ACCA Applied Knowledge · Management Accounting

Cost classification: formula sheet

Full chapter guide

Key formulas

Prime cost: Prime cost = direct materials + direct labour + direct expenses; Only direct costs. Overheads are never in prime cost.
Total production cost: Production cost = prime cost + production overheads; Production overheads include indirect materials, indirect labour and indirect expenses of the factory.
Total cost: Total cost = production cost + administration, selling and distribution overheads; Also called full cost or total cost of sales when other overheads are included.
Overheads: Overheads = indirect materials + indirect labour + indirect expenses; Overheads can be split by function: production, administration, selling and distribution.
Selling price from cost plus: Selling price = total cost + profit; If profit is a margin on sales, divide total cost by (1 − margin %). If it is a mark-up on cost, multiply total cost by (1 + mark-up %).
Total production cost: Direct materials + Direct labour + Direct expenses + Production overheads; Direct costs plus factory overheads. Excludes administration, selling, distribution and finance costs.
Total cost of sales (full cost): Production cost + Administration + Selling and distribution (+ Finance if included); Used when a question asks for the full cost of a product. Read the wording to see which functions to include.
Inventory valuation rule: Inventory cost = production costs only (absorption costing); Non-production costs are period costs and are not put into inventory.
Total cost (linear): y = a + bx; y = total cost, a = fixed cost, b = variable cost per unit, x = activity level.
Variable cost per unit (high-low): b = (cost at highest activity − cost at lowest activity) ÷ (highest activity − lowest activity); Use the highest and lowest activity levels, not the highest and lowest costs, unless they coincide.
Fixed cost (high-low): a = total cost at either level − (b × activity at that level); Using the high or the low level gives the same answer.
Fixed cost per unit: Total fixed cost ÷ number of units; Falls as activity rises. Total fixed cost does not change in the relevant range.
Relevant cost test: Relevant = future + cash flow + differs between options; All three conditions must hold. Fail any one and the cost is not relevant.
Opportunity cost of using a resource: Opportunity cost = contribution or benefit lost from the next best use; Include it in addition to any extra cash cost of using the resource.
Relevant cost of materials already in inventory: If no other use: scrap or resale value. If it would be replaced: replacement cost; The original purchase price is sunk and is never used.
Closure decision: Keep if avoidable revenue lost > avoidable costs saved; Ignore unavoidable costs such as apportioned head office costs.
Responsibility centre scope: Cost centre: costs. Profit centre: costs + revenues. Investment centre: costs + revenues + assets; Revenue centres are responsible for revenue only.
Purpose of a code: Code = identifier of cost type + location + purpose (as designed); This is a description, not a calculation. Each part of the code answers one question about the cost.
Qualities of a good coding system: Unique, simple, consistent, flexible, meaningful, compact; Use as a checklist when asked to assess or design a code.
Code types: Sequential, block, hierarchical, faceted, mnemonic (numeric, alphabetic, alphanumeric); Know one-line definitions and an example of each.
Information uses: Planning, control, decision making; Link each use to the cost classification that supports it.

Quick revision

Elements of cost are materials, labour and expenses; each can be direct or indirect.
Direct costs can be traced to a cost unit; indirect costs (overheads) cannot economically be traced.
Prime cost = direct materials + direct labour + direct expenses.
Functional classes are production, administration, selling and distribution, and finance.
Fixed costs stay constant in total within the relevant range; fixed cost per unit falls as activity rises.
Variable costs change in total with activity; variable cost per unit stays constant.
Semi-variable (mixed) costs have a fixed part and a variable part; stepped costs jump at set activity levels.
High-low method: variable cost per unit = change in total cost ÷ change in activity.
Relevant costs are future, cash and differ between alternatives; sunk and committed costs are not relevant.
An opportunity cost is the benefit lost from the next best alternative.
A controllable cost can be influenced by a manager at a given level; others are uncontrollable by that manager.
Codes should be unique, simple and consistent so costs go to the correct cost centre or unit.

Common mistakes

Putting all labour into direct labour. Fix: Only labour that works directly on the product is direct. Supervisors, cleaners and maintenance staff are indirect labour.
Including factory overheads in prime cost. Fix: Prime cost is direct costs only. Add production overheads afterwards to reach production cost.
Classifying all rent or depreciation as production cost. Fix: Check where the asset is used. Factory building is production, head office is administration, showroom is selling.
Including selling and administration costs in inventory valuation. Fix: Under absorption costing, only production costs go into inventory. The rest are period costs.
Picking the highest and lowest costs instead of the highest and lowest activity levels in the high-low method. Fix: Always scan the activity column. Choose those two rows, then read off their costs.
Saying fixed cost per unit is constant. Fix: Remember: total fixed stays constant, per unit falls as output rises. Total variable rises, per unit stays constant.
Including the original cost of inventory already bought as a relevant cost. Fix: It is sunk. Use resale value or replacement cost, depending on whether the material would be replaced.
Treating depreciation and apportioned overheads as relevant. Fix: They are non-cash or unchanged by the decision. Only include extra cash costs caused by the decision.
Confusing a block code with a sequential code. Fix: Sequential codes just run in order. Block codes reserve a range for each group, such as 100-199 for materials.
Thinking a cost code is the same as a cost centre. Fix: A cost centre is a place or function that incurs cost. A code is the label used to record cost against it.

Exam tips

In multiple choice questions, check the cost unit first. The same cost can be direct or indirect.
For number entry questions on prime cost, list only direct items and add them. Leave out everything else.
In multiple response questions, select exactly the stated number of options. Do not add extras.
Watch for words like depreciation, supervisor, rent and insurance. These usually signal indirect costs.
Read the last line of the question. It may ask for prime cost, production cost or total cost, and each needs a different stop point.
Look for location words such as factory, office, showroom and delivery. They usually give the function.
In inventory valuation questions, strip out every non-production cost before you add.
Read whether finance costs are in or out of the total. Most questions leave them out.