Cost Accounting

Cost classifications

• Direct costs can be traced to a product (direct materials, direct labour); indirect costs (overheads) cannot.
• Variable costs change in total with output; fixed costs stay the same in total within a range of output.
• Manufacturing (production) costs versus non-manufacturing costs (administrative, selling and distribution).

Absorption costing and marginal costing

	Absorption costing	Marginal costing
Product cost	All manufacturing costs, including fixed manufacturing overheads	Variable manufacturing costs only
Fixed manufacturing overheads	Absorbed into units; part carried forward in closing inventory	Charged in full as a period cost
Income statement shows	Gross profit	Contribution margin

When production exceeds sales, absorption costing reports a higher profit, because part of the fixed overheads is carried forward in closing inventory.

Cost-volume-profit (CVP) analysis

$\text{Contribution per unit} = \text{Selling price per unit} - \text{Variable cost per unit}$

$\text{Breakeven point (units)} = \frac{\text{Total fixed costs}}{\text{Contribution per unit}}$

$\text{Sales units for a target profit} = \frac{\text{Total fixed costs} + \text{Target profit}}{\text{Contribution per unit}}$

$\text{Margin of safety} = \text{Budgeted (actual) sales} - \text{Breakeven sales}$

Relevant costs for decision making

Relevant costs are future costs that differ between alternatives. Sunk costs and fixed costs that will be incurred anyway are irrelevant.

• Accept or reject an order at a special price: with spare capacity, accept if the special price is above the variable cost per unit (positive contribution). Also consider whether regular customers will demand the same lower price.
• Hire, make or buy: compare the relevant cost of making (variable costs plus any avoidable fixed costs) with the purchase price. Non-financial factors: quality, reliability of the supplier, other uses of the spare capacity.
• Limiting factor: when a resource is scarce, rank products by contribution per unit of the limiting factor.

Common mistake: using the full cost per unit, which includes allocated fixed costs, for a special-order decision. Fixed costs do not change, so they are not relevant.