AC106 Management Accounting Revision

Introduction to Management Accounting & Cost Terminology

What management accounting is; cost objects and drivers; capitalised vs expensed; product vs period costs; cost behaviour; manufacturing cost categories; resource flow calculations.

Management vs financial accounting

Dimension	Financial Accounting	Management Accounting
Primary users	External (investors, creditors, regulators)	Internal managers
Time orientation	Historical	Forward-looking
Regulation	Governed by accounting standards (IFRS/GAAP)	No mandatory rules — relevance over compliance
Verification	Audited and verifiable	Usefulness matters more than precision
Data used	Financial data only	Financial and non-financial data

Key idea: management accounting uses any data that helps managers fulfil organisational objectives — customer behaviour, defect rates, delivery times, competitor analysis.

Cost accounting vs management accounting

Cost accounting is narrower — it records, classifies and summarises cost data. Management accounting is broader — it combines cost data with other information for planning, forecasting, performance evaluation and decision-making. Cost accounting supports management accounting.

Cost object and cost driver

A cost object is anything for which you want to measure cost separately. Before calculating cost, always ask: cost of what?

Product (one chocolate bar)
Customer (a bank's business client)
Department (a university faculty)
Activity, distribution channel, project

A cost driver is something that causes cost to change — machine hours, labour hours, number of orders, floor space, kilowatt hours.

Example: if electricity cost rises when machine hours rise, machine hours may be the cost driver for electricity.

Capitalised vs expensed costs

Capitalised cost

Treated as an asset in the Statement of Financial Position. Delays impact on profit. Example: inventory until it is sold.

Expensed cost

Charged to the Income Statement in the period incurred. Reduces profit immediately. Example: advertising, salaries, rent.

Capitalising a cost delays its profit impact; expensing it reduces profit now. This timing distinction drives important differences between absorption and marginal costing (Week 3).

Product costs vs period costs

Product cost

Cost of purchasing or producing goods / delivering services. Becomes part of inventory until goods are sold. Includes: direct materials, direct labour, manufacturing overhead.

Period cost

Not included in product cost. Expensed in the period — selling costs, admin, advertising, office salaries.

Exam rule: Product costs can be held in inventory. Period costs are always expensed immediately.

Cost behaviour — four types

Type	Total cost as activity ↑	Unit cost as activity ↑	Example
Variable	Rises proportionally	Constant	Direct materials
Fixed	Unchanged (relevant range)	Falls	Factory rent
Stepped fixed	Jumps at capacity limits	Jumps then falls	Supervisors
Semi-variable	Fixed element + variable element	Falls overall	Phone bill

Key distinction: variable cost per unit stays constant; fixed cost per unit falls as output rises.

Manufacturing cost categories

\[\text{Prime cost} = \text{Direct materials} + \text{Direct labour}\]

\[\text{Conversion cost} = \text{Direct labour} + \text{Manufacturing overhead}\]

\[\text{Total manufacturing cost} = \text{Prime cost} + \text{Manufacturing overhead}\]

What counts as manufacturing overhead?

Indirect materials, indirect labour, factory rent, factory electricity, depreciation of factory assets, maintenance staff, cleaners, security guards — any manufacturing cost that cannot be traced to specific units.

Three types of inventory in manufacturing

Raw materials → Work-in-progress (WIP) → Finished goods. A trading business has only finished goods inventory. A service business typically has no inventory.

Resource flow — key formulas

\[\text{DM used} = \text{Opening RM} + \text{Purchases} - \text{Closing RM}\]

\[\text{Total manufacturing cost} = \text{DM used} + \text{DL} + \text{Mfg overhead}\]

\[\text{Cost of goods manufactured} = \text{Opening WIP} + \text{Total mfg cost} - \text{Closing WIP}\]

\[\text{Cost of goods sold} = \text{Opening FG} + \text{Cost of goods mfd} - \text{Closing FG}\]

Worked example

Item	£
Opening raw materials	32,000
+ Purchases	276,000
− Closing raw materials	(28,000)
= DM used	280,000

Types of business — inventory rules

Business type	Inventory	Cost of sales includes
Manufacturing	Raw materials, WIP, finished goods	Materials, labour, manufacturing overhead
Trading	Goods for resale	Purchase cost of goods
Service	Usually none	Usually operating expenses only

Service firms (investment banks, law firms, consulting firms) typically have no inventory or cost of goods sold. Their costs are operating expenses.

Exam methodology — resource flow questions

1
Start with raw materials: opening + purchases − closing = DM used.
2
Add direct labour and manufacturing overhead to get total manufacturing cost.
3
Add opening WIP, subtract closing WIP to get cost of goods manufactured.
4
Add opening finished goods, subtract closing finished goods to get COGS.
5
Check: period costs (admin, selling) are excluded from all inventory calculations.

Common exam traps

Advertising and admin costs are period costs — never include in product cost or inventory.
Depreciation on factory machinery = manufacturing overhead (product cost). Depreciation on office equipment = period cost.
Variable cost per unit is constant; it is total variable cost that changes.
Fixed cost total is constant within the relevant range; fixed cost per unit falls as output rises.
The relevant range is a key assumption — fixed costs only behave as "fixed" within that range.

Job-Order Costing & Absorption Costing

Full costing; allocation, apportionment and re-apportionment; overhead absorption rates; under- and over-absorption; direct vs step-down method.

Costing methods — when to use which

Method	When used	Examples
Job-order costing	Specific, distinct orders	Construction, aircraft, ships, wedding cakes
Batch costing	Groups of identical/similar units	Furniture, smartphones
Process costing	Continuous mass production	Chemicals, oil refining, flour, plastics

The method depends on the nature of production. Job-order costing tracks each job individually; process costing averages costs over continuous output.

Full costing — the central problem

Direct costs can be traced to a specific cost object. Indirect costs (overheads) cannot be traced — they must be shared.

The central question of absorption costing:

"If overheads do not belong to one specific product, how do we decide how much each product should absorb?"

The answer: use a systematic allocation → apportionment → re-apportionment → OAR process.

Direct costs

Traced directly to the cost object. No estimation needed.

Indirect costs

Absorbed using a predetermined rate. Requires judgement.

Absorption costing — five steps

1
Allocate costs that clearly belong to one department.
2
Apportion shared overheads across departments using a suitable basis.
3
Re-apportion service department costs to production departments.
4
Calculate an Overhead Absorption Rate (OAR) for each production department.
5
Absorb overhead into products using the OAR and actual activity.

Apportionment bases — which to use

Overhead	Suggested basis
Rent / property rates	Floor area (m²)
Machine depreciation	Machine value or machine hours
Personnel / HR	Number of employees (headcount)
Maintenance	Service hours or machine hours
Canteen	Number of employees
Light and heat	Floor area or volume

The basis should reflect what drives the cost. A poor basis leads to misleading product costs and department performance measures.

OAR — the key formula

\[\text{OAR} = \frac{\text{Budgeted overhead expenditure}}{\text{Budgeted activity level}}\]

\[\text{Overhead absorbed} = \text{OAR} \times \text{Actual activity used by product}\]

Example

Department 1 budgeted overhead = £14,880. Budgeted machine hours = 2,000.

\[\text{OAR} = \frac{£14{,}880}{2{,}000} = £7.44 \text{ per machine hour}\]

Product X uses 2 machine hours per unit:

\[\text{Absorbed} = £7.44 \times 2 = £14.88 \text{ per unit}\]

Activity bases: machine hours, direct labour hours, direct labour cost, units of output.

Under- and over-absorption

\[\text{Over-absorption} = \text{Overhead absorbed} > \text{Actual overhead}\]

\[\text{Under-absorption} = \text{Overhead absorbed} < \text{Actual overhead}\]

Why it happens

OARs are based on budgets. Actual overhead and actual activity will almost always differ.

Example

Item	£
Budgeted overhead	400,000
Budgeted DL hours	100,000
OAR	£4 per DL hour
Actual activity	90,000 hours
Overhead absorbed (£4 × 90,000)	360,000
Actual overhead incurred	350,000
Over-absorbed	10,000 F

Over-absorbed = favourable (absorbed more than incurred). Under-absorbed = unfavourable (absorbed less than incurred).

Re-apportionment methods

Direct method

Service department costs re-apportioned only to production departments. Ignores services between support departments. Simpler.

Step-down method

Recognises that service departments serve other service departments. Re-apportion the department serving the most others first. More accurate. This method is examinable.

Step-down methodology

1
Identify which service department serves the most other departments.
2
Re-apportion that department's total costs to all others (including remaining service depts).
3
Repeat for the next service department — but it no longer serves the first one.
4
Continue until all service department costs are in production departments only.

Advantages of absorption costing

Improves awareness of total cost — managers see the full picture.
Helps set selling prices that cover full product cost.
Required by IAS 2 for valuing closing inventory in financial statements.
OARs useful for budgeting and control.

Limitations

Overhead apportionment can be arbitrary — different bases give different product costs.
Can lead to incorrect pricing or product mix decisions.
Requires under/over-absorption adjustments.
Ignores the distinction between fixed and variable costs — unhelpful for short-term decisions.
Can become political — allocations affect department performance measures.

Exam methodology — absorption costing question

1
Set up a table: production departments across columns, service departments below, overheads as rows.
2
Allocate directly attributable costs to departments.
3
Apportion shared costs using the basis given (floor area, headcount, etc.).
4
Re-apportion service department totals — step-down if inter-service exists.
5
Calculate OAR = production dept total ÷ budgeted activity.
6
Multiply OAR by units used per product to get absorbed overhead per unit.
7
Calculate under/over-absorption if actual activity differs from budgeted.

