CMA Foundation · Fundamentals of Financial and Cost Accounting

Classification of Costs (CAS 1): formula sheet

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Key formulas

Elements of cost: Cost = Material + Labour + Expenses; Every cost falls in one of these three elements.
Direct cost: Direct cost = Direct material + Direct labour + Direct expenses; This total is called prime cost.
Indirect cost: Overheads = Indirect material + Indirect labour + Indirect expenses; Also called overhead. Must be apportioned or absorbed, not traced.
Total cost link: Total cost = Prime cost + Overheads; Overheads here include factory, administration and selling and distribution overheads.
Prime cost: Prime cost = Direct material + Direct labour + Direct expenses; Part of production cost. Excludes all overheads.
Factory (works) cost: Factory cost = Prime cost + Factory overheads; Adjusted for work-in-progress changes in a full cost sheet.
Cost of production: Cost of production = Factory cost + Administration overheads; As in the standard cost sheet, administration overheads are added at this stage. Do not add them again later.
Cost of goods sold / Cost of sales: Cost of sales = Cost of production (adjusted for finished goods stock) + Selling and distribution overheads; Selling and distribution costs are added after cost of production is complete. Administration is not added again.
Functional split rule: Production = making; Administration = managing; Selling = getting orders; Distribution = delivering; R&D = developing; Use this one-line test to place any cost item.
Total fixed cost: Total fixed cost = constant within the relevant range; Does not change with output in total. Fixed cost per unit = Total fixed cost ÷ Units, which falls as units rise.
Total variable cost: Total variable cost = Variable cost per unit × Units; Variable cost per unit is constant. Total rises in proportion to units.
Semi-variable cost: Total cost = Fixed part + (Variable rate × Units); Use this to find the cost at any activity level once the two parts are known.
Variable rate from two levels (high-low): Variable rate = (Cost at high level − Cost at low level) ÷ (High units − Low units); Then Fixed part = Total cost − Variable rate × Units at either level.
Total cost: Total cost = Total fixed cost + Total variable cost; Cost per unit = Total cost ÷ Units.
Controllable cost test: Controllable = the specified manager can influence the cost in the specified period; Both the manager and the time period must be named. Without them you cannot classify a cost.
Level of management rule: Non-controllable at a lower level may be controllable at a higher level; A cost is non-controllable only for the manager who lacks authority over it.
Responsibility reporting: Manager's performance is judged on controllable costs only; Non-controllable costs are excluded or shown separately when evaluating a manager.
Treatment of normal cost: Normal cost → included in the cost of good production; It raises the cost per good unit.
Treatment of abnormal cost: Abnormal cost → written off to Costing Profit and Loss Account; It is not included in product cost or stock valuation.
Cost per unit with normal loss: Cost per unit = (Total cost − Scrap value of normal loss) ÷ (Input units − Normal loss units); Divide by expected good output, not by actual output.
Abnormal loss units: Abnormal loss = Actual loss units − Normal loss units; Use this only when actual loss is more than normal loss.
Value of abnormal loss: Abnormal loss cost = Abnormal loss units × Cost per unit, less any scrap value realised on those units; The net amount is transferred to the Costing Profit and Loss Account.
Relevant cost test: Relevant cost = future cost that differs between alternatives; Both conditions are needed. Past costs and common costs are irrelevant.
Differential cost: Differential cost = Cost of Alternative A − Cost of Alternative B; Also used for the change in total cost when output changes. Can include fixed cost changes.
Marginal cost per unit: Marginal cost per unit = Direct material + Direct labour + Direct expenses + Variable overhead per unit; Assumes fixed costs do not change with one more unit.
Opportunity cost: Opportunity cost = Benefit lost from the best rejected alternative; Take only the best alternative given up, not the sum of all.
Sunk cost rule: Sunk cost → ignore in decisions; Past, unrecoverable and unaffected by the decision.
Historical cost: Historical cost = Actual cost incurred (known after the event); Also called actual cost. It is ascertained after production or service is completed.
Estimated cost: Estimated cost = Predicted cost (set before the event, based on past data and expected changes); Used for quotations, tenders and pricing. It is a forecast and can differ from actual.
Standard cost: Standard cost = Predetermined target cost under defined efficient conditions; Used for control. Variance = Actual cost − Standard cost.
Cost centre vs cost unit: Cost centre = where cost is collected; Cost unit = what cost is measured per; Cost centre is a place, person or function. Cost unit is a measure of output.
Cost per unit: Cost per unit = Total cost ÷ Number of cost units; The cost unit must be the one that suits the industry, such as tonne, kWh or passenger-km.

Quick revision

Bases of classification: nature, function, behaviour, controllability, normality, decision use, and more.
Elements of cost are material, labour and expenses; each can be direct or indirect.
Direct costs can be traced to a cost unit; indirect costs are common and need apportionment or absorption.
Functional classes include production, administration, selling and distribution, and research and development.
Fixed cost: total stays the same within a range of output; per unit cost falls as output rises.
Variable cost: total changes with output; per unit cost stays the same.
Semi-variable cost has a fixed part and a variable part.
A controllable cost can be influenced by a given manager at a given level; otherwise it is non-controllable.
Normal cost is expected at normal output; abnormal cost is beyond normal and is not part of product cost.
Sunk cost is already spent and is irrelevant to a future decision.
Opportunity cost is the benefit given up by choosing one option over the next best.
Marginal cost is the change in total cost from producing one more unit. It consists of variable costs only: direct material, direct labour, direct expenses and variable overheads.
Historical cost is actual cost incurred; standard cost is a predetermined target; estimated cost is a forecast.

Common mistakes

Treating all wages as direct labour. Fix: Only wages of workers who make the product are direct. Salaries of supervisors, storekeepers and cleaners are indirect labour.
Calling every material direct. Fix: Fuel, lubricants, cotton waste and small items like screws are indirect material because they are not traced to a unit.
Treating selling and distribution as the same thing. Fix: Selling means securing orders, such as advertising and commission. Distribution means moving goods to the customer, such as carriage outwards.
Putting carriage inwards under distribution. Fix: Carriage inwards is the cost of bringing materials to the factory, so it is part of material cost and production. Only carriage outwards is distribution.
Saying fixed cost per unit is constant. Fix: Remember: fixed is fixed in total; per unit it falls as output rises. Variable is the opposite: constant per unit, changing in total.
Treating a semi-variable cost as fully variable. Fix: Split it first. Only the variable part scales with activity; the fixed part stays.
Treating all fixed costs as non-controllable and all variable costs as controllable. Fix: Judge by authority, not behaviour. Ask who can change the cost. Top management can control some fixed costs.
Ignoring the level of management in the question. Fix: Always identify the manager first. The same cost can change category when the level changes.
Adding abnormal loss to the cost of good units Fix: Only normal loss is absorbed by good units. Abnormal loss goes to the Costing Profit and Loss Account.
Dividing total cost by actual output to get cost per unit Fix: Divide by input minus normal loss units, which is expected good output.

Exam tips

Most questions are one-line: 'Which of the following is an indirect cost?' Use the two-question test and finish in under 30 seconds.
Watch the product named in the question. The same item can be direct or indirect depending on it.
Remember that direct expenses exist. Options that say 'prime cost has only material and labour' are wrong.
In sums, first sort items into direct and indirect on rough paper, then add. This avoids missing an item.
Skip items such as interest, tax and dividends when summing costs.
Read the cost item for location words such as factory, office, showroom or outward. They usually decide the answer.
Expect questions that ask you to separate selling from distribution. Learn one example of each.
Watch for carriage inwards versus carriage outwards. Examiners use this as a trap.