Cost and Management Accounting: Costing, Decisions and Variances
Cost and Management Accounting tests whether you can build a cost, decide between alternatives and explain a variance - not simply memorise formulae. The examiner rewards candidates who state the decision rule and then compute, because most marks sit in the reasoning step.
Costing systems
- Classification: direct and indirect, fixed and variable (including stepped fixed), product and period costs. Only product costs enter inventory valuation.
- Absorption costing: overhead absorption rate = budgeted overhead / budgeted activity (labour hours, machine hours or units). Charged overhead above actual overhead gives over-absorption (a credit to cost of sales); below gives under-absorption.
- Marginal costing: inventory carries variable production cost only. Profit differs from absorption profit solely by the fixed overhead held in the movement in inventory.
- Activity-based costing: pools costs by activity and charges them on cost drivers, which is more accurate where products consume overheads in different proportions.
Decisions and control
- CVP: contribution per unit = selling price less variable cost; breakeven units = fixed costs / contribution per unit; margin of safety = (budgeted sales - breakeven sales) / budgeted sales.
- Relevant costing: include only future, incremental, cash flows. Exclude sunk costs and apportioned fixed overhead; include opportunity cost of scarce resources.
- Limiting factors: rank products by contribution per unit of the scarce factor, not by contribution per unit.
Worked example
Standard: 3 kg at EUR 4 per kg per unit. Actual output 900 units; material purchased and used 2,800 kg for EUR 10,920 (actual price EUR 3.90).
- Price variance = (4.00 - 3.90) x 2,800 = EUR 280 favourable.
- Usage variance = (2,700 - 2,800) x EUR 4 = EUR 400 adverse.
- Net EUR 120 adverse.
The reasoning matters: the purchasing gain was more than cancelled by a yield loss, so the production manager's performance should be judged on the usage figure while purchasing is judged on price measured at the quantity actually bought.
Traps that cost marks
Computing the price variance on quantity used when the question gives quantity purchased; adding fixed overhead per unit into marginal cost; treating apportioned head office cost as relevant to a shutdown decision; ignoring the opportunity cost of using a owned building; and giving the over/under-absorption adjustment the wrong sign.