Alternative cost accounting principles: formula sheet

Key formulas

Marginal cost per unit

Direct materials + direct labour + variable production overhead

Used to value inventory under marginal costing. Variable selling costs are not included in inventory.

Absorption cost per unit

Marginal production cost + fixed production overhead absorption rate per unit

Used to value inventory under absorption costing. Production costs only.

Fixed overhead absorption rate

Budgeted fixed production overhead ÷ budgeted activity (units or hours)

Based on budgeted, normal activity, not actual output.

Marginal costing profit

Sales − variable costs = contribution; contribution − fixed costs = profit

Variable costs of sales use marginal inventory values. Include variable selling costs, and all fixed costs.

Profit difference

Change in inventory units × fixed overhead absorption rate per unit

Absorption profit − marginal profit. Positive if inventory rises, negative if it falls. Valid when the rate is the same for opening and closing units.

Profit difference

Difference = (Closing inventory units − Opening inventory units) × fixed overhead absorbed per unit

Use units, not money values. The rate is the fixed production overhead absorption rate per unit.

Inventory increases

Absorption profit = Marginal profit + (inventory increase in units × fixed overhead per unit)

Production is greater than sales.

Inventory decreases

Absorption profit = Marginal profit − (inventory decrease in units × fixed overhead per unit)

Sales are greater than production.

Fixed overhead absorption rate

Rate per unit = Budgeted fixed production overhead ÷ Budgeted activity (units)

Only fixed production overhead counts. Selling and administration costs are period costs in both methods.

Inventory unchanged

Marginal profit = Absorption profit

Production equals sales, so no fixed overhead moves in or out of inventory.

Cost driver rate

Cost driver rate = Total cost of the activity pool ÷ Total volume of the cost driver

Calculate one rate per cost pool. Use the total driver volume across all products.

Overhead assigned to a product

Overhead assigned = Cost driver rate × Product's usage of the driver

Add the amounts from every pool to get the product's total overhead.

Overhead cost per unit

Overhead per unit = Total overhead assigned to the product ÷ Units produced

Add direct materials and direct labour for full unit cost.

Total product cost under ABC

Total cost = Direct costs + Σ (driver rate × driver usage)

Σ means add up across all activity pools.

Throughput

Throughput = Sales revenue − Totally variable costs (usually direct materials)

Direct labour is normally treated as a fixed cost unless the question says it is truly variable.

Throughput per unit of bottleneck resource

Throughput per bottleneck hour = Throughput per unit ÷ Bottleneck hours per unit

Use this to rank products when the bottleneck is limited.

Factory cost per bottleneck hour

Cost per bottleneck hour = Total factory cost ÷ Total bottleneck hours available

Total factory cost = all operating costs except direct materials.

Throughput accounting ratio (TPAR)

TPAR = Throughput per bottleneck hour ÷ Factory cost per bottleneck hour

Equivalent: Return per hour ÷ Cost per hour. Above 1 is acceptable. Higher is better.

Return per factory hour

Return per factory hour = (Sales price − Material cost) ÷ Time on bottleneck resource

Same as throughput per bottleneck hour.

Target cost

Target cost = Target selling price − Target profit

Profit can be given as an amount per unit or as a percentage of selling price. If it is a percentage of cost, convert carefully.

Cost gap

Cost gap = Expected cost − Target cost

A positive gap means costs must fall. A zero or negative gap means the target is met.

Total life cycle cost

Life cycle cost = Development + Introduction + Growth + Maturity + Decline (and disposal) costs

Add all costs from all stages. Compare with total revenue over the same life to get lifetime profit.

Life cycle cost per unit

Cost per unit = Total life cycle cost ÷ Total units over the life

Use total units for the whole life, not one year's units.

Quick revision

• Absorption costing includes fixed production overhead in the cost of each unit; marginal costing does not.
• Under marginal costing, fixed production overhead is charged as a period cost in full.
• If production is greater than sales, inventory rises and absorption costing profit is higher.
• If sales are greater than production, inventory falls and marginal costing profit is higher.
• If inventory does not change, both methods give the same profit.
• Profit difference = change in inventory units × fixed production overhead per unit.
• Marginal costing shows contribution, which is useful for short-term decisions.
• ABC shares overheads using cost drivers linked to activities, not just a single volume-based rate.
• ABC rate = cost pool ÷ number of cost driver units.
• Throughput = sales revenue − direct material cost, in the usual exam definition.
• The bottleneck limits output, so throughput accounting aims to make the best use of it.
• Target cost = target selling price − required profit margin. Life cycle costing considers costs from design to disposal.

Common mistakes

• Including fixed production overheads in marginal costing inventory values. Fix: Under marginal costing, value inventory at variable production cost only. Strip out the fixed overhead rate.
• Putting the wrong sign on the profit difference. Fix: Ask whether inventory rose or fell. Rising inventory means fixed overhead is deferred, so absorption profit is higher.
• Using total inventory units instead of the change in inventory. Fix: Always take closing minus opening units. Only the movement affects the profit difference.
• Adding the difference when inventory falls. Fix: Ask the question: is inventory up or down? Up means absorption is higher. Down means absorption is lower.
• Dividing the pool cost by the driver volume of one product only Fix: Always add driver volumes for all products first. The rate is the same for every product.
• Choosing the wrong cost driver Fix: Ask what makes the cost rise. Inspection cost rises with the number of inspections, not with units made.
• Deducting direct labour when calculating throughput. Fix: In throughput accounting, deduct only totally variable costs, normally materials. Treat labour as part of factory cost unless the question says otherwise.
• Ranking products by throughput per unit instead of per bottleneck hour. Fix: Always divide by the bottleneck hours used per unit before ranking. A product with high throughput per unit can use too much bottleneck time.
• Calculating the cost gap as target cost − expected cost. Fix: Always write expected cost first: gap = expected cost − target cost. A positive answer means costs are too high.
• Applying a profit margin percentage to cost when it was given on selling price. Fix: Read the wording. Margin on price means profit = % × price. Mark-up on cost means price = cost × (1 + %).

Exam tips

• Most questions in Section A are short reconciliations. Learn the quick method so you finish them in about two minutes.
• Always identify whether inventory rose or fell first. It tells you which profit is higher before you calculate anything.
• If the exam asks which statement is true, remember that profits are equal when inventory is unchanged, assuming the same unit costs.
• Read carefully for variable selling costs and fixed non-production costs. They are the usual traps in marginal costing layouts.
• For number entry questions, round only at the end and check whether the answer should be positive or negative.
• Read what profit you are given. Many questions give the marginal profit and ask for absorption profit, or the reverse. Adding when you should subtract is the commonest slip.
• Write the direction before you calculate: inventory up or down. It takes five seconds and prevents sign errors.
• In multiple response questions, check which statements are true for each inventory movement. Statements about equal profits are only true when inventory is unchanged.