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.
Sources
references/sources.md in this skill lists the outside authorities that settle the questions
here — what each one is authoritative for, and what you may do with it. Check them before
answering on anything they cover, and cite what you used. Most are free to read and not free
to reproduce; the use note on each is binding.
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.
