Cost Accounting Basics

Cost Accounting Basics

🟢 Lite — Quick Review (1h–1d)

Rapid summary for last-minute revision before your exam.

Cost accounting captures the money spent on materials, labour and overhead so management can price products, control spending and judge performance. The two build-up formulas every ICAN candidate must memorise:

• Prime Cost = Direct Materials + Direct Labour (production costs traceable to the item, no overhead).
• Conversion Cost = Direct Labour + Manufacturing Overhead (the cost of converting raw inputs into finished goods).

Together with Manufacturing Overhead they yield Total Production Cost. Behaviour-wise, costs split into fixed (rent, depreciation — unchanged by volume), variable (raw materials, sales commission — change proportionally with output) and semi-variable/mixed (e.g. telephone bills with a line rental plus usage charge). Under marginal costing only variable costs are product costs; under absorption costing fixed production overhead is absorbed into unit cost, so the two methods report different profits whenever inventory levels change.

---

🟡 Standard — Regular Study (2d–2mo)

Standard content for students with a few days to months.

Cost classification

Costs are grouped three ways. By behaviour: fixed, variable, semi-variable (split using high–low or scattergraph method). By traceability: direct cost (charged in full to a single cost unit, e.g. timber for a chair) versus indirect cost (shared across cost units via allocation and apportionment). By function: production/manufacturing, selling, distribution and administration — only production costs enter inventory valuation under both IAS 2 and ICAN’s framework.

Cost build-up

Working from the bottom:

1. Direct Materials + Direct Labour = Prime Cost
2. Prime Cost + Manufacturing Overhead = Works/Production Cost
3. Works Cost + Opening WIP − Closing WIP = Cost of Goods Manufactured
4. Cost of Goods Manufactured + Opening FG − Closing FG = Cost of Sales

Marginal vs absorption profit

Under marginal (variable) costing, fixed production overhead is period cost. Under absorption costing, it is absorbed into units using OAR = Budgeted Overhead ÷ Budgeted Activity (machine- or labour-hour base). When production exceeds sales, absorption profit > marginal profit because some fixed overhead is deferred in closing inventory; when sales exceed production the reverse occurs.

CVP and break-even

Contribution Margin = Sales − Variable Cost. Break-even point (units) = Fixed Cost ÷ Contribution per unit. The same denominator is used for margin of safety and target-profit calculations. ICAN’s Financial Accounting & Reporting paper usually tests break-even and contribution computations as 3–4 mark MCQs or short computations.

Standard costing and variances

Standard costs act as benchmarks. The two elemental variances most often tested:

• Material Price Variance = (Standard Price − Actual Price) × Actual Quantity (favourable when actual price is lower).
• Labour Rate Variance = (Standard Rate − Actual Rate) × Actual Hours.

Volume and efficiency variances follow the same (Standard − Actual) × Standard logic.

---

🔴 Extended — Deep Study (3mo+)

Comprehensive coverage for students on a longer study timeline.

Allocation, apportionment and absorption

Indirect costs first allocated to cost centres using a direct basis (e.g. floor area for rent), then apportioned between production and service centres using reciprocal or step-down methods, and finally absorbed into cost units through a pre-determined overhead absorption rate (OAR). Under-absorption (actual overhead > absorbed) and over-absorption are reconciled to cost of sales in the period they arise.

CVP edge cases

Where products are multi-mix, compute a weighted average contribution per unit before applying the break-even formula — assuming a constant sales-mix ratio. Semi-variable costs must be split (high–low: y = a + bx) before CVP analysis; treating them as purely fixed or variable distorts both break-even and margin of safety.

Reconciling profits

Reconciliation: Absorption profit − Marginal profit = (OAR × Change in inventory units). Candidates frequently forget the opening/closing inventory adjustment — a classic 4–5 mark ICAN trap.

Activity-based costing (ABC)

ABC traces overhead to activities then to cost objects using cost drivers (number of set-ups, purchase orders, inspections). It produces more accurate product costs in environments with high overhead and product diversity, but demands richer data collection than traditional volume-based absorption.

Common mistakes

• Confusing prime cost with conversion cost (only one contains overhead).
• Absorbing selling and administration overhead into inventory — IAS 2 forbids it.
• Using absorption profit for short-term decisions; only relevant costs (future, incremental, cash) matter.
• Computing break-even with total contribution instead of per-unit contribution.

Practice prompts

1. A product sells for ₦2,000, variable cost ₦1,200, fixed cost ₦400,000. Compute break-even units and units required for a target profit of ₦160,000.
2. Standard: 5 kg @ ₦200/kg. Actual: 5,200 kg costing ₦1,092,000. Calculate the material price and usage variances.

---

Content adapted based on your selected roadmap duration. Switch tiers using the selector above.