A controller is asked why operating income jumped $40,000 when units sold stayed flat. The answer sits in absorption costing capitalizing fixed factory overhead into a growing inventory, and the exam rewards candidates who can name the method, the formula for the gap, and the allocation choice in three sentences.
Fixed costs (rent, salaried supervisors) stay constant in total within a relevant range and decline per unit as volume rises. Variable costs (direct materials, hourly piece-rate labor) stay constant per unit and rise in total with volume. Mixed costs (utility bill with a base charge plus usage) split into a fixed component and a variable rate.
TRAP: Outside the relevant range, fixed costs step up (new lease, new shift supervisor) and variable rates shift (volume discounts, overtime premiums). Long term, nearly every cost behaves as variable because capacity is revisited. Short term, even direct labor can act fixed if layoffs are impractical.
A cost object is anything you want costed: a product, a department, a customer, a project.
Common mistakes
- Treating fixed cost per unit as fixed. Fixed cost per unit falls as volume rises within the relevant range. Total stays flat, per-unit does not. The exam puts a per-unit fixed figure in the stem to trap you.
- Using normal costing actuals for overhead. Normal costing applies a predetermined OH rate × actual driver, not actual overhead. The actual-versus-applied gap is the over/under-applied balance reconciled at period end.
- Forgetting that production equals sales kills the gap. When production = sales, absorption and variable operating income are identical. Candidates routinely compute a gap when none exists.
Bottom line
- Fixed costs are constant in total within the relevant range; variable costs are constant per unit; mixed costs follow y = a + bx (so fixed cost per unit falls as volume rises)
- Cost drivers must have a causal link to the pool, not just correlation; the driver anchors every allocation downstream
- Job, process, and operation costing accumulate WIP differently based on product homogeneity, with process costing using equivalent units
- Actual costing uses actuals throughout; normal costing uses a predetermined OH rate times actual driver (creating an over/under-applied balance); standard costing uses standards and isolates variances
Exam shortcut
When a question gives production and sales units plus fixed OH, compute the income gap first: change in inventory units × fixed OH per unit. The sign follows production minus sales. That single number often is the answer choice. When the stem names a costing technique, lock the formula: actual = actual × actual; normal = predetermined rate × actual driver; standard = standard × standard.
The full lesson (about 2,032 words, 14 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- 1D1
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