Cost Accounting

---
name: cost-accounting
description: Establishes what something actually costs — fixed, variable and mixed cost behavior, absorption versus variable costing, job-order, process and activity-based methods, breakeven and operating leverage, and price/volume/mix decomposition. Use this to set a price floor, explain why revenue or margin moved, decide make versus buy, judge whether a product line earns its place, or work out how an allocation basis is distorting a reported margin.
---

# Cost accounting

Most bad pricing decisions, bad product-line decisions, and bad margin arguments come from the same
place: nobody agrees what the thing costs.

## Classify cost behavior before you allocate anything

- **Fixed** costs do not move with volume — within a relevant range. Outside that range they step,
  and the step is usually large: another shift, another facility, another tier of licensing.
- **Variable** costs move with each unit: materials, payment processing, per-unit fulfillment,
  usage-based infrastructure.
- **Mixed** costs have both, and most real accounts are mixed. Split them with high-low or a
  regression on historical volume rather than guessing the proportion.

The split is not academic. Variable cost sets the floor for one more incremental order. Fully
loaded cost sets the floor for the business as a whole. Confusing the two is how companies price
themselves into volume that loses money.

## Know which costing basis you are looking at

**Absorption costing** puts fixed production overhead into inventory and releases it when the unit
sells. **Variable costing** expenses that overhead as incurred.

Absorption is what external reporting requires. Variable is what decisions want. The consequence
worth carrying: under absorption, producing more than you sell moves fixed cost onto the balance
sheet and raises reported profit without a single additional sale. When margin improves and
inventory grows in the same period, check whether that is what happened.

## Match the costing method to how the work actually runs

- **Job-order** — distinct, identifiable jobs. Construction, custom manufacture, print runs, agency
  engagements. Cost accumulates per job.
- **Process** — continuous, homogeneous output. Chemicals, food, high-volume components. Cost
  accumulates per period and divides across equivalent units.
- **Activity-based** — worth the overhead when indirect cost is large and consumed unevenly. Its
  value is rarely precision; it is discovering that a low-volume product consumes a
  disproportionate share of support, setup, or handling.

**Choose an allocation driver that causes the cost.** Allocating overhead on revenue is not costing,
it is redistribution — it guarantees the largest product looks worst and tells you nothing.

## Breakeven, margin of safety, and operating leverage

Contribution margin is revenue less variable cost. Breakeven volume is fixed cost divided by
contribution per unit; margin of safety is how far current volume sits above it.

Operating leverage follows from the mix: a high fixed-cost structure amplifies profit on the way up
and losses on the way down. It is a deliberate choice about how much volatility the business can
absorb, and it should be made deliberately rather than accumulated.

## Decompose price, volume and mix

Revenue moved for three reasons and you cannot manage any of them until they are separated.

- **Price** — the change in realized price applied at actual volume.
- **Volume** — the change in units applied at the original price.
- **Mix** — the shift in what sold, toward or away from higher-margin items.

This is the single most useful technique here and the one most often skipped. Without it, a mix
shift toward an expensive product gets reported as a pricing win, and a discount gets buried under
volume growth.

## Never

- Allocate overhead on revenue and present the result as a product margin.
- Quote a long-term price off variable cost. It covers the incremental order and nothing else.
- Compare absorbed unit cost across periods without checking whether production volume changed.
- Attribute a revenue change to price without separating volume and mix.