Al Wadi International International School ABSORPTION COSTING – (NOTES) Absorption costing is also full or total costing. The key principle of absorption also know known n as full costing is that all overheads are ‘absorbed’ in cost units. In other words, all overheads are includ included ed when when calcul calculati ating ng the cost cost of produci producing ng partic particula ularr items. items. The main main diffic difficult ulty y in absorption costing is deciding how to divide the cost of overheads between these cost units. There are four main stags in the absorption costing process. •
•
•
•
The first stag is the allocation of those overhead costs that are directly incurred by particular cost centres. The scon! scon! stag is to apportion i.e., divide, all shared overheads between the production and service cost centres. The t"ir! stag is to apportion (or ‘reapportion’) all service cost centre overheads to the production cost centres. The final stag is to absorb the allocated and apportioned overheads into the costs of production of cost units.
Cost Cntrs an! Cost #nits
In order to carry out absorption costing, the production costs and overheads of running a busine business ss must must be collec collected ted and recorded. recorded. cost cntr is a particular area or point of a business for which costs are collected. !epending on the type of business, a cost centre might be" geographical geographical location, such as a factory, factory, a sales region or a shop# • •
functional functional department, such as production or distribution#
•
n item of e$uipment or machinery, machinery, such as a vehicle vehicle or photocopier#
•
person, such as a sales representative representative or maintenance worker.
In the case of manufacturing businesses, there are t$o main types of cost centres# •
•
Pro!uction cost cntrs , for e%ample production departments such as machining or assembly. Sr%ic cost cntrs , for e%ample service departments such as administration and distribution. &ometimes these are sub'divided into smaller cost centres such as ‘stores’ or ‘canteen’, or into items of e%pense that are shared between departments such as ‘heat and light’ or ‘rent and rates’.
hen costs have been collected and recorded in cost centres, the process of absorption costing involves involves calculating calculating the cost of each unit of production production or cost unit. This might be a single finished product, such as a chair, a batch of finished products, such as a thousand loaves of bread, or a sub'assembly, such as an aircraft wing.
Absorption Costing Costing
1
Al Wadi International International School Cost allocation
hen cost accountants calculate the total cost of operating a cost centre, they must include both the !irct and in!irct costs of production. !irect costs are, by definition, associated with particular particular products or cost units and can therefore therefore be charged charged to the relevant cost centre. or e%ample, the wages paid to assembly line workers can be allocated directly to the production department. Indirect costs or overheads that are wholly associated with a particular cost centre can also be charged ‘directly’ to that cost centre. The process is known as cost allocation& or e%ample, the wages of an assembly line supervisor or the depreciation on an assembly line machin machine e can both both be alloca allocated ted direct directly ly to the produc productio tion n depart departmen ment. t. *%amp *%amples les of cost cost allocation also occur in service cost centres. or instance, the paper used in a photocopying machine might be charged directly to the administration department. The rent payable for a sales office might be charged directly to the sales department. Apportionmnt of O%r"a!s to cost cntrs
In many cases, it is not possible to allocate overheads directly to cost centres because the costs are shared between several. or e%ample, the cost of heating, insurance and maintenance might all be shared between a number of production and service departments. +nder these circumstan circumstances, ces, cost apportionmnt is used to divide the costs between the various cost centres. number of methods or bass can be used to apportion overheads. There are no set guidelines guidelines when it comes to selecting selecting bases for apportionment. apportionment. owever, owever, the basis should be 'uitabl. This means that a fair share of the overheads should be apportioned to the relevant cost centre. It is important for overheads to be apportioned fairly because businesses will want to determine as accurately as possible the true cost of operating each cost centre. If overheads are not apportioned fairly, the business might charge an inappropriate price to its customers. nother reason is to avoid unfair discrimination between cost centres. -anagers responsible for cost cost cent centres res migh mightt be demo demoti