Cost and Managerial Accounting Basics: Cost Behavior and CVP
This domain tests cost classification, product costing, and the cost-volume-profit model used for short-term decisions. Expect computations rather than definitions alone.
Core rules
- Product costs (direct materials, direct labor, manufacturing overhead) attach to inventory; period costs (selling, general, administrative) are expensed as incurred.
- Variable cost per unit is constant; fixed cost per unit falls as volume rises.
- Contribution margin = revenue − variable costs; CM ratio = contribution margin ÷ revenue.
- Break-even units = fixed costs ÷ CM per unit; break-even revenue = fixed costs ÷ CM ratio.
- Relevant costs are future, incremental cash flows; sunk costs and allocated common fixed costs are irrelevant.
Worked example
Fixed costs are ₩60,000,000, selling price ₩10,000, and variable cost ₩6,000 per unit. CM = ₩4,000 per unit and the CM ratio is 40%. Break-even = ₩60,000,000 ÷ ₩4,000 = 15,000 units, or ₩150,000,000 of revenue. At budgeted sales of 20,000 units, the margin of safety is 5,000 units, or 25% of budgeted sales. A target profit of ₩20,000,000 requires (60,000,000 + 20,000,000) ÷ 4,000 = 20,000 units.
Traps
- Adding fixed overhead to unit cost when evaluating a special order that uses spare capacity.
- Treating sunk research spending or allocated head-office costs as relevant.
- Mixing up mark-up on cost with margin on price.
- Forgetting that above break-even, each extra unit adds exactly the CM per unit to profit.