Specialist Management Accounting Techniques
Costing methods and their decision traps
Know the distinction between absorption costing and activity-based costing (ABC). Absorption costing allocates overheads on a single volume driver (labour hours, machine hours), so high-volume products absorb more overhead. ABC assigns costs to activities via cost pools and cost drivers, revealing that low-volume, complex products often consume disproportionate overhead. Examination traps include forgetting that under ABC some products previously profitable become loss-making, and confusing cost pool with cost driver. Always check whether the question asks for the activity rate (pool cost / total driver units) or the cost per unit.
Target costing and life-cycle costing
Target cost = target selling price − target profit margin. The gap between target cost and current cost is the cost gap, which must be closed through value engineering. Life-cycle costing accumulates costs across design, manufacture and end-of-life, so design decisions lock in most costs. A common trap is treating only production costs as relevant when the question invites design and disposal costs.
Throughput accounting and environmental costing
Throughput accounting uses throughput = sales − material cost, with the throughput accounting ratio (TPAR) = return per bottleneck minute / cost per bottleneck minute. A TPAR above 1 indicates a product is worth producing. Environmental management accounting separates costs that are often hidden, such as waste disposal and energy.
Worked example
A product sells for $50 with a target margin of 20%. Target cost = $50 × 0.80 = $40. If current cost is $46, the cost gap is $6 per unit, which must be eliminated by redesign, not by raising the price.