tiva vate ted d if thei theirr cent centre res s are are char charge ged d an unre unreal alis isti tic c shar share e of overheads. overheads. It would would suggest suggest that their centres are more e%pensive e%pensive to operate operate than they really are. Eampl *ntons +t!, a clothing manufacturer. Three overheads incurred by !entons are ,-./... for ,0./. ... in wages ,1./.. ... . for insuri heating/ ,0./ wages for two two superv superviso isors rs and ,1./ insuring ng e$uipm e$uipment ent.. The business is divided into four cost centres. The cutting and assmbl2 !partmnts are both pro!uction cost cntrs and the cantn and maintnanc !partmnts are both sr%ic cost cntrs. Bass for apportioning o%r"a!s O%r"a!s ent and rates eating and lighting /ersonnel /ersonnel costs costs for e.g e.g (health (health and welfare welfare)) 1uilding insurance
-achinery and e$uipment insurance !epr !eprec ecia iati tion on (pla (plant nt,, mach machin iner ery y and and tools tools)) -aintenance &upervisory costs &taff canteen dministration
Absorption Costing Costing
Possibl basis of apportionmnt loor area of cost centres loor area, or volume of space, occupied by cost centres 0umber 0umber of staff staff employ employed ed by each cost cost centre centre loor area, or book value of buildings, in each cost centre 1ook value of machinery2e$uipment in each cost centre 1ook 1ook val value ue of of asse assets ts in in each each cost cost cent centre re 1ook value of assets in each cost centre 0o. of staff, or hours worked by supervisor, in each cost centre 0o. of staff employed in each cost centre 0o. of staff employed or direct labour costs in each cost centre
2
Al Wadi International School T" four cost cntrs in *ntons +t!& Cutting 34m3 64 :45,555
loor area &taff employed 1ook value of e$uipment
Assmbl2 355m3 95 :694,555
Cantn 655m3 3 :65,555
3aintnanc 74m3 9 :4,555
Total 855m3 45 :355,555
4ating
The heating cost of ,-./... can be apportioned according to the production of total floor space that each cost centre occupies. The amount to be apportioned to each cost centre is calculated using the formula" 5loor spac occupi! b2 Cost cntr Cost to b apportion!6 7777777777777777777777777777777777777777777777777 Total 4ating Cost Total 5loor spac
&o"
;utting <
25m2
×
400m2
ssembly <
;anteen <
$10, 000 = $625
200m2 400m
100m2 400m2
2
×
×
$10, 000 = $5, 000
$10, 000 = $2, 500
75m 2
-aintenance <
400m
2
×
$10,000 = $1,875
Supr%ision
The supervisory costs of ,0./... can be apportioned according to the proportion of total staff employed in each cost centre. The amount to be apportioned to each centre is calculated using the formula" No& of staff mplo2! b2 Cost cntr Cost to b apportion!6 7777777777777777777777777777777777777777777777777 Total Supr%ision Cost Total numbr of staff
&o"
;utting <
15 50
×
ssembly <
;anteen <
$40,000 = $12,000
30 50 2
50
×
-aintenance <
Absorption Costing
×
$40,000 = $24,000
$40,000 = $1,600 3 50
×
$40, 000 = $2, 400
3
Al Wadi International School Insuranc
The insurance cost of ,1./... can be apportioned according to the proportion of the total book value of e$uipment used in each cost centre. The amount to be apportioned to each centre is calculated using the formula" Boo8 %alu of 'uipmnt in cost cntr Cost of apportion! 6 77777777777777777777777777777777777777777777777777777 Total insuranc cost Total boo8 %alu
&o"
;utting <
50,000 200,000
ssembly <
;anteen <
×
135,000 200,000 10,000
200,000
-aintenance <
$20, 000 = $5, 000
×
×
$20,000 = $13,500
$20,000 = $1,000
5,000 200,000
×
$20, 000 = $500
&ometimes more than one basis of apportionment could be used in a particular cost centre. or e%ample, heating costs could be apportioned according to floor area or to the volume of space occupied by each cost centre. It is, to some e%tent, a sub9cti% 9u!gmnt which basis is chosen. owever, the decision should be consistent and appropriate, and it should always be made clear which basis is chosen. S"ar of o%r"a!s apportion! to cost cntrs Basis 5loor ara eating &upervisory 0o. =f employee s Insurance 1ook value Total
Cutting ,
Assmbl2 :
Cantn ,
3aintnanc ,
:1;
;/...
1/;..
-/<=;
63,555
38,555
6,>55
3,855
Total , 65,555 85,555
35,555 4,555 -=/:1;
69,455 01/;..
6,555 ;/-..
455 0==;
=./...
Apportionmnt of Sr%ic cost cntr o%r"a!s
In order to calculate the full cost of producing each cost unit, it is necessary to apportion the service cost centre overheads to the production cost centres. This process is sometimes called rapportionmnt or scon!ar2 apportionmnt& &o, for e%ample, the costs involved in operating service departments, such as stores, planning, canteen and maintenance, must be shared between the production departments. The reason for this is that it is only the production cost centres that are directly associated with the manufacture of the cost units. number of different apportionment bases can be used when apportioning service cost centre overheads.
