Cost and Management Accounting: Costing Systems, Decision Tools and Variances
Costing systems
Be fluent in cost classification (direct versus indirect, fixed versus variable versus semi-variable, product versus period), material and labour costing, and overhead treatment. Know job, batch and contract costing, process costing with normal loss, abnormal loss or gain and equivalent units, joint and by-product apportionment, and activity-based costing.
Decision tools
Marginal costing gives contribution, break-even point (fixed costs divided by contribution per unit), margin of safety and target profit. Absorption costing gives gross profit and absorbs fixed overhead at a predetermined rate, creating over- or under-absorption. Relevant costing excludes sunk costs and apportioned fixed overhead but includes opportunity cost. Budgeting, standard costing and variance analysis (material price and usage, labour rate and efficiency, fixed overhead expenditure and volume) complete the picture.
Traps
- Contribution is not gross profit; only contribution supports short-term decisions.
- In process costing, abnormal gain is valued at full cost, and scrap value reduces the cost of normal loss before the cost per unit is calculated.
- Under absorption costing fixed cost per unit falls as volume rises, so profit differs from marginal costing only through inventory movement.
- With a limiting factor, rank by contribution per unit of the scarce resource, not per unit sold.
- Sunk costs and absorbed fixed overhead are never relevant.
Worked example
Budgeted overhead Rs 500,000, budgeted machine hours 25,000, giving an absorption rate of Rs 20 per hour. Actual hours 26,000 means absorbed overhead of Rs 520,000. Actual overhead Rs 510,000, so overhead is over-absorbed by Rs 10,000, credited to profit or loss.