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Management Accounting · Applications of Marginal Costing in Short Term Decision Making

Key Factor and Product Mix Decisions in Marginal Costing

Updated 10 October 2026 · Fact-checked

A key factor (limiting factor) is the one resource that restricts output. When only one resource is scarce, rank products by contribution per unit of that resource, not by contribution per unit of product. Allocate the resource to the top-ranked product first, up to its maximum demand, then to the next, until the resource runs out.

Understand Key Factor and Product Mix Decisions

Every business would like to make and sell as much as it can. In practice, something usually stops it. It may be raw material, labour hours, machine hours or even sales demand. The resource that limits activity is called the key factor or limiting factor.

When no resource is short, the rule is easy: make every product with a positive contribution. When one resource is short, you must choose. A product with a high contribution per unit may still use up a lot of the scarce resource. Another product with a lower contribution per unit may use very little of it. So you cannot rank by contribution per unit of product.

The correct question is: how much contribution does each product earn from each unit of the scarce resource? If material is short, find contribution per kg. If machine time is short, find contribution per machine hour. The product with the highest figure earns the most from the resource, so it gets the resource first.

Then you allocate. Give the first-ranked product enough of the resource to meet its maximum demand. Move to the second-ranked product with what is left. Continue until the resource is used up. Total contribution minus fixed costs gives profit.

This method works under marginal costing because fixed costs do not change with the choice. Only variable cost, and therefore contribution, matters. The method is valid for one limiting factor only. With two or more limiting factors you need linear programming, which is a different technique.

Key rules to remember

Contribution per unit
Contribution per unit = Selling price per unit − Variable cost per unit
Use only variable costs. Ignore fixed costs in ranking.
Contribution per unit of key factor
Contribution per key factor unit = Contribution per unit ÷ Units of key factor needed per unit of product
Key factor may be kg of material, labour hours or machine hours. This is the ranking basis.
Maximum units from the resource
Units that can be made = Resource available ÷ Resource needed per unit
Compare with maximum demand. Produce the lower of the two.
Profit under key factor
Profit = Total contribution − Fixed costs
Fixed costs are the same for every mix, so they do not affect the choice.

How to solve Key Factor and Product Mix Decisions questions

Use this method for any key factor question with one scarce resource.

  1. 1Identify the key factor from the question: the resource whose requirement exceeds availability. Check demand limits too.
  2. 2Compute variable cost and contribution per unit for each product.
  3. 3Compute the key factor needed per unit of each product.
  4. 4Compute contribution per unit of key factor for each product and rank them from highest to lowest.
  5. 5Allocate the resource in rank order. Give each product its maximum demand (or the amount you can make) until the resource is exhausted.
  6. 6Compute units, contribution of each product and the total contribution. Deduct fixed costs if profit is asked.
  7. 7State the optimal mix clearly and add a one-line conclusion, for example that a product with high contribution per unit is ranked lower.

Quickest way: Rank, fill, stop

When to use it: Use when one resource is short and the question gives per-unit price, variable cost and resource usage.

  1. Write a small table: product, contribution per unit, resource per unit.
  2. Divide the first column by the second to get contribution per resource unit. Rank.
  3. Compute the resource needed for full demand of rank 1. Subtract from the total available.
  4. Repeat for rank 2 and so on. The last product gets only the leftover resource.
  5. Multiply units by contribution per unit and add. Check that resource used equals resource available.

Common mistakes in Key Factor and Product Mix Decisions

  • Ranking products by contribution per unit or by P/V ratio.

    These are the usual ranking tools in other marginal costing questions, so students apply them automatically.

    Fix: When a resource is limited, rank only by contribution per unit of that resource.

  • Including fixed costs or absorbed overheads in unit cost.

    Cost sheets in the question often show total cost per unit with fixed overheads.

    Fix: Separate variable and fixed costs first. Use only variable cost to find contribution.

  • Ignoring the maximum demand limit and allotting all the resource to the top product.

    Students stop after ranking and forget the sales ceiling.

    Fix: Produce the lower of demand and what the resource allows. Pass any leftover resource to the next product.

  • Choosing the wrong key factor when demand is also limited.

    Students assume material is always scarce.

    Fix: Compute the resource needed for full demand of all products. If it exceeds availability, that resource is the key factor.

  • Forgetting to deduct fixed costs when profit is asked, or deducting them when only the best mix is asked.

    The requirement is read quickly.

    Fix: Underline what is asked. Mix needs contribution only; profit needs contribution minus fixed costs.

