Management costing, budgets and relevant decisions
Management costing and cost allocation
What the domain tests
This domain covers cost classification, costing methods, overhead absorption, marginal costing, break-even analysis, relevant costing and budgeting. Calculations and short explanations are both examined.
Core rules
Costs are classified as direct or indirect, fixed or variable, and product or period. Costing methods include job, batch, contract, process and service costing. Production overheads are absorbed using a predetermined rate, such as budgeted overheads ÷ budgeted direct labour hours or machine hours.
Marginal costing separates variable and fixed costs. Contribution = sales − variable costs. Profit = contribution − fixed costs. Break-even units = fixed costs ÷ contribution per unit. Break-even revenue = break-even units × selling price. Margin of safety = actual sales − break-even sales. Target profit units = (fixed costs + target profit) ÷ contribution per unit.
For decisions, use relevant costs: future incremental cash flows that differ between alternatives. Sunk costs and future costs that do not change between the alternatives are excluded from incremental comparison. A fixed cost that becomes avoidable or incremental can be relevant.
Budgets include sales, production, materials, labour and cash budgets. A cash budget records receipts and payments, including capital expenditure and loan receipts, but excludes depreciation because it is not a cash flow.
Worked example
Selling price is 5,000 FCFA; variable cost 3,000; fixed costs 4,000,000. Contribution is 2,000 per unit.
- Break-even = 4,000,000 ÷ 2,000 = 2,000 units, or 10,000,000 FCFA of sales.
- At sales of 3,000 units, margin of safety = 1,000 units, or 33.3% of sales.
- To earn 1,000,000 profit: (4,000,000 + 1,000,000) ÷ 2,000 = 2,500 units.
Traps
Fixed cost per unit falls as output rises; do not treat it as constant per unit. Do not include sunk costs in a relevant-cost decision. A predetermined overhead rate uses budgeted figures; under- or over-absorption can arise from differences in spending, activity or both. A cash budget excludes depreciation but includes capital expenditure. Break-even analysis assumes constant selling price and variable cost per unit.
Cost centers and a supplied overhead schedule
A cost-center allocation sheet can organize indirect costs by the activities that incur them before those costs are assigned to products. German exercises may call this a Betriebsabrechnungsbogen. Direct material cost is Materialeinzelkosten, while related material overhead is Materialgemeinkosten. A percentage surcharge must state its base: eighteen thousand of material overhead divided by one hundred twenty thousand of direct material cost gives fifteen percent. It is not eighteen percent merely because the overhead total begins with eighteen.
For a fictional job, direct materials are four hundred, the material-overhead surcharge is twenty percent, direct manufacturing labor is two hundred fifty and manufacturing overhead is sixty percent of that labor. Material overhead is eighty and manufacturing overhead is one hundred fifty. Manufacturing cost is therefore eight hundred eighty. If the supplied exercise then assigns administration at ten percent and selling overhead at five percent of manufacturing cost, those additions are eighty-eight and forty-four, giving full cost one thousand twelve. These administration and selling surcharges are internal costing allocations, not permission to include them automatically in externally reported inventory.
A percentage surcharge and an hourly absorption rate are different quantities. With budgeted overhead forty-eight thousand and budgeted activity one thousand six hundred machine hours, the rate is thirty per machine hour. A job using four hours absorbs one hundred twenty of overhead. If actual activity later totals one thousand five hundred hours, absorbed overhead is forty-five thousand. Actual overhead of forty-seven thousand then leaves two thousand under-absorbed. Check both activity and spending before explaining that difference.
Allocated full cost does not determine the best short-run decision by itself. A special order below full cost can still contribute to unavoidable fixed costs if there is idle capacity and no displacement, but that is not a guarantee that every discounted order is sensible. Include incremental preparation, delivery and quality costs, possible lost regular sales, capacity opportunity costs and relevant strategic effects. A long-run business must recover the costs necessary to sustain its capacity, even when a particular short-run decision properly ignores a sunk amount.