Absorption Costing
4
Al Wadi International School Bass for apportioning sr%ic cntr cost o%r"a!s Sr%ic cost cntr ;anteen -aintenance /lanning &tores
Possibl basis of apportionmnt 0umber of staff or meals served in each cost centre ours of maintenance work carried out for each cost centre 0umber of hours worked in each cost centre 0umber of times that materials are re$uisitioned by each cost centre
;onsider again the e%ample of !entons ?td. *%ample below shows how the company’s overheads are allocated and apportioned to four cost centres. The first line shows that some costs are allocated directly to the cost centres. These costs include, for e%ample, overheads such as depreciation on e$uipment that is used in each cost centre. They also include some direct costs such as direct labour. The second line shows the apportioned costs. S"ar of o%r"a!s allocat! an! apportion! to cost cntrs& Cutting (production)
llocated costs pportioned costs Total
Assmbl2 (production)
Cantn (service)
3aintnanc (service)
-./;..
0/0..
:/:..
67,>34 1:/-1;
83,455 ;>/...
4,655 ?/;..
8,774 --/>=;
Total >./...
75,555 -../...
The costs associated with the t$o sr%ic cost cntrs are reapportioned in the following ways" •
Cantn ccording to the number meals served to staff employed in each cost centre#
•
3aintnanc ccording to the number of hours that maintenance staff work in each cost centre.
*%ample below shows that >.@ (i&& >=;. mals -1;.. mals) of the costs associated with the canteen are apportioned to the cutting !partmnt and :.@ (i&& =/;.. mals -1/;.. mals) are apportioned to the assmbl2 !partmnt. 0ote also that -.@ (-/1;. mals -1/;.. mals) of the canteen costs are apportioned to the other service department, maintnanc. This is because the maintenance workers also make use of the canteen. The costs associated with the maintenance department are split e$ually between the cutting and assembly departments. This is because, in this e%ample, they both use half the total number of maintenance hours. Sr%ic cost cntr apportionmnt Cutting
;anteen" 0o. of meals (as a @ of total) -aintenance" 0o. of hours (as a @ of total)
Assmbl2
Cantn
3aintnanc
Total
>/=;.
=/;..
7
-/1;.
-1/;..
95@ 9,555 45@
>5@ 9,555 45@
' ' '
65@ ' '
655@ >,555 655@
*%ample below shows how the total overhead costs are charged to the two production departments.
Absorption Costing
5
Al Wadi International School
•
The first step is to reapportion the overheads associated with the canteen. +sing the information from e%ample, >.@ of the costs are charged to the cutting department, i.e. ,1/<;. (>.@ ,?/;..)/ :.@ are charged to the assembly department, i.e. ,;/=.. (:.@ ,?;..) an! -.@ are charged to the maintenance department i.e. ,?;. (-.@ ,?/;..)&
•
The ne%t stage is to reapportion the maintenance overheads to the production departments. In this e%ample these include some of the apportioned canteen overheads. The maintenance costs are split e$ually with ,:/-:1&;. (;.@ ,--/>=; ,?;.) being charged to each production department.
Total o%r"a!s apportion!
Total overheads ;anteen overheads apportioned &ub'total -aintenance overheads apportioned Total overheads apportioned
Cutting ,
Assmbl2 ,
Cantn ,
3aintnanc ,
Total ,
1:/-1;
;>/...
?/;..
--/>=;
-../...
3,A45 3A,B74 >,6>3.45 >;/->=&;.
4,755 4A,755 >,6>3.45 :0/<:1&;.
B,455 '
B45 63,934 63,934 7
7
655,555 -../...