Worked examples

Example 1

Sharma Industries makes products A and B. Raw material is limited to 2,400 kg. Data per unit: A: selling price ₹100, variable cost ₹60, material 4 kg. B: selling price ₹90, variable cost ₹60, material 2 kg. Maximum demand: A 500 units, B 800 units. Fixed costs are ₹30,000. Find the optimal mix and profit.

Show the solution
  1. Check key factor: full demand needs 500 × 4 + 800 × 2 = 2,000 + 1,600 = 3,600 kg. Only 2,400 kg are available, so material is the key factor.
  2. Contribution per unit: A = 100 − 60 = ₹40. B = 90 − 60 = ₹30.
  3. Contribution per kg: A = 40 ÷ 4 = ₹10. B = 30 ÷ 2 = ₹15.
  4. Rank: B first (₹15), A second (₹10).
  5. Allocate to B: 800 units × 2 kg = 1,600 kg. Remaining = 2,400 − 1,600 = 800 kg.
  6. Allocate to A: 800 ÷ 4 = 200 units, which is below demand of 500.
  7. Contribution: B = 800 × 30 = ₹24,000. A = 200 × 40 = ₹8,000. Total = ₹32,000.
  8. Profit = 32,000 − 30,000 = ₹2,000.

Answer: Make 800 units of B and 200 units of A. Total contribution is ₹32,000 and profit is ₹2,000. B is preferred although A has the higher contribution per unit.

Example 2

Iyer Metals makes X and Y using machine hours, limited to 1,000 hours. Per unit: X: selling price ₹200, variable cost ₹140, 4 machine hours. Y: selling price ₹150, variable cost ₹100, 2 machine hours. Demand: X 250 units, Y 300 units. Fixed cost ₹20,000. Find the best mix and profit.

Show the solution
  1. Hours for full demand: X = 250 × 4 = 1,000. Y = 300 × 2 = 600. Total 1,600 hours exceeds 1,000, so machine hours are the key factor.
  2. Contribution per unit: X = 200 − 140 = ₹60. Y = 150 − 100 = ₹50.
  3. Contribution per machine hour: X = 60 ÷ 4 = ₹15. Y = 50 ÷ 2 = ₹25.
  4. Rank: Y first (₹25), X second (₹15). X has the higher contribution per unit but the lower contribution per hour.
  5. Allocate to Y: 300 units × 2 hours = 600 hours, which meets its full demand. Remaining = 1,000 − 600 = 400 hours.
  6. Allocate to X: 400 ÷ 4 = 100 units, which is below demand of 250.
  7. Contribution: Y = 300 × 50 = ₹15,000. X = 100 × 60 = ₹6,000. Total = ₹21,000.
  8. Check: 600 hours × ₹25 + 400 hours × ₹15 = 15,000 + 6,000 = ₹21,000. Profit = 21,000 − 20,000 = ₹1,000.

Answer: Make 300 units of Y and 100 units of X. Total contribution is ₹21,000 and profit is ₹1,000. Y is preferred although X has the higher contribution per unit.

Exam tips

  • Show the check for the key factor first: total resource needed at full demand against availability. Examiners award a step mark for it.
  • Present a neat table of contribution per unit, resource per unit, contribution per resource unit and rank. It earns step marks even if you slip later.
  • Read the requirement: optimal mix, total contribution or profit. Do not deduct fixed costs unless asked for profit.
  • In MCQs, rank by contribution per key factor quickly and watch for demand caps. There is no negative marking, so always attempt.
  • Add a one-line comment on why the ranking differs from contribution per unit. Interpretation is expected in written answers.

Practice questions from Applications of Marginal Costing in Short Term Decision Making

Key Factor and Product Mix Decisions in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Key Factor and Product Mix Decisions: frequently asked questions

What is a key factor in marginal costing?

A key factor is the resource that limits the activity of a business, such as material, labour hours, machine hours or sales demand. It stops the firm from making and selling all it would like to. Decisions must be made to use it best.

Why do we rank by contribution per key factor and not per unit?

Because the scarce resource is what limits total contribution. A product with a high unit contribution may use much of the resource. Contribution per unit of the resource shows which product earns the most from each scarce unit.

What if there are two limiting factors?

The simple ranking method works only for one limiting factor. With two or more constraints, you need a technique such as linear programming. At this level, questions on this topic normally give a single key factor.

Do fixed costs affect the product mix decision?

No. Fixed costs stay the same whichever mix you choose, so they do not affect the ranking or the best mix. You deduct them only when you must find the final profit.