Key distinction to remember

Direct costs are traced.
Indirect costs are absorbed.

The basis chosen for absorption is a judgement call. Different firms — and different exam questions — may use different bases. Always justify your choice by linking it to the cost driver.

Absorption Costing vs Marginal Costing & Relevant Costs

Profit reconciliation; inventory effects; production volume variance; dysfunctional incentives; relevant costs; sunk costs; opportunity costs; make-or-buy.

The core difference

\[\underbrace{\text{Absorption costing}}_{\text{Fixed mfg OH in inventory}} \quad \text{vs} \quad \underbrace{\text{Marginal costing}}_{\text{Fixed mfg OH = period cost}}\]

Marginal costing structure

\[\text{Contribution} = \text{Sales} - \text{Variable costs}\]

\[\text{Profit} = \text{Contribution} - \text{Fixed costs}\]

Absorption costing structure

\[\text{Gross profit} = \text{Sales} - \text{Full production cost}\]

\[\text{Net profit} = \text{Gross profit} - \text{Period costs}\]

Under absorption costing, closing inventory includes fixed overhead. Under marginal costing, closing inventory is valued at variable cost only — fixed overhead is expensed immediately.

Profit reconciliation — the exam rule

\[\text{AC profit} - \text{MC profit} = \Delta\text{Inventory} \times \text{Fixed OH per unit}\]

Where \(\Delta\text{Inventory} = \text{Closing inventory} - \text{Opening inventory}\).

Inventory increases

Absorption profit > marginal profit. Fixed OH deferred in closing inventory under AC.

Inventory decreases

Marginal profit > absorption profit. Previously stored fixed OH released into cost of sales under AC.

If inventory is unchanged: profits are identical under both methods.

Worked example from slides

Year	AC profit (£)	MC profit (£)	Inventory change
2025	56	16	+40 units → AC higher by £40
2026	MC higher	—	−30 units → MC higher by £30

In 2025: £1 fixed OH per unit × 40 extra inventory units = £40 difference. Exactly matches.

Production volume variance

\[\text{PVV} = (\text{Actual production} - \text{Budgeted production}) \times \text{Fixed OH per unit}\]

Produce < budget

Under-absorbed fixed OH → Unfavourable PVV. Subtract from profit.

Produce > budget

Over-absorbed fixed OH → Favourable PVV. Add to profit.

Note: PVV does not measure efficiency — it only measures whether production volume was above or below budget.

Dysfunctional effects of absorption costing

Because absorption costing defers fixed overhead into inventory, managers can boost reported profit by producing more than needed:

Produce more→More FO in closing inventory→Less FO expensed→Higher reported profit

This is real activities earnings management. It leads to unnecessary stockpiling, wasted resources and higher storage costs — even with no improvement in sales.

Solutions suggested

Use integrated ERP systems linking procurement, production and sales.
Evaluate managers on operational efficiency and strategic goals, not just profit.
Use Just-in-Time (JIT) inventory management — pull system, Kanban — to minimise stock.

External reporting requirement

IAS 2 (Inventories) requires absorption costing for external financial statements. Marginal costing is not permitted for inventory valuation in published accounts.

In the long run, total profit is the same under both methods — all costs eventually pass through the Income Statement. The difference is timing only.

Short run

Profits differ — depends on inventory movement.

Long run

Total profit identical under both methods.

Relevant costs for decision-making

\[\text{Relevant cost} = \text{Future costs} + \text{Opportunity costs that differ between alternatives}\]

Relevant costs — include these

Future variable costs
Avoidable fixed costs
Incremental costs
Opportunity costs

Irrelevant costs — exclude these

Sunk costs (past, irrecoverable)
Committed fixed costs (unchanged between options)
Depreciation / non-cash book entries
Any cost identical under all options

Sunk costs and opportunity costs

Sunk cost

A past cost already incurred and unrecoverable. Always irrelevant to current decisions.

Sunk cost fallacy: continuing a bad decision because money has already been spent. Classic exam trap — if the question mentions "we paid £X last year", that figure is irrelevant.

Opportunity cost

The value of the best alternative forgone when a decision is made. Not in the accounts — but always relevant.

\[\text{Opportunity cost} = \text{Best alternative revenue/benefit foregone}\]

Example: using factory space for Product A means forgoing £20,000 rental income. That £20,000 is a relevant cost of making Product A, even though no cash is paid.

Make-or-buy methodology

1
Calculate the avoidable internal cost of making (variable costs + avoidable fixed costs only).
2
Compare with the supplier's purchase price.
3
Add any opportunity cost from freed-up capacity.
4
Buy if supplier price < avoidable cost + opportunity cost savings.

Common mistake: including all fixed overhead automatically. Only include fixed costs that are avoidable if production stops. Unavoidable fixed costs are irrelevant.

Special order decisions

Accept a special order if incremental revenue > incremental (relevant) costs. Ignore fixed overhead already committed unless capacity is affected.

Limitations of marginal costing

Difficult to split all costs neatly into fixed and variable (many are mixed).
Sales staff may mistake marginal cost for total cost and price too low.
Fixed cost behaviour may change in reality — the relevant range assumption is restrictive.
Not permitted under IAS 2 for external reporting.

Marginal costing is useful for internal decisions but must be applied with care. It is a tool, not a complete accounting system.

Cost Behaviour & Cost-Volume-Profit Analysis

High-low method; contribution; breakeven units and revenue; C/S ratio; target profit; margin of safety; operating leverage; CVP for not-for-profits.

CVP assumptions

Total costs are linear — straight-line relationship with activity.
Only one cost driver (units produced, labour hours etc.).
Costs are defined as fixed or variable within a relevant range only.

\[y = a + bx\]

Where \(y\) = total cost, \(a\) = fixed cost, \(b\) = variable cost per unit, \(x\) = activity level.

High-low method — separating mixed costs

\[b = \frac{\text{Cost at high activity} - \text{Cost at low activity}}{\text{High activity} - \text{Low activity}}\]

\[a = \text{Total cost at either point} - b \times \text{Activity at that point}\]

Worked example — Hǎo Ltd

	Hours	Cost (¥)
High	26,000	3,300,000
Low	18,000	2,900,000
Change	8,000	400,000

\[b = \frac{400{,}000}{8{,}000} = ¥50 \text{ per hour}\]

\[a = 3{,}300{,}000 - 50 \times 26{,}000 = ¥2{,}000{,}000\]

Cost equation: \(y = 2{,}000{,}000 + 50x\). At 20,000 hours: \(y = 2{,}000{,}000 + 50 \times 20{,}000 = ¥3{,}000{,}000\).

CVP — core structure

\[\text{Contribution per unit} = P - VC\]

\[\text{Total contribution} = (P - VC) \times Q\]

\[\text{Profit} = \text{Total contribution} - \text{Fixed costs}\]

Contribution first covers fixed costs. Once fixed costs are fully covered, every additional unit generates pure profit equal to the contribution per unit.

Breakeven and target profit

\[Q_{BE} = \frac{FC}{P - VC}\]

\[Q_{\text{target}} = \frac{FC + \text{Target profit}}{P - VC}\]

Peacock Ltd example

Item	£/unit
Selling price (P)	35
Variable cost (VC)	20
Contribution	15
Fixed costs (FC)	45,000

\[Q_{BE} = \frac{45{,}000}{15} = 3{,}000 \text{ units}\]

\[Q_{\text{target £30k}} = \frac{45{,}000 + 30{,}000}{15} = 5{,}000 \text{ units}\]

C/S ratio and breakeven in revenue

\[\text{C/S ratio} = \frac{P - VC}{P} = \frac{\text{Contribution per unit}}{\text{Selling price per unit}}\]

\[\text{Breakeven revenue} = \frac{FC}{\text{C/S ratio}}\]

\[\text{Revenue for target profit} = \frac{FC + \text{Target profit}}{\text{C/S ratio}}\]

Example

C/S = £9.12 ÷ £28.50 = 32%. Fixed costs = £140,000.

\[\text{Breakeven revenue} = \frac{140{,}000}{0.32} = £437{,}500\]

\[\text{Breakeven units} = \frac{140{,}000}{9.12} = 15{,}351 \text{ units (round up)}\]

Always round up when calculating breakeven units — you cannot sell a fraction of a unit.

Margin of safety

\[\text{MOS (units)} = \text{Budgeted sales} - \text{Breakeven sales}\]

\[\text{MOS (£)} = \text{Budgeted revenue} - \text{Breakeven revenue}\]

\[\text{MOS (\%)} = \frac{\text{MOS units}}{\text{Budgeted sales units}} \times 100\]

Peacock Ltd after automation

	Before	After automation
Variable cost	£20	£15
Fixed cost	£45,000	£67,500
Contribution	£15	£20
Breakeven	3,000	3,375
MOS at 5,000 units	2,000 (40%)	1,625 (32.5%)

Automation raises the breakeven point and reduces the margin of safety — higher operating leverage means more risk if sales fall.

Operating leverage

\[\text{Operating leverage} = \frac{\text{Total contribution}}{\text{Profit}}\]

Higher fixed costs → higher operating leverage. Once breakeven is passed, extra units generate profit quickly. But if sales fall, the high fixed cost base creates more loss risk.

Automation effect at 5,000 units

\[\text{Post-automation profit} = 5{,}000 \times £20 - £67{,}500 = £32{,}500\]

Profit rises by £2,500 vs pre-automation. But the firm is now more exposed if volume falls below 3,375 units.