O%r"a!s absorption
hen all overheads have been charged to production cost centres, they can then be absorb! into cost units. This ensures that all costs are taken into account when calculating the cost of producing the goods that are to be sold. The rate at which overheads are charged to cost units is called the o%r"a! absorption rat (OAR) or recovery rate. &everal different methods of calculation are used. Three are e%plained below. 0ote that the overheads are not absorbed on the basis of actual overheads incurred but on the basis of estimated or bu!gt! figures. This is because actual overheads will not be known precisely until the end of the financial year. •
3ac"in "our o%r"a!s absorption rat
This method is most suitable when production is capital intnsi% , i.e. where there is a high investment in fi%ed assets, such as machinery, relative to labour. +nder these circumstances, most of the overheads are related to the cost of using the machinery. They include, for e%ample depreciation, power, insurance, maintenance and repairs. It is appropriate to recover these overheads according to the amount of time that machinery is used on each cost unit. T" mac"in "our OAR is gi%n b2 " Total cost cntr o%r"a!s OAR 6 7777777777777777777777777777777777777777 6 rat pr mac"in "our Numbr of mac"in "ours
&uppose, for e%ample, that in a machining department, the total annual overheads are estimated to be ,1;./.... The budgeted annual total of machine hours in this cost centre is -./.... Therefore, the machine hour = is" :345,555 = < ''''''''''''''' < :34 per machine hour 65,555
Absorption Costing
6
Al Wadi International School
;onse$uently, if a particular cost unit takes : "ours to produce in the machining department, ,-;. (: ,1;) overheads will be charged to the production of that single unit. •
*irct labour "our o%r"a!s absorption rat
This method is most suitable when production is labour intnsi% , ie. hen direct labour costs are high relative to capital costs. +nder these circumstances, it is appropriate to recover overheads according to the number of hours it takes employees to produce each cost unit. T" !irct labour "our OAR is gi%n b2 " Total cost cntr o%r"a!s OAR 6 77777777777777777777777777777777777777 6 rat pr !irct labour "our Total !irct labour "ours
&uppose, for e%ample, that in a packaging department the total annual overheads are estimated to be ,:./.... The budgeted annual total of direct labour hours in the department is 1./.... Therefore, the direct labour hour = is" :>5,555 = < ''''''''''' < :9 per direct labour hour 35,555 ;onse$uently, if it takes half an hour to pack a cost unit, ,-&;. (.&; ,>) overheads will be charged to each unit. •
Cost unit o%r"a!s absorption rat
This method is appropriate when cost units are identical. or e%ample, it would be suitable in a brewery where the only output is a single type of bottled beer. owever, the method is unsuitable if a cost centre produces a wide range of different products that each take a different length of time to produce. T" cost unit OAR is gi%n b2 Total cost cntr o%r"a!s OAR 6 7777777777777777777777777777777777777777 6 rat pr unit Total cost units
&uppose, for e%ample, that a small brewery which produces Cust one type of bottled beer incurs estimated ,-./... annual overheads. The budgeted annual total number bottles produced are 85,555. Therefore, the cost unit = is" :65,555 =< '''''''''' 85,555
< : 5.34 per unit
The overhead to be charged to each bottle produced is ,.&1;&
Absorption Costing
7
Al Wadi International School
Calculating unit costs using absorption costing Eampl" Drig"t +t! , a manufacturer of sailing boat kits. The company manufactures some parts of the boats and buys in a variety of other components that are used to make up the rest of the kits. The business is divided into four cost cntrs . •
1ody shop D produces the fibre glass parts that are needed to construct the boat shell.
•
&ub'assembly ' assembles the boughtDin components.
•
/acking and dispatch D packs and dispatches the kits to customers.
•
Euality control D oversees $uality control in the three production cost centres. This is a service cost centre.
mac"in "our OAR is used in the body shop to charge overheads and a !irct labour "our OAR is used in the other two production departments. !etails of overheads and additional information are shown below" O%r"a!s an! a!!itional information for Drig"t +t! Bo!2 S"op loor space A,555 m3 1ook value of assets :>55,555 0umber of employees 65 Euality control hours 3,555 O%r"a!s ent eat and light !epreciation dministration Total
Sub7 Pac8aging assmbl2 !ispatc" 3 8,555m 3,555 m3 :355,555 :355,555 85 35 A,555
Fualit2 Total control 3,555 m3 6>,555 m3 ' :6,555555 65 A5
, 6,>55,555 855,555 355,555 A55,555 >/.../...
nnual budgeted machine hours in the body shop" 45,555 nnual budgeted direct labour hours in the sub'assembly dept" 85,555 nnual budgeted direct labour hours in the packing and dispatch dept" 35,555 , ;ost of direct materials per boat" 455 ;ost of direct labour per boat" 3,455
Absorption Costing
8
Al Wadi International School Tim ta8n to pro!uc on boat 8it in ac" !partmnt
1ody shop" &ub'assembly" /acking and dispatch
65 hours 64 hours A hours
In order to calculate the cost to right ?td of producing one boat, the following steps are taken. Step One •
The first step is to apportion the ,>m overheads to the four cost centres.
•
The rent of ,-/:../... is apportioned according to the floor space used by each centre. or e%ample, ,<../... (,-/:../...
•
•
•
eat and light costs of ,0../... are also apportioned according to floor space. or e%ample, ,1../... (,0../...
T" apportion! o%r"a!s for Drig"t +t!&
ent eat and light !epreciation dministration Total
Bo!2 s"op , A55,555 355,555 635,555 655,555 -/11./...
Sub7 assmbl2 (,) 855,555 655,555 85,555 855,555 ?0./...
Pac8ing !ispatc" (,) 355,555 45,555 85,555 355,555 0?./...
Fualit2 control (,) 355,555 45,555 5 655,555 >;./...
Total , 6,>55,555 855,555 355,555 A55,555 >/.../...
