Cost and Management Accounting: Variances and Relevant Costs
What the exam tests
Cost and Management Accounting tests cost behaviour, absorption and marginal costing, standard costing variances, relevant costing, transfer pricing, activity-based costing and throughput accounting. Numerical accuracy and interpretation both matter.
Core rules
- Contribution = sales less variable costs. Break-even units = fixed costs ÷ contribution per unit. Margin of safety = (budgeted sales − break-even sales) ÷ budgeted sales.
- Material price variance = (standard price − actual price) × actual quantity purchased. Material usage variance = (standard quantity for actual output − actual quantity used) × standard price.
- Labour rate variance = (standard rate − actual rate) × actual hours paid. Labour efficiency variance = (standard hours for actual output − actual hours worked) × standard rate.
- Relevant costs are future, incremental cash flows. Sunk costs, committed costs and apportioned fixed overheads are excluded.
- Transfer prices should preserve goal congruence; the general rule is minimum transfer price = variable cost plus opportunity cost of the transfer.
Worked example
Standard: 3 kg at ₹20 = ₹60 per unit. Output was 1,000 units, using 3,200 kg costing ₹67,200, so the actual price is ₹21. Price variance = (20 − 21) × 3,200 = ₹3,200 adverse. Usage variance = (3,000 − 3,200) × 20 = ₹4,000 adverse. Total = ₹7,200 adverse, which agrees with actual cost ₹67,200 less standard cost of output ₹60,000.
Traps
- Using quantity used rather than quantity purchased in the price variance.
- Treating fixed overhead per unit as relevant for a special order.
- Confusing over- and under-absorption of fixed overhead.
- Mixing sales mix and sales quantity variances.
- Ignoring opportunity cost in the minimum transfer price.