CVP for not-for-profit organisations

The NHS/public sector example shows CVP where "revenue" is partly a government grant.

\[\text{Grant} + \text{Patient revenue} = \text{Variable costs} + \text{Fixed costs}\]

If each patient generates £7,200 income but costs £8,400 → negative contribution of −£1,200 per patient. The government grant of £1,200,000 effectively subsidises each patient.

\[1{,}200{,}000 + 7{,}200x = 8{,}400x + 800{,}000\]

\[\Rightarrow x = 333 \text{ patients}\]

A 10% funding cut → grant falls to £1,080,000 → patients supportable falls to 233. A 10% funding reduction causes a ~30% drop in capacity — highly leveraged effect.

All key CVP formulas — summary

\[b = \frac{\Delta\text{Cost}}{\Delta\text{Activity}} \quad \text{(high-low variable cost)}\]

\[\text{Contribution} = P - VC\]

\[Q_{BE} = \frac{FC}{P - VC}\]

\[Q_{\text{target}} = \frac{FC + \pi_{\text{target}}}{P - VC}\]

\[\text{C/S ratio} = \frac{P-VC}{P}\]

\[\text{Revenue}_{BE} = \frac{FC}{\text{C/S}}\]

\[\text{MOS \%} = \frac{\text{Budget} - \text{BE}}{\text{Budget}} \times 100\]

Exam methodology — CVP questions

1
Identify selling price, variable cost, and fixed costs. Confirm relevant range assumptions.
2
Calculate contribution per unit (P − VC).
3
For breakeven: FC ÷ contribution per unit. Always round up.
4
For target profit: (FC + target profit) ÷ contribution per unit.
5
For revenue-based questions: use C/S ratio.
6
Margin of safety: budgeted − breakeven, express as units, £ and %.
7
Proof: contribution − fixed costs = target profit. Always verify.

Activity-Based Costing

Problems with traditional costing; hidden factory; Cooper-Kaplan cost hierarchy; ABC steps; time-driven ABC; when to use ABC; advantages and limitations.

The problem with traditional absorption

Traditional systems use one cost driver (often direct labour hours or machine hours) to allocate all overheads. This is inaccurate in complex multi-product businesses.

High-volume standard products

Over-costed — absorb lots of overhead simply by using many labour hours. Appear less profitable than they really are.

Low-volume specialist products

Under-costed — use fewer hours but consume much support overhead. Appear more profitable than they really are.

Modern firms have: more specialised products, more design/support/customisation overhead, and less direct labour. Single-rate systems become increasingly misleading.

Traditional costing vs ABC — the key difference

Traditional costing

Resources → Departments → Cost objects. Uses one predetermined overhead rate.

ABC

Resources → Activities/Activity centres → Cost objects. Uses different cost driver rates for different activities.

Traditional asks: which department used the cost?
ABC asks: which activity caused the cost?

That is why ABC is usually better for pricing and product mix decisions in complex businesses.

The hidden factory — Miller and Vollmann

Overhead is often caused by hidden support activities — transactions that happen behind the scenes, not directly in physical production.

Transaction type	Examples
Logistical	Ordering, moving, confirming movement of materials
Balancing	Ensuring labour, materials and capacity match demand
Quality	Specifications, certification, quality checks, recording data
Change	Engineering design changes, materials specs, schedules, BOM updates

Overhead is driven by complexity, not just volume. A specialist product triggers many change transactions even if few units are made.

Cooper-Kaplan cost hierarchy

\[\text{Unit-level} \rightarrow \text{Batch-level} \rightarrow \text{Product-level} \rightarrow \text{Facility-level}\]

Level	Varies with	Examples
Unit-level	Each unit made	Direct materials, direct labour, power per unit
Batch-level	Each batch (not each unit)	Machine set-up, materials handling, batch inspection
Product-level	Each product line	Product design, specifications, special purchasing
Facility-level	Whole organisation	Plant security, property taxes, grounds maintenance

Key exam point: if most overhead is batch-level or product-level, ABC and traditional costing will give very different product costs.

ABC steps — methodology

1
Group overheads into activity cost pools (e.g., materials handling, engineering, power).
2
Identify a cost driver for each activity pool.
3
Calculate the cost driver rate.
4
Assign activity costs to products using driver rate × product's driver usage.
5
Calculate full production cost per unit.

\[\text{Activity cost driver rate} = \frac{\text{Total cost in pool}}{\text{Total cost driver units}}\]

\[\text{Overhead absorbed} = \text{Activity driver usage} \times \text{Cost driver rate}\]

Ed Light Manufacturing — ABC example

Total overhead = £64,000. Three activity pools:

Activity	Cost	Cost driver
Materials handling	£10,000	Direct material cost
Engineering	£30,000	Engineering change notices
Power	£24,000	Kilowatt hours

L-Ultimate: many engineering changes → higher engineering cost. Lplus: many kWh → higher power cost. Under ABC, Lplus absorbed 175% more overhead than traditional costing suggested — it had been severely under-costed.

Result: L-Ultimate and L1 were overpriced; Lplus was underpriced. Poor costing directly damages profitability.

Time-driven ABC — service sector

\[\text{Cost per minute} = \frac{\text{Total dept overhead}}{\text{Available minutes}}\]

\[\text{Activity cost} = \text{Cost per minute} \times \text{Time required} \times \text{Volume}\]

Example — GP practice

Practice costs £600/hour to run. A consultation takes 20 minutes.

\[\text{Consultation cost} = £600 \times \frac{20}{60} = £200\]

Useful for: banks, hospitals, GP practices, law firms, call centres — any service where time is the key resource.

When to use ABC

ABC is most valuable when:

Indirect costs are significant relative to direct costs.
Products are complex and require many different processes.
The firm loses bids it thought were low and wins bids it thought were high — a sign of cost distortion.
Low-volume specialist products appear profitable while high-volume standard products appear unprofitable.
Operations have changed but the costing system has not.

Advantages and limitations of ABC

Advantages

More accurate product costs — multiple cost drivers reflect actual resource consumption.
Better pricing and product mix decisions.
Identifies inefficient support activities.
Recognises that overheads are increasingly important in modern businesses.

Limitations

Assumes linear cost behaviour — one pool, one driver (may oversimplify).
Facility-level costs (rent, rates) still need arbitrary apportionment.
Complex and costly to implement and maintain.
Activities must be measurable; staff may resist change.
ABC is mainly for decision-making — not directly used for external inventory valuation (IAS 2 still applies).

Budgeting & Planning

Purpose of budgets; planning hierarchy; master budget; production/materials/labour budgets; cash budget; budgetary systems; top-down vs bottom-up; ZBB, rolling, flexible and ABB.

What budgets are and why they matter

A budget is a financial plan of action for a specific period — usually one year or less. Budgeting is the process of systematically collecting, evaluating and communicating quantified information about future activities.

Budgets turn strategy into numbers. Example: strategy = increase European sales → budget = 5 new salespeople + £500k marketing + £3m target revenue.

Seven purposes of budgets

Purpose	What it means
Planning	Force forward thinking
Control	Compare actual vs budget; investigate variances
Communication	Communicate plans and expectations
Coordination	Align department plans
Motivation	Give targets for managers to aim for
Delegation	Authorise spending within limits
Authorisation	Formal approval of expenditure

Operating budget — step-by-step

1
Start with the sales budget — everything else depends on expected sales.
2
Production budget: \(\text{Production} = \text{Sales} + \text{Closing FG} - \text{Opening FG}\)
3
Raw materials purchases budget.
4
Direct labour budget.
5
Manufacturing overhead budget.
6
Compute unit production cost and closing inventory value.
7
Cost of goods sold budget.
8
Non-production costs budget.
9
Budgeted income statement.
10
Cash budget and budgeted balance sheet.

Production and materials formulas

\[\text{Production} = \text{Budgeted sales} + \text{Desired closing FG} - \text{Opening FG}\]

\[\text{If scrap rate} = s\%: \quad \text{Required starts} = \frac{\text{Good units needed}}{1 - s}\]

\[\text{RM purchases} = \text{RM for production} + \text{Closing RM} - \text{Opening RM}\]

Example

Sales = 60,000; closing FG = 3,000; opening FG = 2,000:

\[\text{Production} = 60{,}000 + 3{,}000 - 2{,}000 = 61{,}000\]

If 10% scrap: need to start 90,000 ÷ 90% = 100,000 units. Note: defective units cannot count as closing finished goods.

Labour budget and gross-up for rejection

\[\text{Labour hours} = \text{Production units} \times \text{Hours per unit}\]

\[\text{Labour cost} = \text{Labour hours} \times \text{Wage rate}\]

Rejection rate example

Good units needed = 41,400; rejection rate = 8%.

\[\text{Units to start} = \frac{41{,}400}{0.92} = 45{,}000\]

\[\text{Labour hours} = 45{,}000 \times 5 = 225{,}000 \text{ hours}\]

Always gross up production before calculating labour hours when there is a rejection rate.

Cash budget — why profit ≠ cash

Cash and profit differ because of:

Depreciation (non-cash charge in OH budget — exclude from cash payments)
Credit sales (revenue recognised before cash received)
Credit purchases (expense recognised before cash paid)
Inventory movements, accruals, prepayments
Capital expenditure (cash out, not an expense)

\[\text{Closing cash} = \text{Opening cash} + \text{Cash receipts} - \text{Cash payments}\]

Cash receipts methodology

1
Identify the credit terms (e.g., 50% cash, 60% of credit in month 1, 39% in month 2, 1% bad debt).
2
For each month, collect cash sales + prior-period credit receipts.
3
Deduct discounts and bad debts as applicable.

Cash payments methodology

Materials paid 1 month late → June cash = May purchases. Wages 75% in month, 25% next → May cash = 75% May wages + 25% April wages.

