Management Accounting: Costing, Budgeting and Performance
Core concepts
Management accounting supports internal decisions through cost classification (direct/indirect, fixed/variable, product/period), cost-volume-profit (CVP) analysis, contribution margin, break-even, margin of safety, relevant costing, and budgeting. Candidates must compute break-even in units and dollars, target-profit volumes, and interpret variances (material, labour, overhead). Understand the behavioural and ethical dimensions of budgeting, including participative budgeting and budgetary slack.
Common traps
- Mixing absorption and variable costing: under absorption costing, fixed manufacturing overhead is product cost; under variable costing it is a period cost. Closing inventory valuation differs.
- Contribution vs gross margin: contribution = sales − variable costs (all variable, including variable selling); gross margin = sales − cost of goods sold.
- Sunk costs and irrelevant costs: allocated fixed overhead and past costs are irrelevant to special-order decisions; only incremental cash flows matter.
- Break-even with a product mix: use weighted average contribution per unit, not a simple average of prices.
- Favourable/unfavourable direction: a favourable material variance may arise from buying cheaper but lower-quality material, harming later processes.
Worked example
Selling price $50, variable cost $30, fixed costs $80,000. Contribution per unit = $20. Break-even = 80,000 ÷ 20 = 4,000 units. To earn $20,000 profit: (80,000 + 20,000) ÷ 20 = 5,000 units. Margin of safety at 5,000 units = 1,000 units (20%).
Rule of thumb
For any decision question, isolate future, incremental, cash effects. If a cost does not change with the decision, exclude it.