Cost and Management Accounting: costing, variances and decisions
This domain tests costing systems, budgeting and decision support. You must choose between absorption and marginal costing, compute and interpret variances, and give a recommendation that survives scrutiny.
Costing systems
- Absorption costing: overheads are allocated and apportioned, then absorbed on a base such as labour hours or machine hours. Over- or under-absorption is absorbed overhead minus actual overhead.
- Marginal costing: product cost is variable cost only; fixed costs are period costs; contribution = sales − variable costs.
- Activity-based costing: costs are pooled by activity and absorbed on cost drivers, which helps where overheads are not driven by volume.
Standard costing variances
Material price and usage, labour rate and efficiency, sales price and sales volume. In marginal costing the sales volume variance is valued at standard contribution; in absorption costing it is valued at standard profit.
Worked example
Budgeted overhead €180,000; budgeted machine hours 45,000, so the absorption rate is €4.00 per hour. Actual overhead €190,000 and actual hours 46,000 give absorbed overhead of €184,000. Overhead is therefore under-absorbed by €6,000 (184,000 − 190,000), so profit is €6,000 lower than if overhead had been fully absorbed. The rate is always based on budgeted figures - using actual hours would leave nothing to over- or under-absorb.
Traps that cost marks
- Dividing budgeted overhead by actual hours.
- Treating a sunk cost or an apportioned fixed cost as relevant to a decision.
- Sign errors: an adverse variance when actual cost exceeds standard, favourable when it falls below.
- Ignoring a limiting factor: rank products by contribution per unit of the scarce resource, not per unit sold.