Budgetary systems

System	Method	Best for
Incremental	Adjust prior year's budget by expected changes	Stable costs (rent, insurance)
Zero-based (ZBB)	Justify every cost from scratch	Cost control, discretionary spend
Rolling	Always maintain a 12-month forward budget	Volatile / uncertain environments
Flexible	Adjust variable costs to actual activity	Variable output environments
Activity-based (ABB)	Budget by activity cost driver	Firms already using ABC

Top-down vs bottom-up budgeting

Top-down (imposed)

Advantages: fast; strong financial control; aligned with senior strategy.
Disadvantages: may be inaccurate (senior managers lack local knowledge); damages morale; unrealistic targets.

Bottom-up (participative)

Advantages: better information; higher motivation; staff ownership; frees senior time.
Disadvantages: slower; risk of budgetary slack; weak managers may produce poor budgets; may not align with corporate goals.

Budgetary slack: managers deliberately underestimate sales or overestimate costs to make targets easier to meet. A risk of participative budgeting.

Flexible budgets — exam methodology

\[\text{Flexed variable cost} = \text{Variable cost per unit} \times \text{Actual output}\]

Fixed costs remain unchanged in the flexible budget.

Example: budget = 10,000 units; actual = 12,000 units. Variable costs must be flexed to 12,000 before comparing with actual. Otherwise the comparison is unfair — 20% more output naturally causes higher variable costs.

The flexed budget separates: volume effect (selling more or fewer units) from efficiency/price effect (costs per unit being different from standard).

Benefits and limitations of budgets

Benefits

Promotes forward thinking and identifies problems early.
Provides a control system — actual vs budget variances trigger investigation.
Coordinates departments and authorises spending.

Limitations (Argyris)

Strengthen vertical command and control — can feel oppressive.
Encourage gaming and budgetary slack.
Updated too infrequently — become stale.
Create emotional pressure: missing a budget causes embarrassment.
Reinforce departmental silos rather than cross-functional thinking.

Variance Analysis

Standard costing; static vs flexible budgets; sales volume variance; material, labour and overhead variances; causes and interdependencies; hospital service example.

Standard costing — purpose

A standard cost is an estimated unit cost used as a benchmark. A variance is the difference between standard and actual performance.

Management by exception: managers focus on significant variances rather than reviewing everything. Small variances within tolerance are ignored.

Ideal standards

Perfect efficiency — no waste, no downtime. Usually unrealistic. May demotivate staff.

Practical standards

Allow for normal downtime and interruptions. Challenging but achievable. Used in practice.

Three levels of variance analysis

Level	Comparison	Tells you
Level 1	Actual vs static budget	Total difference (volume + all other effects)
Level 2	Flexible budget vs static budget	Volume effect only (sales volume variance)
Level 2	Actual vs flexible budget	Price/efficiency effects at actual volume
Level 3	Further decomposition	Price variance + efficiency/usage variance

\[\underbrace{\text{Actual} \to \text{Flexible budget}}_{\text{Price/efficiency effect}} \quad + \quad \underbrace{\text{Flexible budget} \to \text{Static budget}}_{\text{Volume effect}}\]

Sales volume variance

\[\text{SVV} = (\text{Actual units} - \text{Budgeted units}) \times \text{Standard margin}\]

Standard margin = standard contribution per unit (marginal costing) or standard profit per unit (absorption costing).

Actual > budget → Favourable
Actual < budget → Unfavourable

Sofiya Ltd example: sold 10,000 units vs budgeted 12,000 → 2,000 unit shortfall → unfavourable SVV. This explains the volume-driven portion of the profit difference from the static budget.

All variance formulas

Materials

\[\text{MPV} = AQ(AP - SP)\]

\[\text{MUV} = SP(AQ - SQ)\]

Labour

\[\text{LRV} = AH(AR - SR)\]

\[\text{LEV} = SR(AH - SH)\]

Variable overhead

\[\text{VOH spending} = AH(AR - SR)\]

\[\text{VOH efficiency} = SR(AH - SH)\]

Fixed overhead

\[\text{FOH expenditure} = \text{Actual FOH} - \text{Budgeted FOH}\]

F = favourable (reduces cost or increases revenue). U = unfavourable (increases cost or reduces revenue).

If (AP − SP) > 0 → paid more than standard → U. If (AQ − SQ) > 0 → used more than allowed → U.

Material variances — worked example

Standard: 2m² leather per jacket at €30/m². Output: 10,000 jackets. Actual: 22,200m² used at €31/m².

\[SQ = 10{,}000 \times 2 = 20{,}000\text{m}^2\]

\[\text{MPV} = 22{,}200 \times (€31 - €30) = €22{,}200 \text{ U}\]

\[\text{MUV} = €30 \times (22{,}200 - 20{,}000) = €66{,}000 \text{ U}\]

Paid €1 more per m² than standard and used 2,200m² more than allowed. Both unfavourable.

Labour variances — hospital example

120 hip operations performed. Standard: doctors 2.5 hrs/op at £50/hr; nurses 8 hrs/op at £22/hr. Actual: doctors 400 hrs, total cost £24,000; nurses 900 hrs.

\[AR_{doc} = \frac{£24{,}000}{400} = £60/\text{hr}\]

\[SH_{doc} = 120 \times 2.5 = 300 \text{ hrs}\]

\[\text{Doctor LRV} = 400(£60 - £50) = £4{,}000 \text{ U}\]

\[\text{Doctor LEV} = £50(400 - 300) = £5{,}000 \text{ U}\]

\[SH_{nurse} = 120 \times 8 = 960; \quad \text{Nurse LEV} = £22(900 - 960) = £1{,}320 \text{ F}\]

Shows that variance analysis applies equally to services, not just manufacturing.

Causes of variances — exam table

Variance	Unfavourable causes	Favourable causes
MPV	Market price rises, emergency orders, no bulk discount, inflation	Bulk discounts, cheaper supplier, lower quality material
MUV	Defective material, excessive waste, pilferage, unskilled labour	Higher quality material, skilled labour, better machinery
LRV	Overtime, senior staff used, union negotiations, skills shortage	Cheaper staff, lower grades used
LEV	Inexperience, poor equipment, poor-quality materials, bad supervision	Skilled/motivated workers, better equipment, good training
FOH expenditure	Unexpected cost increases, poor control	Cost savings, underutilised resources

Variance interdependencies — key exam point

Variances are connected. A favourable variance in one area may cause an unfavourable variance elsewhere:

Favourable MPV (bought cheaper material) → Unfavourable MUV (cheaper material = lower quality = more waste).
Favourable LRV (used cheaper/less skilled labour) → Unfavourable LEV (less skilled workers take longer).
Favourable LRV (used fewer hours) → Unfavourable MUV (rushed work = more material waste).

A favourable variance is not always good. Always consider trade-offs. Investigate the cause before judging performance.

Criticisms of standard costing

Can damage staff morale — always chasing a standard.
Focuses on financial measures; ignores quality, customer satisfaction, innovation.
Time-consuming to install and maintain.
Less useful in JIT environments — where waste elimination is the goal, not meeting a standard.
May judge managers for factors beyond their control.
"Good enough" thinking — meeting the standard stops continuous improvement.
Over-focuses on labour variances when processes are increasingly automated.

Performance Measurement

Responsibility centres; decentralisation; ROI; DuPont decomposition; RI; EVA; financial vs non-financial KPIs; leading vs lagging; Balanced Scorecard; Norreklit critique.

Responsibility centres — four types

Type	Manager accountable for	Examples	Judged on
Cost centre	Costs only	Back office, HR, maintenance	Cost control
Revenue centre	Revenue only	Sales booking team, hotel restaurant	Revenue generated
Profit centre	Revenue and costs	Retail branch, restaurant outlet	Profit
Investment centre	Revenue, costs and assets	Division with capex authority	ROI / RI / EVA

Return on Investment (ROI)

\[\text{ROI} = \frac{\text{Pre-tax profit}}{\text{Net assets}} \times 100\%\]

DuPont decomposition

\[\text{ROI} = \underbrace{\frac{\text{Profit}}{\text{Sales}}}_{\text{Return on sales}} \times \underbrace{\frac{\text{Sales}}{\text{Investment}}}_{\text{Asset turnover}}\]

Two routes to improve ROI: (1) increase profit margin, (2) increase asset turnover — generate more sales from the same asset base, or reduce assets.

Example

\[\text{ROI} = \frac{£110{,}000}{£500{,}000} \times 100 = 22\%\]

Behavioural problems with ROI

Because ROI is a percentage, managers may reject value-creating projects that reduce their division's average ROI.

Example

Item	Value
Current divisional ROI	30%
New project return	25%
Company cost of capital	10%

The project is good for the company (25% > 10%) but the manager may reject it because it lowers their average ROI from 30%.

ROI also encourages short-termism: new assets increase the denominator and can reduce ROI in the short run, so managers delay long-term investment.

Residual Income (RI)

\[\text{RI} = \text{Profit} - (\text{Required rate of return} \times \text{Investment})\]

Why RI improves goal congruence

A manager should accept any project where return > required rate → positive incremental RI. No incentive to reject a project just because it reduces average percentage ROI.

Company X example (cost of capital = 20%)

Division	Profit £000	Assets £000	ROI	RI £000
1	110	500	22%	+10
2	100	1,000	10%	−100
3	35	100	35%	+15

Division 2 destroys value (earns below required return). Division 3 is best performer on both measures despite being smallest.

