Cost Concepts, Costing Methods and Budgeting
Cost classification
Candidates must classify costs by behaviour (fixed, variable, mixed, step-fixed), by traceability (direct versus indirect/overhead), and by function (product versus period). Know prime cost, conversion cost, contribution margin and the high-low method for splitting mixed costs. Understand relevant costing: only future, incremental, cash costs that differ between alternatives matter, so sunk costs and allocated common fixed costs are excluded from special-order and make-or-buy decisions.
Costing systems
Be able to apply job costing and process costing, including equivalent units and normal versus abnormal loss, and activity-based costing where overhead is driven by activities rather than labour hours. Know the causes and treatment of under- and over-applied overhead, and how it is prorated or closed to cost of sales.
Budgeting
Understand the master budget sequence: sales budget, production budget, direct materials, direct labour, overhead, cash budget and budgeted statements. Know flexible versus static budgets, zero-based and incremental budgeting, and the behavioural uses of budgets.
Traps to watch
Common errors include using absorption costing unit cost for a special-order decision, forgetting that production equals sales adjusted for opening and closing inventory, treating depreciation as a cash outflow in the cash budget, and omitting loan interest or tax instalments from the cash budget.
Worked example
Sales of 5,000 units, opening inventory 400, closing inventory 700, so production is 5,300 units. Each unit needs 2 kg at $6 per kg, giving a materials purchases budget of 10,600 kg, adjusted further for raw material inventory movements. Rule of thumb: build budgets in dependency order and never budget a cost before its driver.