Cost Management and Performance Measurement
Domain 5 - Cost Management and Performance Measurement. This section tests cost accumulation (job order, process, ABC), joint and by-product costing, standard costing, variable versus absorption costing, quality costs, segment performance measures and transfer pricing.
Core rules
- Absorption costing defers fixed manufacturing overhead into inventory; variable costing expenses it. The income difference equals the fixed overhead rate multiplied by the change in inventory units.
- Joint costs at split-off are allocated by physical units, net realisable value or constant gross margin, and are irrelevant to a sell-or-process-further decision; only incremental revenue versus incremental cost matters.
- Quality costs: prevention and appraisal are conformance costs; internal and external failure are nonconformance, with external failure the most damaging.
- Segment metrics: ROI = margin × turnover; residual income = operating income − required return × invested capital; EVA adds capital-charge and accounting adjustments.
- Transfer price range: floor is variable cost plus opportunity cost; ceiling is the external market price.
Worked example
A plant produces 10,000 units and sells 8,000. Variable cost is $30 per unit, selling price $60, fixed manufacturing overhead $200,000, so the overhead rate is $20 per unit. Absorption income equals 8,000 × ($60 − $50) = $80,000 before selling and administrative costs. Variable costing income equals 8,000 × $30 − $200,000 = $40,000. The $40,000 difference is 2,000 ending inventory units × $20 fixed overhead deferred on the balance sheet.
Traps
- Expensing fixed overhead under absorption costing or deferring it under variable costing.
- Allocating joint costs into a sell-or-process-further decision.
- Treating prevention spending as waste when it reduces far costlier external failure.
- Applying a division ROI hurdle that rejects projects earning above the corporate WACC.