Costing and Budgeting
What the exam tests
Costing methods and the budgeting cycle: how full product cost is built, how overhead is absorbed, and how budgets are prepared and controlled. Expect calculations of overhead rates, variances, and cash budgets.
Core rules
- Cost classification: direct/indirect, fixed/variable, product/period. Direct costs are traced to the cost object; indirect costs (overheads) are allocated using a causal base such as labour hours, machine hours, or material cost.
- Absorption costing includes direct costs plus absorbed production overhead. Variable costing includes only variable production costs; fixed overhead is a period cost. Activity-based costing assigns overhead through activities and cost drivers.
- A predetermined overhead rate = budgeted overhead / budgeted activity. Applied overhead = actual activity × rate. Under- or over-absorption is the difference between applied and actual overhead.
- Budgets usually start with sales, then production, direct materials, direct labour, overhead, and cash. A cash budget is not the same as the profit budget because of timing, capital expenditure, and financing.
- Variance analysis separates price and quantity variances; investigate material variances, not every small difference.
Worked example
Budgeted overhead is CZK 1,200,000 and budgeted machine hours are 20,000, so the rate is CZK 60 per machine hour. Actual hours are 21,000 and actual overhead is CZK 1,280,000. Applied overhead is 21,000 × 60 = 1,260,000, so overhead is under-absorbed by 20,000. If one product uses 3 machine hours, its absorbed overhead is 180. The reasoning is to apply the rate to actual activity, then compare with actual overhead; do not compare the rate directly with total actual overhead without adjusting for activity.
Traps
Dividing fixed overhead by actual units when the budget was based on normal capacity; treating under-absorption as a cash item; forgetting that a cash budget includes VAT and loan repayments while a profit budget does not; using last year's budget without adjusting for volume or price changes. Do not confuse a standard cost with a budget: a standard is a unit benchmark, a budget is a total plan.