New project effect — ROI vs RI

Division 1 considers: invest £20,000, earn £4,100 extra profit (20.5% return).

\[\text{New ROI} = \frac{114{,}100}{520{,}000} = 21.94\% \quad \text{(falls from 22\%)}\]

\[\text{Extra RI} = 4{,}100 - 20\% \times 20{,}000 = £100 \text{ F}\]

ROI: manager may reject (average ROI falls). RI: manager should accept (positive incremental RI). This is the core ROI vs RI distinction.

EVA

\[\text{EVA} = NOPAT - WACC \times \text{Net assets}\]

Same logic as RI but uses NOPAT (net operating profit after tax) and WACC. May require up to 200 accounting adjustments to get to economic values. Conceptually strong; practically complex.

RI limitations

Cannot compare divisions of different sizes — absolute £ figure is biased towards larger divisions.
Does not fully solve short-termism — accounting profit still used; managers may delay long-term spending.
Does not adjust for risk differences across divisions.

KPIs — metrics vs KPIs

Metric

Any measurement. Informational. Many. Often operational. Example: number of website visits.

KPI

Strategic measurement that drives decisions. Few. Decision-driving. Example: conversion rate from trial to paid subscription.

Leading vs lagging KPIs

Type	Predicts	Examples
Leading	Future performance	Customer retention, employee satisfaction, engagement
Intermediate	Operational progress	Release velocity, defect rate
Lagging	Past outcomes	Revenue, EBITDA, profit, ROI

Executives over-focus on lagging indicators (quarterly financial results). Leading indicators are more valuable for predicting and shaping future performance.

Balanced Scorecard — four perspectives

Perspective	Question	Example measures
Financial	How do we look to shareholders?	ROI, EVA, revenue growth, cash flow
Customer	How do customers see us?	Satisfaction, loyalty, market share, retention
Internal process	What must we excel at internally?	Defect rates, delivery time, rework levels
Learning & growth	Can we continue to improve?	Employee retention, training, innovation pipeline

Cause-and-effect chain

Better training→Better processes→Customer satisfaction→Financial results

Norreklit's critique of the BSC

Assumed cause-and-effect may not always hold.
Better customer service may not improve profit if customers demand costly short delivery times.
Customer loyalty ≠ profitability.
Employee satisfaction does not automatically produce loyalty or profit.
BSC can be too top-down — measures imposed rather than emerging from operational reality.

The BSC is a useful framework but its assumed relationships need empirical evidence within each organisation. Adopt critically, not uncritically.

✓

Final Exam Map — Everything to Know Cold

All key equations; must-draw diagrams; top evaluation points; 5-step answer template.

All essential equations

\[\text{DM used} = \text{Opening RM} + \text{Purchases} - \text{Closing RM}\]

\[\text{CoGM} = \text{Opening WIP} + \text{Total mfg cost} - \text{Closing WIP}\]

\[\text{OAR} = \frac{\text{Budgeted OH}}{\text{Budgeted activity}}\]

\[\text{AC profit} - \text{MC profit} = \Delta\text{Inv} \times \text{Fixed OH/unit}\]

\[b = \frac{\Delta\text{Cost}}{\Delta\text{Activity}} \quad \text{(high-low)}\]

\[Q_{BE} = \frac{FC}{P-VC}, \quad Q_{\text{target}} = \frac{FC+\pi}{P-VC}\]

\[\text{C/S} = \frac{P-VC}{P}, \quad \text{Revenue}_{BE} = \frac{FC}{\text{C/S}}\]

\[\text{ABC rate} = \frac{\text{Cost pool}}{\text{Cost driver units}}\]

\[\text{MPV} = AQ(AP-SP), \quad \text{MUV} = SP(AQ-SQ)\]

\[\text{LRV} = AH(AR-SR), \quad \text{LEV} = SR(AH-SH)\]

\[\text{ROI} = \frac{\pi}{\text{Assets}} = \frac{\pi}{S} \times \frac{S}{\text{Assets}}\]

\[\text{RI} = \pi - r \times \text{Investment}\]

\[\text{EVA} = NOPAT - WACC \times \text{Net assets}\]

Key exam distinctions

W1: Direct costs traced; indirect costs absorbed. Variable cost/unit = constant; fixed cost/unit falls as output rises.
W2: Allocation = direct; apportionment = shared; re-apportionment = service to production. Step-down method is examinable.
W3: AC includes fixed OH in inventory; MC expenses it. Inventory ↑ → AC profit higher. Inventory ↓ → MC profit higher.
W4: Contribution = P − VC. Always round up breakeven units. MOS shows how far sales can fall.
W5: ABC traces OH to activities then products. Batch-level and product-level costs are the key differentiator vs traditional costing.
W6: Sales budget first. Cash ≠ profit. Depreciation excluded from cash budget. Gross up production for scrap rates.
W7: Favourable variance ≠ always good. Price and efficiency variances are interdependent. Flex variable costs to actual output before comparing.
W8: ROI % may cause rejection of value-creating projects. RI improves goal congruence. BSC combines financial and non-financial measures. Leading KPIs predict; lagging KPIs confirm.

Top evaluation points

Absorption costing is required by IAS 2 — but it can encourage stockpiling (earnings management).
Overhead apportionment is always a judgement call — different bases give different product costs.
ABC is more accurate but costly; facility-level costs still require arbitrary treatment.
Sunk costs are always irrelevant — but the sunk cost fallacy is extremely common in practice.
Standard costing focuses on financial measures and may ignore quality, innovation and motivation.
ROI encourages short-termism and project rejection; RI is better for goal congruence but is size-biased.
The Balanced Scorecard's assumed cause-and-effect chain needs empirical validation (Norreklit).
Top-down budgets are fast but inaccurate; participative budgets motivate but create slack.

5-step answer template

Define the concept precisely. State the formula if there is one.

Calculate step-by-step, showing workings clearly.

Interpret — state whether favourable/unfavourable, what the number means in context.

Cause — suggest the most likely reasons for the result.

Evaluate — limitations of the method; what other information would be needed; trade-offs.

Example — material price variance

"The material price variance (MPV = AQ(AP−SP)) measures whether actual price paid per unit of material differed from standard. Here MPV = 22,200×(31−30) = €22,200U — unfavourable because the firm paid €1 more per m² than standard. Possible causes: market price increase, emergency ordering due to stockouts, or lost bulk discount. However, if cheaper material was deliberately avoided for quality reasons, this may link to a favourable usage variance elsewhere. The variance should be investigated in conjunction with MUV before any conclusion about performance is drawn."

Key Terms Glossary

Every important term from AC106, grouped by topic. Use this to check definitions before the exam.

Management accounting

The process of identifying, measuring, accumulating, analysing, preparing, interpreting, and communicating financial and non-financial information to help managers fulfil organisational objectives. Forward-looking; not restricted by accounting standards; uses any data that is relevant.

Costs & Behaviour

Cost accounting

A subset of management accounting focused on recording, classifying, and summarising cost data. Narrower than management accounting — it tracks costs accurately but does not combine them with broader decision-making analysis.

Costs & Behaviour

Cost object

Anything for which a separate measurement of cost is desired. Could be a product, service, customer, department, project, or distribution channel. The key question before costing is: cost of what?

Costs & Behaviour

Cost driver

Any factor that causes a change in the total cost of an activity. Examples: machine hours, labour hours, number of orders, number of deliveries, floor space, kilowatt hours. The basis chosen should reflect what actually causes the cost.

Costs & Behaviour

Variable cost

A cost that changes in total in direct proportion to changes in activity level. The total increases as output rises, but the cost per unit remains constant. Example: direct materials — if each unit needs £3 of material, 1,000 units cost £3,000.

Costs & Behaviour

Fixed cost

A cost that remains constant in total within the relevant range regardless of changes in activity. The cost per unit falls as output rises because the same total is spread over more units. Example: factory rent stays at £50,000 whether 500 or 5,000 units are produced.

Costs & Behaviour

Stepped fixed cost

A fixed cost that remains constant up to a certain activity level, then increases by a lump sum when capacity must expand. Example: one supervisor covers up to 20 workers; a 21st worker requires a second supervisor, causing a step up in cost.

Costs & Behaviour

Semi-variable (mixed) cost

A cost that contains both a fixed element (constant regardless of activity) and a variable element (changes proportionally with activity). Example: a phone contract with a fixed monthly charge plus a variable charge per call. Equation: y = a + bx.

Costs & Behaviour

Relevant range

The range of activity within which assumptions about cost behaviour hold. Fixed costs are only "fixed" within this range — outside it they may step up or down. CVP analysis and standard costing both depend on this assumption.

Costs & Behaviour

Direct cost

A cost that can be specifically and exclusively traced to a particular cost object. Requires no estimation or sharing. Examples: direct materials and direct labour in manufacturing — the materials in a product can be measured precisely.

Costs & Behaviour

Indirect cost (overhead)

A cost that cannot be directly and exclusively traced to a specific cost object and must be allocated or apportioned. Examples: factory rent, factory electricity, maintenance staff, canteen costs. Must be absorbed using an OAR.

Costs & Behaviour

Product cost

The cost of purchasing or producing goods, or delivering services. In manufacturing: direct materials + direct labour + manufacturing overhead. Can be held in inventory until goods are sold. Contrasts with period costs, which are expensed immediately.

Costs & Behaviour

Period cost

A cost that is not included in product cost and is expensed to the income statement in the period in which it is incurred. Examples: advertising, office salaries, admin, selling expenses. Cannot be held in inventory.

Costs & Behaviour

Prime cost

Direct materials plus direct labour. The most directly traceable manufacturing costs — the main inputs that can be assigned to individual units without estimation. Does not include manufacturing overhead.

Costs & Behaviour

Conversion cost

Direct labour plus manufacturing overhead. The cost of converting raw materials into finished goods — the work done to the materials once they enter the production process. Useful in process costing.