Step Two •
The ne%t step is to apportion (or reapportion) the overheads of the service department to the production departments. This is done according to the number of hours that the $uality control department is estimated to spend working for them. &o, for e%ample, ,;./... (,>;./... 1/... -0/...) is apportioned to the body shop. The amended analysis of overheads is shown below"
Sr%ic cost cntr o%r"a!s apportion! to pro!uction cost cntrs Bo!2 s"op
Absorption Costing
Sub7
Pac8ing
Fualit2
Total
9
Al Wadi International School , Total overheads 6,335,555 Euality control reapportioned 45,555 Total -/1=./...
assmbl2 (,) B85,555
!ispatc" (,) 8B5,555
control (,) 945,555
355,555 -/-0./...
655,555 ;?./...
(945,555) 7
, 9,555,555
FFFFFFF >/.../...
Step Three •
•
hen all the overheads have been apportioned to production cost centres, the ne%t step is to calculate the overhead absorption rates. The body shop uses the machine hours OAR and the annual budgeted number of machine hours is 45,555. Therefore the = of this department is"
:6,375,555 '''''''''''''''' < :34.85 per machine hour 45,555
•
The sub'assembly department uses the direct labour = and the annual budgeted number of direct labour hours is 85,555. Therefore the = of this department is" :6,685,555 '''''''''''''''''''' < :3A.45 per direct labour hour 85,5555
•
The packing and dispatch department also uses the direct labour = and the annual budgeted number of direct labour hours is 35,555. Therefore the = of this department is" :4B5,555 ''''''''''''' < :3B.45 per direct labour hour 35,555
Step four •
The fourth step is to calculate the overheads that are to be charged to each cost unit, i.e. boat. In order to do this, it is necessary to multiply the relevant = by the length of time it takes to process a single cost unit in each department. This is given below" OAR
Numbr of "ours
1ody shop &ub'assembly /acking G dispatch Total O%r"a! pu
34.85 % 65 < 3A.45 % 64 < 3B.45 % A <
Cost pr unit $ 348.55 837.45 39>.55 ?-=&;.
Step five
Absorption Costing
10
Al Wadi International School The final step is to calculate the total cost of each boat or cost unit by adding the total • overheads charged per cost unit to the labour cost and the direct materials cost. The total cost is ,>/?-=&;. as shown below. •
!irect material per cost unit !irect labour per cost unit =verheads per cost unit Total cost pr unit
, 455.55 3,455.55 B67.45 >/?-=&;.
#n!r an! O%r Absorption
The overhead absorption rate (=) is based on budget estimates of overheads costs and the e%pected level of activity in the business. These estimates will be inaccurate if either the actual overhead costs or activity level are higher or lower than budgeted estimates. If this happens, the = will also be inaccurate. Eampl -
1udgeted =verheads 1udgeted /roduction in units
:355555 65555
ctual =verheads ctual /roduction in units
:354555 B455
STEP 1: Calculation of Overhead Absorption ate OA ! "udgeted Overheads "udgeted #nits
= < :355555 65555
< :35 per unit.
STEP $: Calculation of Overheads Absorbed on Actual Production Overheads Absorbed ! Actual production % OA
=verheads bsorbed < B455 H :35 < :6B5555. STEP &: Calculation of Overheads Over ' #nder Absorbed Over ' (#nder) Absorbed Overheads ! Overheads Absorbed * Actual Overheads
=ver 2 (+nder) bsorbed =verheads < :6B5555 ' :354555 < (+1,---) #nder Absorbed . Eampl 1
1udgeted =verheads 1udgeted /roduction in units
Absorption Costing
:396555 66555
11
Al Wadi International School ctual =verheads ctual /roduction in units
:335555 63555
STEP 1:Calculation of Overhead Absorption ate OA ! "udgeted Overheads "udgeted #nits
= < :396555 66555
< :36 per unit.
STEP $: Calculation of Overheads Absorbed on Actual Production Overheads Absorbed ! Actual production % OA
=verheads bsorbed < 63555 H :36 < :343555. STEP &: Calculation of Overheads Over ' #nder Absorbed Over ' (#nder) Absorbed Overheads ! Overheads Absorbed * Actual Overheads
=ver 2 (+nder) bsorbed =verheads < :343555 ' :335555 < +&$--- Over Absorbed . Points to Rmmbr •
#nder Absorption occurs – $"n Actual O%r"a!s is .ore t"an t" Bu!gt! O%r"a!s or $"n Actual output (units) is less t"an t" Bu!gt! output (units)&
•
Over Absorption occurs – $"n Actual O%r"a!s is less t"an t" Bu!gt! O%r"a!s or $"n Actual output (units) is .ore t"an t" bu!gt! output (units)&
A!%antags an! !isa!%antags of absorption costing A!%antags
bsorption costing is a widely used method of costing because it ensures that costs are fully recovered. This means that businesses will cover their costs as long as the actual costs and level of activity are similar to the budgeted figures. A scon! a!%antag of absorption costing is that it conforms to the accounting standard &&/B states that absorption costing should be used valuing stocks in the final accounts. This is because absorption costing includes a share of fi%ed costs. It therefore recognises these fi%ed costs in the same period as revenues, and so conforms to the ‘matching’ principle. *isa!%antags
The main disadvantage of absorption costing is that it is based on budgeted figures, which might be inaccurate. This is because the figures are generally based on historical data that might not reflect future costs or activity levels. s a result, businesses might under or over absorb their overheads, and therefore set prices that are too low or too high.
