Management Services: Cost Behavior, Decision Making, and Performance Measurement
Cost concepts
Classify costs by behavior (fixed, variable, mixed), by traceability (direct, indirect), and by relevance for decisions (relevant, sunk, opportunity, avoidable). Apply the high-low method and regression for cost estimation. Know the contribution margin approach and the break-even formula: break-even units = fixed costs / unit contribution margin; break-even peso sales = fixed costs / contribution margin ratio.
Decision making
Use relevant costing for special orders, make-or-buy, sell-or-process-further, and keep-or-drop decisions. Include opportunity costs and incremental costs, and exclude sunk costs and allocated common fixed costs that do not change. For constrained resources, maximize the contribution margin per unit of the scarce resource.
Budgeting and variance analysis
Know the master budget sequence and flexible versus static budgets. Compute price and quantity variances for materials and labor, and separate the overhead spending and volume variances. Remember the mnemonic that a price variance is the difference between actual and standard price times actual quantity.
Performance measurement
Distinguish return on investment from residual income and understand the behavioral problem of suboptimization under ROI. Know transfer pricing methods and the balanced scorecard perspectives.
Traps
- Including allocated fixed overhead in a special-order decision.
- Ranking products by contribution margin per unit instead of per unit of scarce resource.
- Using actual volume in a static budget variance comparison.
- Rewarding managers on ROI alone, encouraging rejection of profitable projects.
Worked example
Fixed costs 120,000; unit price 50; unit variable cost 30. Unit CM = 20; break-even = 120,000 / 20 = 6,000 units; CM ratio = 40 percent; break-even sales = 300,000.