneck, so that only the
variable costs are used for the assessment:
The product in question shall be produced on those installations where the lowest
variable unit costs are incurred.
However, in the case of an investment decision (b.) fixed costs must also be
included. For this purpose, the output quantity must be determined where both
investment objects lead to the same total costs, i.e. where a system with lower
fixed costs and higher variable unit costs is just as worthwhile as the other system
with relatively higher fixed costs but lower variable unit costs.

Example:
A company is faced with the decision to replace an existing production system. The
two models available, each with a capacity of 60.000 units per period, cause the
following costs:
Fixed costs per period Variable unit costs
System A 350.000 € 23,00 €
System B 460.000 € 19,00 €
Which of the two systems is to be preferred depends on the planned production
quantities. Machine A causes 4€ higher variable unit costs, so that their unit CM is
4€ lower; on the other hand, machine B causes higher fixed costs. System B, which
is more fixed-cost intensive, is preferable if the higher fixed costs are due to the
higher unit costs for large output quantities.
CM can be overcompensated. The quantity at which the same profit contribution is
achieved with both machines is therefore of interest.
This quantity is enclosed:

"#8 "# :;<.<<< >?<.<<< AA<.<<<
xa-b = = = = 27.500 pcs.
+9 +98 @> AB :
If the quantity produced exceeds 27.500 units, maschine B is to be preferred; if not

machine A is the preferred choice.
Comparison of Several Investments

Such an approach can also be used to assess several alternative investments.
Fixed costs per period Variable unit costs
system A 350.000 € 23,00 €
Xa-b = 27.500 pcs.
system B 460.000 € 19,00 €
system C 500.000 € 18,00 € Xb-c = 40.000 pcs.
"#C "#8 ?<<.<<< :;<.<<< :<.<<<
xb-c = = = = 40.000 pcs.
+98 +9C AB AD A
Xa-b Xb-c
quantity 20.000 27.500 30.000 40.000 50.000 60.000
kf 17,50 12,73 11,67 8,75 7,00 5,83
A kv 23,00 23,00 23,00 23,00 23,00 23,00
K 40,50 35,73 34,67 31,75 30,00 28,83
Kf 23,00 16,73 15,33 11,50 9,20 7,67
B Kv 19,00 19,00 19,00 19,00 19,00 19,00
K 42,00 35,73 34,33 30,50 28,20 26,67
Kf 25,00 18,18 16,67 12,50 10,00 8,33
C Kv 18,00 18,00 18,00 18,00 18,00 18,00
k 43,00 36,18 34,67 30,50 28,00 26,33

Comparison of Several Invest.

45
● What is wrong or
simplified in the sketch? 40
A
35
B
30
cA
C cB
25 cC
cvA
20
cvB
cvC
20 30 50
27,5 40 60

Comparison of several methods

45
● What is wrong or
simplified in the sketch? 40
E
E E
A
E 35
E E
Unit cost [EUR]

B
Unit cost curve: 30
cA
Hyperbola asymptotically
approaching variable costs! C cB
25 cC
cvA
The axes are not labeled! 20
cvB
cvC
20 30 50
27,5 40 60
Quantity [1000 pcs.]

S-Shaped Cost Curve C total costs

useful useful
threshold border R total revenue
expenses
revenues
Cf fixed costs
production volume
full costs
unit-related c profit zone
per item
expenses
revenues
r revenue per unit (price)

optimal
cost point
production quantity
S-Shaped Cost Curve C total costs

useful useful
threshold border R total revenue
expenses
revenues profit maximum
the slope of the total cost curve corresponds to
the slope of the revenue curve
Cf fixed costs
production volume
unit-related c
full costs marginal F slope of the
per item c cost curve
expenses cost F
revenues
Profit
maximum
R Slope of the revenue curve

marginal => r revenue per unit (price)
c
cost Optimal
cost item
production quantity
S-shaped Cost Curve with Falling Revenue C total costs

useful useful
threshold border
R total revenue
expenses
profit zone
Cf fixed costs
production quantity
unit-related marginal F slope of the