Costs & Behaviour

Capitalised cost

A cost recorded as an asset on the Statement of Financial Position rather than expensed immediately. Example: inventory is capitalised until the goods are sold, at which point it becomes cost of goods sold on the income statement. Delays the impact on profit.

Costs & Behaviour

High-low method

A technique for separating a mixed cost into its fixed and variable elements. Uses the highest and lowest activity data points. Variable cost per unit = (cost at high − cost at low) ÷ (high activity − low activity). Fixed cost = total cost − variable element at either point.

Costs & Behaviour

Absorption costing (full costing)

A costing system in which all manufacturing costs — both variable and fixed — are assigned to products. Fixed manufacturing overhead is included in inventory value and only expensed when goods are sold. Required by IAS 2 for external reporting.

Absorption Costing

Cost centre

An organisational unit (usually a department) that incurs costs but is not directly responsible for revenue generation. Acts as the collecting point for overhead costs before they are absorbed into products. Production departments and service departments are both cost centres.

Absorption Costing

Allocation

Charging a cost directly and wholly to the department where it definitively belongs, without sharing. No estimation needed. Example: a chef's salary is allocated entirely to the canteen department because the chef works only there.

Absorption Costing

Apportionment

Sharing overhead costs across departments using a fair and rational basis when a cost cannot be allocated to a single department. Example: rent apportioned using floor area because multiple departments use the building. Different bases give different cost figures.

Absorption Costing

Re-apportionment

Transferring service department costs to production departments. Service departments (canteen, maintenance) do not directly produce output, so their costs must move to departments that do. The step-down method handles this when service departments serve each other.

Absorption Costing

Overhead Absorption Rate (OAR)

A predetermined rate used to assign overhead costs to products. Calculated as: budgeted overhead ÷ budgeted activity level. Multiplied by actual (or budgeted) activity per product to find overhead absorbed. Usually set at the start of the period using budgets.

Absorption Costing

Over-absorption

When the overhead absorbed into product costs exceeds actual overhead incurred. Happens when actual activity is higher than budgeted, or actual costs are lower than budgeted. Over-absorbed overhead is added back to profit (favourable adjustment).

Absorption Costing

Under-absorption

When the overhead absorbed into product costs is less than actual overhead incurred. Happens when actual activity is lower than budgeted, or actual costs are higher than budgeted. Under-absorbed overhead is subtracted from profit (unfavourable adjustment).

Absorption Costing

Step-down method

A re-apportionment technique that recognises that service departments provide services to other service departments as well as production departments. The service department that serves the most other departments is re-apportioned first. More accurate than the direct method.

Absorption Costing

Job-order costing

A costing system used when products or services are made to specific customer orders. Each job is unique and costs are accumulated separately per job. Examples: construction projects, custom machinery, aircraft, ships. Contrasts with process costing for continuous production.

Absorption Costing

Marginal costing (variable costing)

A costing approach where only variable manufacturing costs are included in inventory. Fixed manufacturing overhead is treated as a period cost and expensed immediately. Not permitted under IAS 2 for external reporting. Preferred for internal decision-making as it focuses on contribution.

Marginal & Decisions

Contribution

Sales revenue minus all variable costs. The amount that remains from each sale to contribute first to fixed costs and then to profit. Under marginal costing, contribution is the key performance measure. Contribution per unit = selling price − variable cost per unit.

Marginal & Decisions

Production volume variance (PVV)

In absorption costing, the difference between budgeted and actual production volume, valued at the fixed overhead absorption rate. Produces over- or under-absorption. Produce less than budget → unfavourable (under-absorbed). Produce more → favourable (over-absorbed). Does not measure efficiency.

Marginal & Decisions

Relevant cost

A future cost that will differ between decision alternatives. Only relevant costs should influence decisions. Includes: future variable costs, avoidable costs, incremental costs, and opportunity costs. Excludes sunk costs, committed fixed costs, and costs identical under all options.

Marginal & Decisions

Sunk cost

A cost that has already been incurred and cannot be recovered regardless of any future decision. Always irrelevant to current decision-making. Example: £10,000 paid for a machine last year is sunk — it should not affect whether to keep or sell the machine now. The sunk cost fallacy is continuing a bad decision because of past spending.

Marginal & Decisions

Opportunity cost

The value of the best alternative forgone when a decision is made. Not recorded in the accounting system but always relevant to decisions. Example: using factory space for Product A means forgoing £20,000 rental income — that £20,000 is a relevant cost of making Product A.

Marginal & Decisions

Avoidable cost

A cost that will not be incurred if a particular activity or decision is discontinued. Avoidable costs are relevant to shutdown and make-or-buy decisions. Contrasts with unavoidable (committed) costs, which continue regardless of the decision and are therefore irrelevant.

Marginal & Decisions

Real activities earnings management

Manipulation of reported profit through real operational decisions rather than accounting adjustments. Under absorption costing, managers can increase reported profit by producing more units than needed, pushing fixed overhead into closing inventory instead of expensing it. Leads to unnecessary stockpiling.

Marginal & Decisions

Cost-Volume-Profit (CVP) analysis

A technique that examines the relationships between cost, volume, and profit. Assumes linear costs, a single cost driver, and a relevant range. Used to calculate breakeven point, target profit output, margin of safety, and the impact of cost structure changes on profitability.

CVP Analysis

Breakeven point

The level of activity at which total revenue equals total cost and profit is exactly zero. At this point, all fixed costs have been recovered by contribution but no profit yet exists. In units: fixed costs ÷ contribution per unit. In revenue: fixed costs ÷ C/S ratio.

CVP Analysis

C/S ratio (contribution-to-sales ratio)

Contribution per unit divided by selling price per unit, expressed as a proportion or percentage. Indicates what fraction of each pound of sales revenue remains as contribution after variable costs. Used to calculate breakeven revenue and target revenue when units are not given.

CVP Analysis

Margin of safety

The amount by which budgeted sales exceed the breakeven point. Measures how much sales can fall before the business starts making a loss. Can be expressed in units, revenue, or as a percentage of budgeted sales. A higher MOS means lower risk.

CVP Analysis

Operating leverage

The ratio of total contribution to profit, reflecting how much of the cost structure is fixed. High operating leverage means a small change in sales volume causes a large change in profit. Firms with high fixed costs and low variable costs have high operating leverage — more risk, but more profit per unit above breakeven.

CVP Analysis

Activity-Based Costing (ABC)

A costing method that assigns overhead to products based on the activities they consume. Resources are first traced to activity cost pools, then assigned to products using cost drivers specific to each activity. More accurate than traditional single-rate absorption in complex, multi-product businesses.

ABC

Activity cost pool

A grouping of overhead costs that are caused by the same activity or have the same cost driver. Examples: a materials handling pool for all costs related to moving materials; an engineering pool for all design and specification change costs. Each pool has its own cost driver rate.

ABC

Unit-level activity

An activity performed for every unit produced. Costs vary directly with the number of units. Examples: direct materials, direct labour, energy per unit. Under ABC, these are similar to variable costs and produce the same result as traditional costing at the unit level.

ABC

Batch-level activity

An activity performed once for each batch of units, regardless of batch size. Costs vary with the number of batches, not the number of units. Examples: machine set-up, materials handling, batch quality inspection. This level causes the greatest distortion in traditional costing.

ABC

Product-level activity

An activity performed to support a particular product line, regardless of how many units or batches are made. Costs exist because the product exists. Examples: product design, engineering specifications, dedicated purchasing. These costs are incurred even if no units are produced in a period.

ABC

Facility-level activity

An activity that supports the organisation as a whole and cannot be traced to specific products. Examples: plant security, property taxes, CEO salary, grounds maintenance. These costs must still be allocated arbitrarily, even under ABC — they do not vary with product decisions.

ABC

Hidden factory

Miller and Vollmann's concept that a large portion of overhead is caused by hidden support transactions (logistical, balancing, quality, and change transactions) rather than by direct production. These transactions grow with product complexity, explaining why traditional unit-based costing understates the cost of specialist products.

ABC

Time-driven ABC

A simplified ABC approach using time as the universal cost driver. Total department overhead is divided by available time to get a cost per minute or per hour. Each activity is costed by multiplying the time it takes by the cost per minute. Particularly useful in service-sector organisations.

ABC

Budget

A financial plan of action for a specific future period, usually one year. It quantifies expected revenues, costs, and cash flows based on organisational plans. Budgets serve seven purposes: planning, control, communication, coordination, motivation, delegation, and authorisation.

Budgeting

Master budget

The top-level budget that consolidates all subsidiary operating and financial budgets. Includes a budgeted income statement, budgeted balance sheet, and cash budget. Prepared after all subsidiary budgets (sales, production, materials, labour, overhead) are completed.

Budgeting

Budgetary slack

The deliberate underestimation of revenues or overestimation of costs by managers in a participative budgeting process, to create targets that are easier to meet. A dysfunctional consequence of bottom-up budgeting. Reduces the usefulness of budgets as a control and performance evaluation tool.

Budgeting

Zero-based budgeting (ZBB)

A budgeting method where every line of expenditure must be justified from scratch each period as if the activity were new. Does not use the prior year's budget as a starting point. Challenges the assumption that existing spending is automatically justified. Time-consuming but effective for cost control.

Budgeting

Rolling (continuous) budget

A budget that is continuously updated by adding a new future period as each current period ends. The firm always maintains a full 12-month forward-looking budget. More responsive to changing conditions than an annual fixed budget, but requires more management time and effort to maintain.

