CAT 4 is accounting for costs. Basically, it deals with how to code, collect, calculate and analyze costs according to its title. More than that, it builds up a framework of how to use costing information to make simple decisions. Investment appraisal is also an important part of the syllabus.  

Paper structure

CAT 4 is mainly divided into 4 parts, absorption costing and marginal costing, job costing, service costing and process costing, CVP analysis and decision making and, investment appraisal. The picture below gives an outlook and a relationship between different parts.

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Part one: absorption costing and marginal costing (thereafter, AC and MC)

AC and MC are the core contents of the syllabus. AC looks at how to collect costs from a finance-based view, dealing with production cost and non-production cost. MC focuses on variable cost and fixed cost to help for cost analysis and decision making. 

For AC, students need to have a clear mind that production cost is made up with four elements:

Direct material

Direct labour

Direct expenses and,

Absorbed overhead costs.

AC gives great attention on how to absorb overhead costs into cost unit. Although the four steps, allocation, apportionment, reapportionment and absorbing are all included in CAT 2 syllabus, CAT 4 specially examines students’ understanding on the whole absorbing process giving computation questions on, apportionment process, step-down method of reapportionment, and absorbing overheads into cost unit. Along with the whole process, students are expected to know the arbitrary feature of overhead apportionment which may result in distorted profit per unit and mislead decision making process.

Apart from the basic computations, paper 4 tests students understanding on over-/under-absorption of overheads, which is resulted from the difference between actual and budget overhead costs, or actual and budget activity level, and or both costs and activity levels are different between actual and the budget. Students are expected to know the reasons above. To calculate over-/under-estimated overhead costs, structure below may help your thinking:

Absorbed overhead costs   (absorption rate × actual activity production level)

Actual overhead costs

Over-/(under-)absorption* (difference between the above two elements)

*when absorbed overheads is bigger than the actual, Over-absorption

 when absorbed overheads is smaller than the actual, Under-absorption

Effects on profit of over-/under-absorption should be fully concerned. For over-absorption, as there is not that much overhead costs in actual, it should be added up into income statement to reach a reasonable profit figure. Under-absorption has the opposite effect on profit and is deducted from profit.

MC considerates variable costs (thereafter VC) and fixed costs (thereafter FC)  as more than usual, VC is relevant costs to decisions, while FC is not concerned relevant in a short term except it is specially mentioned in exam questions. A simple structure of MC is below:

Sales

Minus: VC

Contribution

Minus: FC

Profit

Worth to know, VC includes both production cost and non-production cost. And the same happens to FC which is treated in total as period cost.

MC looks at max-contribution to maximize profit as FC is concerned constant unless being told.

Relationship between AC and MC is mainly tested with the profit reconciliation under two methods. Students need to be able to describe the reasons of different profits and the way to do reconciliations.

AC profit

Adjustment:

+ overheads in opening stock

- overheads in closing stock

MC profit

Part two: job costing, service costing and process costing

Job costing

Job costing tests students understanding of customer-focused production. It is possible to finish the job in one accounting period. Cost unit of job costing is the job. As it specially follows customer expectations, products of job costing is likely to be heterogeneous. Small builders and plumbers can be examples for job costing.

Collecting job costs using below structure:

Direct material

Direct labour

Direct expenses

Absorbed overheads

Other overheads

Total job cost

Service costing

Service costing is used when products are intangible, and where direct materials are relatively less than manufacturing business, while labour and overhead costs are respectively high. Service costing does not specifically deal with inventories as the service provided is the cost unit which cannot be stored.

Service costing questions can be complicating with comprehend details and composite cost units. Students are suggested to start from simplifying the requirements. For example, by translating requirements into $cost/km so that you know you need to find total costs and total kms to meet the target. Generally, activity level is easy to be found. While total costs need to be carefully and patiently collected following the sequence from the questions. Mind yourself with VC and FC as VC need to vary with the specific activity level, and FC may require you to multiply the length of the period or the number of quantity.  

Process costing

Process costing is used for continuous production with homogeneous products. Food production and oil refining can be examples for this costing method. Key points for process costing are treatments for losses (normal loss, abnormal loss and abnormal gain), costing for closing WIP and FG, joint cost splitting and further processing decisions.

Normal loss does not have a cost, but its scrap value is deducted from total input cost.

Abnormal loss/gain share a cost with normal output, which means they have the same unit cost with finished goods. When there is no closing WIP,

Unit cost of FG =

If there is closing WIP, costing for losses is not tested under CAT4 syllabus. However, how to split production cost between closing WIP and FG using equivalent unit becomes a key testing point. Mind yourself, material and conversion cost may have different complete degree. When calculating EU for closing WIP, different cost elements should be listed separately so that different EU can be found. See the below example to help your understanding:

	Total	Equivalent units
		Transferred from process 1 100%	Added material 100%	Conversion cost 30%
FG	800	800	800	800
WIP	200	200	200	60
Total EU	1000	1000	1000	860
costs		$10000	$4000	$17200
Cost/EU		$10	$4	$20

Unit cost of FG = $(10+4+20) = $34

Cost of FG = $34 × 800 = $27200

Cost of WIP = $10×200 + $4×200 + $20×60 = $ 4000

Joint cost splitting has three different ways: weighting (quantity), sales value, net realizable value. It apportions joint costs into different cost unit so that price can be decided according to costs already incurred.

Further processing decisions is made according to incremental profit figure. If it is positive, from the finance-based view, further processing should be carried out, vice versa.

Incremental sales

Incremental costs (further processing costs, both VC & FC)

Incremental profit

*always deals with incremental for decisions.

Part three: CVP analysis and decision making

CVP analysis is under MC philosophy. Key testing points are BEP, MOS, sales volume or value for a target profit, and P/V chart and conventional BEP chart.

Decision making may test students understanding on pricing, further processing decision, relevant costs, limiting factor analysis and make-or-buy decisions. Read the revision kit carefully and recall the key points before sitting in your exams.

Part four: investment appraisal

This is the last part for CAT4. It focuses on time value of capital, investment payback period, discounted cash flow, NPV analysis and the IRR of an investment. Students are required to describe each concept in detail and be able to cope with simple computations. 

Paper 4 is not a difficult paper if you follow up the key testing points and effort on grasping what is expected. Each part listed above is equally important. Students are suggested to practice past exam papers repetitively, especially correct mistakes until you reach a satisfying answer independently. When sitting in the exam, it is better to start from the requirements then move on to think what is needed in mind before you finally start to read long questions. You may feel it is easier to write down what is in your mind as it keeps a light for your solutions. You are strongly advised to practice this method during your study time.

Mind your time in the exam as CAT4 is time challenging. Do not waste too much time on questions that you feel struggling. Come back to it after you have done all that you have confidence with.

Avoid mistakes of carelessness. Do use your calculators smartly. It saves time and helps you for certain accuracy as long as you use it in a right way.

Once again, practice makes perfect and learning from mistakes. Find the mistakes, correct it, reinforce the learning outcomes, and be easy and happy with your effort before your exam.

Good luck and all the best.

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