c cost curve
expenses cost F
revenues
c average cost per unit

r average revenue per unit (priece)
marginal
c Optimal
cost cost item
production quantity
S-shaped Cost Curve with Falling Revenue C total costs

useful useful
threshold border
R total revenue
expenses
Cf fixed costs
production volume
unit-related marginal F slope of the

c cost curve
expenses cost F
revenues
optimal
cost point
c average cost per unit
r average revenue per unit (price)
marginal FG
c slope of the
cost profit R marginal revenue revenue curve
maximum
production quantity
F

Direct Costing Explained

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TECHNICAL UNIVERSITY DEGGENDORF

Investment Calculation and Technical Controlling

5.4. Direct Costing

● Problems with full cost accounting

Prof. Dr.-Ing. Stefan Scherbarth www. t h - d e g . d e 1

Comparison of Full Costs and Marginal Costing

cost accounting system

full costing marginal costing

is based on the split is based on the split

direct costs overhead variable costs fixed costs

What are the costs? What are the costs?

Prof. Dr.-Ing. Stefan Scherbarth www. t h - d e g . d e 2

Problems with Full Cost Accounting

Full costing has the following disadvantages:

Prof. Dr.-Ing. Stefan Scherbarth www. t h - d e g . d e 3

Risk of Proportionalization of Fixed Overhead Costs

Prof. Dr.-Ing. Stefan Scherbarth www. t h - d e g . d e 4

Problems with Full Cost Accounting

One can calculate oneself out of the market

Prof. Dr.-Ing. Stefan Scherbarth www. t h - d e g . d e 5

Alternative to Full Cost Accounting

● At a price of 120 €/person only 40 persons were interested.

Prof. Dr.-Ing. Stefan Scherbarth www. t h - d e g . d e 6

Decision on Acceptance or Rejection of an Application for a

production fixed variable total turnover outcome

Calculation of an additional order for 100 pieces at one price

Acceptance of the additional

production fixed variable total turnover outcome

Prof. Dr.-Ing. Stefan Scherbarth www. t h - d e g . d e 7

Contribution Margin in Case of Profit and Loss

Variable costs Variable costs

Contribution margin Contribution margin

Prof. Dr.-Ing. Stefan Scherbarth www. t h - d e g . d e 8

Partial Costing - Contribution Margin

Turnover - Profit contribution margin

Variable costs Variable costs Variable costs

full-cost analysis Contribution margin Contribution margin

Prof. Dr.-Ing. Stefan Scherbarth www. t h - d e g . d e 9

Separation into Variable and Fixed Costs

● Objective: Allocation of the cost elements in:

● Possibilities for cost separation:

Prof. Dr.-Ing. Stefan Scherbarth www. t h - d e g . d e 10

Partial Costing Definition: Contribution Margin

Contribution margin (CM):

Fixed costs in the contribution margin calculation:

Prof. Dr.-Ing. Stefan Scherbarth www. t h - d e g . d e 11

Partial costing - contribution margin CM1, CM2, CM3, CM4

Definition of the contribution margin:

Prof. Dr.-Ing. Stefan Scherbarth www. t h - d e g . d e 12

Single- and Multi-Level Contribution Margin Accounting

Multilevel Product group A Product B

Prof. Dr.-Ing. Stefan Scherbarth www. t h - d e g . d e 13

Allocation of Fixed Cost Blocks for CM1 - CM4

● Fixed costs that can be allocated to the individual product type

Prof. Dr.-Ing. Stefan Scherbarth www. t h - d e g . d e 14

Multilevel Contribution Margin Accounting

Partial Cost Accounting - Cost Accounting Procedure

Importance of cost accounting procedures:

Today with the main use of direct costing applies:

Prof. Dr.-Ing. Stefan Scherbarth www. t h - d e g . d e 16

Multilevel Contribution Margin Accounting

- variable manufact. costs 52.000 36.000 80.000 40.000 38.000 246.000