Cost and Management Accounting: Cost Behaviour, Budgeting and Decisions
Core concepts
Understand cost classification (direct, indirect, fixed, variable, semi-variable, sunk, opportunity, relevant), overhead absorption using predetermined rates, and the causes of over- and under-absorption. Master process costing with normal loss, abnormal loss and equivalent units, job and contract costing, marginal versus absorption costing including the profit reconciliation, cost-volume-profit analysis with contribution and margin of safety, limiting factors, and make-or-buy or accept-or-reject decisions. Budgeting concepts include functional budgets, flexible budgets, variance analysis and behavioural implications.
Traps
Examiners exploit the fixed-cost-per-unit fallacy, the treatment of normal loss scrap value as a reduction in process cost, and the difference between contribution and gross margin. Watch for questions where a fixed cost is irrelevant to a short-term decision but the question invites its inclusion, and for variances where the sign convention is reversed. In limiting-factor problems, rank by contribution per unit of the scarce resource, not per unit sold.
Rule of thumb
For any short-term decision, include only future, incremental cash flows; exclude sunk costs and apportioned fixed overheads.
Worked example
A product sells for 50 with variable cost 30, giving contribution of 20. Fixed costs are 80,000. Break-even is 80,000 / 20 = 4,000 units. At sales of 5,000 units, margin of safety is 1,000 units or 20 per cent. If machine hours are limited and each unit needs two hours, contribution per limiting factor is 10 per hour; rank competing products on this basis.