Budgeting

Flexible budget

A budget that adjusts variable costs to the actual level of activity while keeping fixed costs unchanged. Used to make fair comparisons between budgeted and actual performance. Without flexing, any cost increase caused simply by producing more units would appear as an unfavourable variance.

Budgeting

Activity-based budgeting (ABB)

A budgeting approach that starts from budgeted output, identifies the activities needed to achieve it, estimates cost driver usage, and calculates budgeted costs using activity cost driver rates. Directly linked to ABC — applies the same logic to future planning rather than past cost analysis.

Budgeting

Incremental budgeting

A budgeting method that uses the previous period's actual results as the starting point and adjusts for expected changes such as inflation or growth. Simple and quick to prepare. Weakness: assumes existing spending patterns are justified without challenge.

Budgeting

Standard cost

A predetermined cost per unit that acts as a benchmark for performance measurement. Derived from standard input quantities and standard input prices. Used to compare with actual costs and calculate variances. Expressed on a standard cost card showing each cost element per unit.

Variance Analysis

Variance

The difference between standard (budgeted) performance and actual performance. Favourable (F) if it increases profit (actual cost lower than standard, or actual revenue higher than standard). Unfavourable/adverse (U/A) if it reduces profit. Used for management by exception.

Variance Analysis

Material price variance (MPV)

The difference between what was actually paid for materials and what should have been paid at standard price, for the actual quantity purchased. Formula: AQ × (AP − SP). Unfavourable if AP > SP. Caused by: price inflation, emergency purchasing, quality differences, lost bulk discounts.

Variance Analysis

Material usage variance (MUV)

The difference between the actual quantity of material used and the standard quantity allowed for actual output, valued at standard price. Formula: SP × (AQ − SQ). Unfavourable if more material was used than standard. Caused by: waste, defective material, pilferage, unskilled labour, poor machinery.

Variance Analysis

Labour rate variance (LRV)

The difference between actual wage rate paid and standard wage rate, for actual hours worked. Formula: AH × (AR − SR). Unfavourable if actual rate > standard rate. Caused by: overtime, use of more senior staff, union wage increases, skills shortages.

Variance Analysis

Labour efficiency variance (LEV)

The difference between actual hours worked and standard hours allowed for actual output, valued at standard rate. Formula: SR × (AH − SH). Unfavourable if more hours taken than standard. Caused by: inexperienced workers, poor equipment, poor supervision, low-quality materials causing rework.

Variance Analysis

Sales volume variance (SVV)

The difference between actual sales volume and budgeted sales volume, valued at standard margin (contribution per unit under marginal costing, or profit per unit under absorption costing). Explains the volume-driven portion of the difference between static and flexible budget profit.

Variance Analysis

Management by exception

A management control approach where managers focus attention only on results that deviate significantly from budget or standard. Small or expected variances are ignored; only material variances trigger investigation and action. Makes control more efficient by avoiding information overload.

Variance Analysis

Static budget

The original budget prepared at the start of the period, based on one planned output level. Not adjusted for actual activity. Comparing actual results with a static budget gives the total static budget variance, but does not separate volume effects from price and efficiency effects.

Variance Analysis

Return on Investment (ROI)

A financial performance measure for investment centres. Pre-tax profit divided by net assets (invested capital), expressed as a percentage. Allows comparison across divisions of different sizes. Can be decomposed into return on sales × asset turnover (DuPont method). Risk: encourages rejection of value-creating projects that reduce average ROI.

Performance

Residual Income (RI)

Profit minus a capital charge equal to the required rate of return multiplied by investment. Measures the absolute profit earned above the minimum required return. Improves goal congruence versus ROI because managers should accept any project with positive RI — any return above the required rate increases RI regardless of the average percentage.

Performance

Economic Value Added (EVA)

NOPAT (net operating profit after tax) minus WACC multiplied by net assets. Same conceptual logic as RI, but uses after-tax profit and the weighted average cost of capital. May require extensive adjustments (up to 200) to convert accounting profit and book values to economic values. Conceptually strong but practically complex.

Performance

Balanced Scorecard (BSC)

A performance management framework (Kaplan and Norton) combining financial and non-financial measures across four perspectives: financial, customer, internal business process, and learning and growth. Based on a cause-and-effect logic linking non-financial drivers to long-term financial outcomes. Criticised by Norreklit for assumed but unproven causal relationships.

Performance

Investment centre

A responsibility centre whose manager is accountable for revenues, costs, and investment decisions (asset acquisition and disposal). The most comprehensive responsibility centre. Performance measured using ROI, RI, or EVA rather than simple profit, because these metrics relate profit to the capital employed to generate it.

Performance

Decentralisation

The delegation of decision-making authority to divisional or local managers. Benefits: faster decisions, better use of local knowledge, management development, higher motivation. Risks: dysfunctional decisions that benefit a division but harm the whole organisation, duplication of services, and loss of central control.

Performance

KPI (Key Performance Indicator)

A strategic measurement that drives management decisions, distinct from a general metric. KPIs are few, decision-driving, and strategically important. A metric is any measurement. Examples of KPIs: annual recurring revenue growth, customer retention rate, conversion rate from trial to paid.

Performance

Leading vs lagging indicator

Leading indicators predict future performance (e.g. customer satisfaction, employee retention, engagement). Lagging indicators confirm past outcomes (e.g. revenue, profit, ROI, EBITDA). Most financial KPIs are lagging. Effective performance management systems use both, since lagging indicators tell you what happened, while leading indicators tell you what will happen.

Performance

Key Equations & Formulas

Every formula from the course, grouped by topic, with worked examples and the exam context for each.

Week 1 — Resource Flow & Cost Structures

Direct materials used

\[\text{DM used} = \text{Opening RM} + \text{Purchases} - \text{Closing RM}\]

Start of every manufacturing account question. Raw materials (RM) balance flows into production; closing RM stays on the balance sheet.

Total manufacturing cost

\[\text{Total mfg cost} = \text{DM used} + \text{Direct labour} + \text{Mfg overhead}\]

All three components must be manufacturing-related. Admin and selling costs are period costs — exclude them.

Cost of goods manufactured

\[\text{CoGM} = \text{Opening WIP} + \text{Total mfg cost} - \text{Closing WIP}\]

WIP (work-in-progress) captures partially completed units. CoGM is transferred to the finished goods account.

Cost of goods sold

\[\text{CoGS} = \text{Opening FG} + \text{CoGM} - \text{Closing FG}\]

FG = finished goods. This completes the resource flow from raw material to the income statement charge.

Prime cost

\[\text{Prime cost} = \text{Direct materials} + \text{Direct labour}\]

The most directly traceable costs. No overhead included.

Conversion cost

\[\text{Conversion cost} = \text{Direct labour} + \text{Manufacturing overhead}\]

The cost of converting raw material into finished goods. Used in process costing.

Week 2 — Absorption Costing

Overhead Absorption Rate (OAR)

\[\text{OAR} = \frac{\text{Budgeted overhead expenditure}}{\text{Budgeted activity level}}\]

Activity base is usually machine hours or direct labour hours. OAR is predetermined — set at the start of the period using budgets.

Overhead absorbed by product

\[\text{Overhead absorbed} = \text{OAR} \times \text{Activity used by product}\]

Multiply OAR by the units of activity (e.g. machine hours) that the specific product uses. Gives overhead charge per unit.

Over / under absorption

\[\text{Over-absorption} = \text{Overhead absorbed} - \text{Actual overhead incurred}\]

Positive = over-absorbed (favourable, add to profit). Negative = under-absorbed (unfavourable, deduct from profit). Caused by actual activity or costs differing from budget.

Full product cost

\[\text{Full cost} = \text{Direct materials} + \text{Direct labour} + \text{Overhead absorbed}\]

The total product cost under absorption costing. Used for inventory valuation (IAS 2) and cost-plus pricing.

Week 3 — Marginal Costing & Relevant Costs

Contribution

\[\text{Contribution} = \text{Sales revenue} - \text{Variable costs}\]

The starting point for marginal costing profit statements. Contribution first covers fixed costs; the remainder is profit.

Marginal costing profit

\[\text{MC profit} = \text{Total contribution} - \text{Total fixed costs}\]

All fixed costs expensed immediately regardless of inventory movement. Fixed costs are period costs under MC.

Profit reconciliation

\[\text{AC profit} - \text{MC profit} = \Delta\text{Inventory units} \times \text{Fixed OH per unit}\]

ΔInventory = closing − opening inventory. If inventory rises, AC profit > MC profit. If inventory falls, MC profit > AC profit. If unchanged, profits are equal.

Production volume variance

\[\text{PVV} = (\text{Actual production} - \text{Budgeted production}) \times \text{Fixed OH per unit}\]

Measures under/over-absorption due to volume only. Produce less than budget → unfavourable. Produce more → favourable. Not an efficiency measure.

Relevant cost (general)

\[\text{Relevant cost} = \text{Future incremental costs} + \text{Opportunity costs}\]

Only costs that differ between options. Exclude sunk costs and committed fixed costs identical under all alternatives.

Week 4 — Cost-Volume-Profit Analysis

Mixed cost equation (y = a + bx)

\[y = a + bx\]

y = total cost, a = fixed element, b = variable cost per unit, x = activity level. Derived using the high-low method or regression.

High-low — variable cost per unit

\[b = \frac{\text{Cost}_{high} - \text{Cost}_{low}}{\text{Activity}_{high} - \text{Activity}_{low}}\]

"Rise over run." Use only the highest and lowest activity observations. Sensitive to outliers — a limitation of the method.

Contribution per unit

\[\text{Contribution} = P - VC\]

P = selling price per unit, VC = variable cost per unit. Every unit sold above breakeven contributes this amount directly to profit.

