Cost accounting fundamentals and cost classification
Domain 1 tests the vocabulary and classification logic that underpins every later calculation: cost objects, elements of cost, direct versus indirect, product versus period, and cost behaviour. Expect objective-test items and short scenarios asking you to classify a cost or split a semi-variable cost.
Cost objects and elements
- A cost object is anything for which a separate cost is measured; a cost unit is the unit of product or service; a cost centre is a location, function or item of equipment for which costs are gathered and responsibility assigned.
- The elements of cost are material, labour and expenses. Each is direct if traceable to the cost object, otherwise indirect and treated as overhead.
Classification
- By function: production, administration, selling, distribution and research.
- By behaviour: variable, fixed (committed or discretionary), semi-variable and stepped fixed. Fixed cost per unit falls as volume rises; total fixed cost is constant only within the relevant range.
- Product costs (direct costs plus production overhead) are carried in inventory until sale; period costs are expensed. Misclassification changes profit and inventory valuation.
High-low method
- Select the periods with the highest and lowest activity, not the highest and lowest cost. Variable cost per unit = change in total cost / change in activity. Fixed cost = total cost - variable cost per unit × activity. Check the result on a third data point.
Worked example
Total overhead is GHS74,000 at 8,000 units, GHS84,000 at 10,000 units and GHS94,000 at 12,000 units. Highest activity 12,000; lowest 8,000. Variable cost = (94,000 - 74,000) / (12,000 - 8,000) = GHS5 per unit. Fixed cost = 94,000 - (5 × 12,000) = GHS34,000. Check at 10,000: 34,000 + 50,000 = GHS84,000, so the data are consistent. Budget at 11,000 units = 34,000 + (5 × 11,000) = GHS89,000, provided 11,000 lies within the relevant range.
Traps
- Choosing highest and lowest cost rather than activity.
- Averaging all points instead of using the two extreme activity levels.
- Treating a stepped fixed cost as variable inside a step.
- Assuming a cost is direct merely because it is production-related.
- Forgetting that fixed cost per unit changes with volume.