Cost Management and Cost Behaviour
What the exam tests
Cost management questions test classification, costing system choice, and whether you can strip a decision down to relevant cash flows. Expect cost behaviour, job and process costing, ABC, target and life-cycle costing, throughput, and short-term decisions.
Core rules and concepts
- Cost behaviour: variable, fixed, mixed and step costs; define the relevant range. Unit fixed cost changes with volume, so it is unsafe for decisions outside the range.
- Job costing suits customized or batch output; process costing suits homogeneous continuous output and uses equivalent units for work in process. Normal costing applies a predetermined overhead rate.
- ABC assigns overhead through activities and cost drivers; it improves accuracy when overhead is large and products consume activities differently, but it adds measurement cost.
- Target cost = competitive price - required profit margin. Life-cycle costing includes design, production, use and disposal costs.
- Relevant costing: include future cash flows that differ between alternatives; include opportunity cost; exclude sunk costs and allocated fixed costs that do not change.
Worked example
A plant can make 5,000 extra units. A one-time order offers $22 per unit for 2,000 units. Variable cost is $15 per unit; allocated fixed overhead is $6 per unit. The capacity could otherwise earn $10,000 contribution. Relevant revenue is $44,000. Relevant cost is variable cost $30,000 plus opportunity cost $10,000 = $40,000, so the order adds $4,000. The $6 allocated fixed overhead is excluded because total fixed overhead is unchanged. Without the alternative use, the order would add $14,000 contribution. The error to avoid is accepting because $22 exceeds a $21 full cost, or rejecting because the margin looks thin after an irrelevant allocation; decide on incremental cash flow and capacity.
Traps that cost marks
- Treating allocated fixed cost as avoidable.
- Ignoring opportunity cost when capacity is scarce.
- Using unit fixed costs beyond the relevant range.
- Assuming ABC is always better; it can be costly and arbitrary.
- Mixing sunk costs into future decisions.