Breakeven point (units)

\[Q_{BE} = \frac{FC}{P - VC}\]

Always round UP to the nearest whole unit. At Q_BE, profit = 0. Below Q_BE, the firm makes a loss.

Target profit (units)

\[Q_{\text{target}} = \frac{FC + \pi_{\text{target}}}{P - VC}\]

Add desired profit to fixed costs before dividing. Check by proof: Q × (P − VC) − FC = π_target.

C/S ratio

\[\text{C/S} = \frac{P - VC}{P} = \frac{\text{Total contribution}}{\text{Total sales}}\]

Proportion of each £1 of sales that becomes contribution. Used when questions are in revenue terms rather than units.

Breakeven revenue

\[\text{Revenue}_{BE} = \frac{FC}{\text{C/S ratio}}\]

Equivalent to breakeven units × selling price, but calculated directly from revenue data. Useful when product mix is given as a mix of revenues.

Target revenue

\[\text{Revenue}_{\text{target}} = \frac{FC + \pi_{\text{target}}}{\text{C/S ratio}}\]

Same logic as target profit in units but gives the sales revenue figure needed.

Margin of safety (units)

\[\text{MOS} = \text{Budgeted sales} - Q_{BE}\]

How far sales can fall before a loss occurs. Express also in £ (MOS × price) and as a % of budgeted sales for full marks.

Margin of safety (%)

\[\text{MOS\%} = \frac{\text{Budgeted sales} - Q_{BE}}{\text{Budgeted sales}} \times 100\]

Higher MOS% = more cushion before losses. A firm with 5% MOS is far more exposed to a sales dip than one with 40% MOS.

Operating leverage

\[\text{Operating leverage} = \frac{\text{Total contribution}}{\text{Profit}}\]

A high ratio means profit changes dramatically with small volume changes. High fixed cost base = high leverage = high risk and high reward above breakeven.

Week 5 — Activity-Based Costing

Activity cost driver rate

\[\text{Rate} = \frac{\text{Total cost in activity pool}}{\text{Total cost driver units}}\]

Calculated separately for each activity pool. Different activities have different denominators — set-ups use number of set-ups; power uses kWh; handling uses material cost.

Overhead absorbed per product (ABC)

\[\text{OH absorbed} = \sum_i \left( \text{Rate}_i \times \text{Driver usage}_i \right)\]

Sum across all activity pools. Each pool contributes a separate charge based on how much of that activity the product consumes. The key difference from traditional costing.

Time-driven ABC — cost per time unit

\[\text{Cost per minute} = \frac{\text{Total dept overhead}}{\text{Total available minutes}}\]

Divide total department cost by practical capacity in minutes. Multiply by time per activity to cost each service.

Activity cost per service transaction

\[\text{Activity cost} = \text{Cost per minute} \times \text{Minutes per transaction}\]

Example: £600/hr practice × 20/60 = £200 per GP consultation. Simple and practical for service organisations.

Week 6 — Budgeting

Production budget

\[\text{Production} = \text{Budgeted sales} + \text{Closing FG} - \text{Opening FG}\]

The sales budget comes first — production is derived from it. Closing FG is management's desired inventory level, not a given.

Gross-up for scrap / rejection

\[\text{Required starts} = \frac{\text{Good units needed}}{1 - s}\]

s = scrap rate as a decimal. If 10% of output is rejected, produce 90,000 ÷ 0.9 = 100,000 to get 90,000 good units. Defective units cannot count as closing inventory.

Raw materials purchases

\[\text{Purchases} = \text{RM for production} + \text{Closing RM} - \text{Opening RM}\]

RM for production = production units × material per unit. Then adjust for desired closing vs existing opening RM stock.

Labour budget

\[\text{Labour cost} = \text{Production units} \times \text{Hours per unit} \times \text{Wage rate}\]

Gross up production for rejection rate before calculating hours. Labour hours = hours needed for gross (starting) production, not just good units.

Closing inventory value

\[\text{Closing inventory} = \text{Units} \times \text{Unit production cost}\]

Unit production cost = DM + DL + manufacturing OH per unit. Period costs excluded. Used in budgeted income statement and balance sheet.

Cash budget balance

\[\text{Closing cash} = \text{Opening cash} + \text{Cash receipts} - \text{Cash payments}\]

Depreciation appears in the overhead budget but NOT as a cash payment. Remove it from cash disbursements. Timing of receipts and payments is crucial — follow credit terms carefully.

Flexed variable cost

\[\text{Flexed VC} = \text{Variable cost per unit} \times \text{Actual output}\]

Fixed costs stay at budgeted level. Variable costs are multiplied by actual output before comparing with actual results. Prevents false variances from volume changes alone.

Week 7 — Variance Analysis

Material price variance (MPV)

\[\text{MPV} = AQ \times (AP - SP)\]

AQ = actual quantity. AP = actual price. SP = standard price. If AP > SP → unfavourable. Often reflects market conditions outside the buyer's control.

Material usage variance (MUV)

\[\text{MUV} = SP \times (AQ - SQ)\]

SQ = standard quantity for actual output = standard per unit × actual output. If AQ > SQ → used more than allowed → unfavourable. Valued at standard price to isolate the usage effect.

Labour rate variance (LRV)

\[\text{LRV} = AH \times (AR - SR)\]

AH = actual hours. AR = actual rate. SR = standard rate. If AR > SR → unfavourable. Overtime and use of more skilled staff are common causes.

Labour efficiency variance (LEV)

\[\text{LEV} = SR \times (AH - SH)\]

SH = standard hours for actual output. If AH > SH → took longer than standard → unfavourable. Valued at standard rate to isolate the time effect from any rate change.

Variable OH spending variance

\[\text{VOH spending} = AH \times (AR - SR)\]

Checks whether overhead cost per hour was higher or lower than standard. Same structure as labour rate variance but applied to variable overhead rates.

Variable OH efficiency variance

\[\text{VOH efficiency} = SR \times (AH - SH)\]

Reflects whether the allocation base (usually labour or machine hours) was used more or less efficiently than standard. Same as LEV structure but for overhead.

Fixed OH expenditure variance

\[\text{FOH expenditure} = \text{Actual FOH} - \text{Budgeted FOH}\]

No efficiency variance for fixed overhead — fixed costs do not vary with output. If actual FOH > budgeted FOH → unfavourable (spent more than planned).

Sales volume variance (SVV)

\[\text{SVV} = (\text{Actual units} - \text{Budgeted units}) \times \text{Standard margin}\]

Standard margin = contribution per unit (MC) or profit per unit (AC). Separates the volume effect from the static budget variance. Unfavourable if actual < budget.

Standard quantity (SQ)

\[SQ = \text{Standard per unit} \times \text{Actual output}\]

The amount of material or labour that should have been used for actual production. This is the flex point — it adjusts the standard to actual volume before comparing with actual usage.

Week 8 — Performance Measurement

Return on Investment (ROI)

\[\text{ROI} = \frac{\text{Pre-tax profit}}{\text{Net assets (investment)}} \times 100\%\]

Net assets = total assets − current liabilities. Expressed as a percentage to allow comparison across divisions. Risk: managers reject profitable projects that reduce their average %.

DuPont decomposition

\[\text{ROI} = \underbrace{\frac{\text{Profit}}{\text{Sales}}}_{\text{Return on sales}} \times \underbrace{\frac{\text{Sales}}{\text{Investment}}}_{\text{Asset turnover}}\]

Decomposes ROI into margin and efficiency. Managers can improve ROI by raising margins, increasing asset utilisation, or reducing unnecessary assets.

Residual Income (RI)

\[\text{RI} = \text{Profit} - (r \times \text{Investment})\]

r = required rate of return (cost of capital). Positive RI means profit above the minimum required. Better for goal congruence than ROI — managers accept any project with positive RI.

EVA

\[\text{EVA} = NOPAT - (WACC \times \text{Net assets})\]

NOPAT = net operating profit after tax. WACC = weighted average cost of capital. Same concept as RI but adjusted to reflect economic rather than accounting values. May require 200+ adjustments in practice.

Capital charge (for RI/EVA)

\[\text{Capital charge} = r \times \text{Investment}\]

The minimum return the division must earn to cover its cost of capital. Deducted from profit to calculate RI. A project should be accepted if its return > r (i.e. project RI > 0).

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AC106 Revision

Introduction to Management Accounting & Cost Terminology

Cost accounting vs management accounting

What counts as manufacturing overhead?

Three types of inventory in manufacturing

Worked example

Job-Order Costing & Absorption Costing

Example

Why it happens

Example

Step-down methodology

Limitations

Absorption Costing vs Marginal Costing & Relevant Costs

Marginal costing structure

Absorption costing structure

Worked example from slides

Solutions suggested

Relevant costs — include these

Irrelevant costs — exclude these

Sunk cost

Opportunity cost

Special order decisions

Cost Behaviour & Cost-Volume-Profit Analysis

Worked example — Hǎo Ltd

Peacock Ltd example

Example

Peacock Ltd after automation

Automation effect at 5,000 units

Activity-Based Costing

Example — GP practice

Advantages

Limitations

Budgeting & Planning

Seven purposes of budgets

Example

Rejection rate example

Cash receipts methodology

Cash payments methodology

Benefits

Limitations (Argyris)

Variance Analysis

Materials

Labour

Variable overhead

Fixed overhead

Performance Measurement

DuPont decomposition

Example

Example

Why RI improves goal congruence

Company X example (cost of capital = 20%)

EVA

Leading vs lagging KPIs

Cause-and-effect chain

Final Exam Map — Everything to Know Cold

Key Terms Glossary

Key Equations & Formulas