Absorption Costing
12
Al Wadi International School A scon! !isa!%antag is that it can be comple%, time consuming and e%pensive to gather detailed information from different cost centres. This is particularly the case in small to medium sie companies that do not employ specialist cost accountants.
Absorption Costing
13
Al Wadi International School ABSORPTION COSTING (DORHS4EET) -&
*arnic8 4ol!alls +t! manufactures t"r t2ps of high $uality hand'made cases, Small/ 3!ium and +arg. These are manufactured in two departments, the cutting !partmnt and t" stitc"ing !partmnt. There are also two sr%ic !partmnts, maintnanc and cantn. The estimated data for the year ending 96 !epartment data for the year ending 96 !ecember 3558 is as follows.
*stimated production (units) -achine hours re$uired per unit +nit &elling price #nit Prim costs !irect materials !irect labour D Cutting !partmnt !irect labour D Stitc"ing !partmnt
Small 65555 9 , 634
3!ium B555 8 , 685
95 67 4
94 6A >
+arg 8855 4 , 644
85 35 7
Estimat! o%r"a!s for t" 2ar n!ing >- *cmbr 1..0 Cutting
Stitc"ing
&pace costs
Total :B5555
!epreciation of *$uipment llocated overheads
:355555 :638A55
:88355
:87>55
3aintnanc
:64555
Cantn
:6A555
,0-0<.. A!!itional information
loor area (s$ metres) 0umber of employees ;ost of e$uipment
4555 63
>555 B
3555 8
3555 4
:755555
:A45555
:345555
:355555
R'uir! (a) /repare an O%r"a! Anal2sis S"t for the year ending 96 !ecember 3558 detailing overheads for the cutting and stitc"ing departments. Cantn costs are shared among all the other departments on the basis of numbr of mplo2s . 3aintnanc costs are shared between the production departments on the basis of =.@ to stitc"ing an! >.@ to cutting. (b) ;alculate the O%r"a! Rco%r2 Rat of# (i) (ii)
The Cutting !partmnt , based on !irct $ags# The Stitc"ing !partmnt , based on mac"in "ours . (&how all workings).
(c) Jive reasons for the two different methods used in (b). (!) ;alculate the Total unit cost of on m!ium cas.
Absorption Costing
14
Al Wadi International School 1&
(a) *%plain the following terms" (i) (ii)
Cost Cntr . Cost #nit&
(b) uli an! Clar2 +t! manufacture toy soldiers. The company has t"r pro!uction !partmnts – 3oul!ing/ San!ing and Painting D and t$o sr%ic !partmnts D Cantn and 3aintnanc . *stimated In!irct o%r"a!s for the year ended 95 pril 3553 are as follows" O%r"a! dministration *lectricity !epreciation Indirect ages ent
Costs :658555 :75555 65@ :9>5555 :A5455
Basis of Apportionmnt or Allocation 0umber of employees Kilowatt hours used ;ost of i%ed sset Allocat! loor area (s$uare metres)
elevant information on the fi% !partmnts is as follows" 0o of employees /ower (Kw hours) ;ost of i%ed sset loor area (s$ m) Indirect wages !irect ?abour hours !irect -achine hours
3oul!ing 85 6855 :6>3555 >34 :>555 A555 7745
San!ing 45 6>55 :674555 874 :66345 7A55 4>34
Painting 85 645 :85555 455 :>974 7455 6345
Cantn 9A 6>5 :89555 955 :6A745
3aintnanc 85 6B5 :A5555 855 :9>6B5
Cantn costs are shared among all the other departments on the basis of numbr of mplo2s& 3aintnanc costs are shared among the t"r pro!uction !partmnts on the basis of floor ara . R'uir! /repare an O%r"a! Anal2sis S"t for the year ending 95 pril 3553 detailing the total (i) overheads for -oulding, &anding and painting. (ii)
3oul!ing and San!ing *partmnt o%r"a! rats are calculated on a *irct 3ac"in "our basis& Painting *partmnt o%r"a! rat is calculated on a *irct labour basis .
