ICAG Paper 1.4 Cost & Management Accounting common mistakes
ICAG Paper 1.4 Cost & Management Accounting · Understand the traps and how to avoid them.
Treating a fixed cost as variable when computing a predetermined absorption rate, then applying the resulting inflated rate to actual activity and reporting a large under-absorption as a 'loss'.
Candidates memorise 'overheads are absorbed per unit' without separating the budgeted fixed overhead from the budgeted activity level used to derive the rate; they divide total overhead by actual hours instead of budgeted hours.
What to do instead
Write the two-line formula every time: rate = budgeted overhead ÷ budgeted activity (not actual). Then absorbed = rate × actual activity, and over/under absorption = absorbed − actual overhead incurred. Practise three numerical drills with different budgeted and actual activity before the exam.
In process costing, adding normal loss scrap value to the cost of good output instead of deducting it, or ignoring normal loss entirely when computing the cost per equivalent unit.
Candidates mix up the direction of the scrap-value adjustment and forget that normal loss units carry no cost but do carry scrap proceeds that reduce net process cost.
What to do instead
Use a fixed layout: input cost − scrap value of normal loss = net cost; equivalent units = completed + closing WIP equivalent − opening WIP equivalent; cost per EU = net cost ÷ EU. Always show normal loss as a separate line and state explicitly whether scrap proceeds are credited to the process account.
In contract costing, recognising the full contract profit as soon as the contract starts, or computing notional profit without applying the cash-received fraction and the degree-of-completion rule.
Candidates learn 'profit = value of work certified − cost to date' and stop there, missing the two-stage test (work certified vs contract price, and cash received vs work certified).
What to do instead
Memorise the decision ladder: if work certified < 25% of contract price, take no profit; if cash received ≥ 90% of work certified, use (2/3 × notional profit × cash received/work certified); if below 90%, use (1/3 × notional profit × cash received/work certified). Compute notional profit first, then apply the fraction, and show the workings.
In marginal costing, including fixed production overhead in the product cost and then comparing the resulting 'profit' with the absorption profit without reconciling the difference through the change in inventory.
Candidates default to absorption costing because it is taught first, and they forget that the marginal-costing profit differs only by fixed overhead carried in opening and closing inventory.
What to do instead
State the reconciliation line explicitly: absorption profit − marginal profit = fixed overhead rate × (closing inventory units − opening inventory units). If inventory rose, absorption profit is higher; if it fell, marginal profit is higher. Check the sign against the inventory movement before writing the answer.
In standard costing variances, mixing the price and usage variances for materials, or computing the labour rate variance on actual hours worked instead of actual hours paid.
Candidates rush the formula and use the same quantity base for both variances; the rate variance must use hours paid while the efficiency variance uses hours worked.
What to do instead
Write the variance name above each formula before substituting: price = (standard price − actual price) × actual quantity purchased; usage = (standard quantity for actual output − actual quantity used) × standard price; rate = (standard rate − actual rate) × actual hours paid; efficiency = (standard hours for actual output − actual hours worked) × standard rate. Label each as favourable or adverse with the sign convention stated.
In budgeting, preparing a cash budget using accrual figures (sales revenue, purchases) rather than cash receipts and cash payments, and omitting the opening balance or the financing section.
Candidates copy figures straight from the sales and purchases budgets without applying the collection and payment periods, and they treat depreciation as a cash payment.
What to do instead
Build a receipts schedule and a payments schedule first, applying the stated credit terms month by month; exclude non-cash items such as depreciation and bad-debt write-offs; close with opening balance + net cash flow = closing balance, and show any loan or overdraft movement separately.
In flexible budgeting, comparing actual costs with the original static budget and labelling every difference a variance, rather than flexing the budget to actual activity first.
Candidates forget that a static budget is only valid at one activity level, so volume differences contaminate the spending variances.
What to do instead
Always flex variable costs to actual activity before comparing; fixed costs stay at the original budget. Present three columns: flexed budget, actual, variance. Explain in one sentence why the static-budget comparison is misleading when activity differs.
In relevant-cost decision making, including sunk costs such as research already spent, or including apportioned fixed overhead that does not change with the decision.
Candidates treat every cost in the accounts as relevant and are swayed by the size of an apportioned overhead figure.
What to do instead
Apply the relevance test to each cost line: does it differ between alternatives, and is it future cash flow? Exclude sunk costs, committed fixed costs and apportioned overhead; include opportunity costs and incremental costs. Write 'relevant' or 'not relevant' beside each figure before calculating the contribution.
In limiting-factor decisions, ranking products by contribution per unit rather than contribution per unit of the scarce resource, and ignoring the possibility of a shadow price or make-or-buy trade-off.
Candidates see the highest unit contribution and stop, without dividing by the scarce resource consumed per unit.
What to do instead
Compute contribution per unit, then divide by the scarce resource per unit to get contribution per limiting factor; rank on that figure. Where a minimum contract quantity exists, allocate the scarce resource to it first, then optimise the remainder; state the shadow price as the extra contribution per additional unit of the scarce resource.
In performance measurement, quoting a single ROI figure without decomposing it into margin and asset turnover, or comparing divisional profits of different sizes without adjusting for invested capital.
Candidates learn ROI as a single ratio and do not see that a division can improve ROI by shrinking its asset base, which may harm the company overall.
What to do instead
Decompose ROI = operating margin × asset turnover and show both components. Evaluate residual income alongside ROI to expose the under-investment problem, and note that RI uses a required charge on capital. When comparing divisions, normalise for size using RI or a common capital charge before drawing conclusions.