Marginal costing

Decision Making: Closing Loss-Making Departments

The trap: full (absorption) costing may show a branch or product line making a loss — but this can be misleading because allocated fixed overheads inflate the apparent cost

Decision rule: only close if the contribution is negative (i.e. variable costs exceed revenue from that area)

If contribution is positive, closing will reduce total profit by that contribution amount — the fixed costs do not disappear

Example — Beynon''s Browndale branch:

• Full costing shows £2,000 loss
• Marginal contribution from branch = +£4,000
• If closed: firm loses £4,000 of contribution
• Total profit falls from £3,000 → −£1,000 (worse off)

Key step: remove centrally allocated fixed costs from the branch accounts before deciding — these costs will not be saved if the branch closes