Absorption Costing
15
>&
Al Wadi International School Bo an! Co +t! t"r pro!uction !partmnts D 3oul!ing/ Assmbl2 and 5inis"ing D and t$o sr%ic !partmnts D Prsonnl an! 3aintnanc . The following figures are re$uired to calculate O%r"a! Rco%r2 Rats "
0umber of employees loor area (s' mtrs) !irect labour hours !irect machine hours /ower (8$ "ours) Indirect wages (,) ;ost of machinery (,)
3oul!ing Assmbl2 355 345 3455 6B55 93555 96355 96555 33455 >555 >445 38555 84555 >45555 755555
5inis"ing 355 3555 95555 4555 >55 34455 435555
Prsonnl 3aintnanc 6B5 355 6355 6>55 ' ' ' ' >45 745 74555 688745 675555 935555
Prsonnl costs are split amongst all the ot"r !partmnts on the basis of numbr of mplo2s. 3aintnanc costs are split amongst the t"r pro!uction !partmnts on the basis of floor ara. In!irct o%r"a!s are apportioned as follows" O%r"a! ent and ates !epreciation /ower Indirect wages
Cost :44355 64@ :89>45 :968345
Basis of apportionmnt loor area ;ost of machinery Kilowatt hours as shown
3oul!ing and Assmbl2 !partmnt o%r"a! rats are applied on a mac"in "our basis . 5inis"ing !partmnt rats are applied on a !irct labour "our basis . R'uir! (a) Calculat O%r"a! Rco%r2 Rats for ac" of t" t"r pro!uction !partmnts& T" follo$ing costs appl2 to ob No& HR5>.0
-oulding department ssembly department inishing department
*irct 3atrials :964 :43 :35
*irct +abour 4ours 85 A 3
Rat pr *irct +abour 4our :4.55 :8.55 :8.55
*irct 3ac"in 4ours 45 63 9
R'uir! (b) Calculat t" Total cost of 9ob HR5>.0&
Absorption Costing
16
0&
Al Wadi International School manufacturing ;ompany has t"r pro!uction !partmnts " A/ B and C. It also has a sr%ic !partmntJ Stors . Bu!gt! O%r"a! pn!itur for t" si mont"s En!! >- *cmbr 1..< , A5555 43555 8A55 6A745 7>555
ent *lectricity Insurance of premises Insurance of machinery ;anteen costs
!epreciation of machinery is calculated at -=&;@ per annum on cost. The company’s budget for the si mont"s ending 96 !ecember 355A is based on the following information"
rea in metres3 -achinery at costs 0o. of workers 0o. of &tores re$uisitions
Pro!uction *partmnts A B C 4555 7555 9555 :>5555 :455555 :645555 75 A4 34 >55 745 645
Stors
6555 65
R'uir! (a)
;omplete the following table to show the apportionment of the overheads to departments A/ B and C, and the basis on which each apportionment is calculated.
(b)
;alculate the O%r"a! Absorption Rat (OAR) for each department based on budgeted man'hours if all workers work a >;7"our $8 for 10 $8s in the period covered by the budget.
(c)
;alculate the Total O%r"a! incurred in making on unit of this product. The time taken in each department for the manufacture of on unit of a particular product is" *pt& A 1K "oursJ *pt& B > "oursJ *pt& C -K "ours&
Absorption Costing
17
;&
Al Wadi International School 4or!n Pro!ucts +t! . -anufactures goods, which could involve any or all of t"r7pro!uction !partmnt. These departments are simply are simply entitled A/ B and C. !irct $ags cost prcntag absorption rat for the recovery of production overheads is applied to individual Cob costs.
!etails from the company’s budget for the year ended 96 -arch 355A are as follows"
Indirect materials Indirect wages !irect wages !irect labour hours -achine hours
*pt& A (,) 39,555 36,555 685,555 34,555 655,555
*pt& B (,) 94,555 98,555 355,555 45,555 85,555
*pt& C (,) 47,555 44,555 634,555 >5,555 65,555
The following information is also available for the production departments. rea (s$uare meters) ;ost of machinery orse power of machinery
*pt& A (,) 95,555 335,555 44
*pt& B (,) 35,555 6>5,555 95
*pt& C (,) 65,555 35,555 64
=ther budgeted figures are" /ower ent, rates, light, heat Insurance (machinery) !epreciation
, 635,555 B5,555 35,555 A5,555
-achinery is depreciated on the basis of 1.@ on cost . ob No&>0= passed through all t"r departments and incurred the following actual direct costs and times.
*pt& A *pt& B *pt& C
*irct 3atrial , 643 A4 43
*irct Dags , AA 6B3 654
*irct +abour 4ours 94 B5 84
3ac"in 4ours >5 95 65
sum amounting to >.@ of the production cost is added to every Cob enable a slling pric to be $uoted. R'uir! (a) statement to show the total pro!uction o%r"a!s pr !partmnt and calculate the absorption rat which the company has adopted. (b) ;alculate the slling pric to be $uoted for ob No& >0= . (c) +sing the available data, calculate absorption rats when based on" (i) *irct labour "our ratJ (ii) 3ac"in "our rat&
Absorption Costing
18
Al Wadi International School :&
The 4arlton 3anufacturing Compan2 uses Cob costing. The company has four pro!uction !partmnts and t"r sr%ic !partmnts. Indirect labour and other indirect costs for a typical month have been allotted as shown" Pro!uction *partmnt
Sr%ic *partmnt
Grin!ing
Bln!ing
5iring
Polis"ing
Prsonnl
A!ministration
3aintnanc
In!irct +abour
: 8>55
: 9955
: 4855
: 3B55
: 755
: 6A55
: A55
Ot"r in!irct Costs
: 6855
: 6355
: 3A55
: 6>55
: 455
: 955
: 6355
The sr%ic *partmnts costs are allotted as follows" Grin!ing
/ersonnel (@) dministration (@) -aintenance (@)
64 65 64
Bln!ing
34 95 94
5iring
95 85 84
Polis"ing
35 64 4
A!ministration
3aintnanc
4 ' '
4 4 '
In the Grin!ing and 5iring departments, Cob costing uses an o%r"a! rat pr mac"in "our # in Bln!ing and Polis"ing an o%r"a! rat pr !irct labour is used. 3ac"in "ours worked are :-- 4ours in Jrinding and ;1. 4ours in iring. *irct labours "ours worked are -/.>0 in 1lending and 0>- in /olishing. R'uir! (a) ;alculate the O%r"a! rco%r2 rats for each of the production departments. (b) +se your answers to calculate the cost of 9ob numbr <0 which incurs the following costs"
Grin!ing *partmnt T"n pass! on to Bln!ing $"rJ
Absorption Costing
!irect materials cost !irect labour hours at , 1&0. per hour -achine hours !irect materials cost !irect labour hours at , 1&:. per hour
: 635 68 rs 95 rs : B7 6A rs
19
=&
Al Wadi International School The factory of Stamfor! +imit! is organised into four cost cntrs . The company manufactures different types of industrial values. t present, &tamford ?imited uses a single production overhead absorption rate calculated by dividing total budgeted production overheads by total budgeted direct wages. Jiven below are the budgeted costs and other data for the year ended 96 !ecember 355A.
;ost centre ;ost centre 1 ;ost centre ; ;ost centre !
*irct Dags ,... 6455 >335 6A95 4655
Pro!uction O%r"a!s ,... 7455 >555 9>74 8A55
*irct +abour "ours L... 345 455 945 935
3ac"in "ours L... >55 635 nil 955
ctual costs and actual times relating to ob M>1, which was completed during =ctober 355A were as follows"
;ost centre ;ost centre 1 ;ost centre ; ;ost centre !
*irct Dags ,... 6355 3>5 674 3B5
Pro!uction O%r"a!s ,... 945 >A5 6A5 385
*irct +abour "ours L... 45 665 95 94
3ac"in "ours L... 655 34 nil 95
&elling prices are calculated by adding to prime cost, production overheads based on the predetermined absorption rate, and then adding a mar87up of 0.@ to the total production cost. The newly appointed accountant at &tamford has suggested that if separate overhead absorption rates were calculated for each centre, this would be a more accurate basis for determined Cob costs. R'uir! (a)
;alculate the present O%r"a! Absorption rat based on the budgeted figures for the year ended 96 !ecember 355A.
(b)
+sing the rate calculated in (a) above, calculate the production overhead allocated to ob M>1/ together with the total production cost and selling price for the Cob.
(c)
;omment on the proposal from the new accountant the calculating overhead production rates separately for each centre would result in more accurate Cob ;osting.
Absorption Costing
20
Al Wadi International School
Absorption Costing
21
Al Wadi International School
Absorption Costing
22
Al Wadi International School
Absorption Costing
23
Al Wadi International School
Absorption Costing
24
Al Wadi International School
Absorption Costing
25
Al Wadi International School
Absorption Costing
26
Al Wadi International School 3#+TIP+E C4OICE F#ESTIONS
Absorption Costing
27
Al Wadi International School
Absorption Costing
28
Al Wadi International School
Absorption Costing
29
