9 Absorption costing Absorption costing – uses predetermined overhead rates Budgeted costs / output Actual costs / output Difference between budget and actual = under or over absorption of overhead costs
11 Inventory valuations Marginal costing of inventory excludes production overheads Full costing of inventory includes production overheads
12 Absorption Costing Example Stroud Ltd is a small manufacturing company which operates from rented premises on a trading estate. The following is available regarding its overheads. The company is split into 5 cost centres Cutting, Painting and Assembling, which are production departments, and two production-related service departments, maintenance and canteen.
14 Other production data Floor areaNumber ofValue of Maintenance (sq mtrs) employees machines (£) Services (%) Cutting2,500 8100,000 40 Painting1,50010 50,000 20 Assembling2,00014 70,000 25 Maintenance 1,000 6 10,000 Canteen1,500 20,000 15 8,50038250,000 10 NOTEThe maintenance department provides services to all production departments and to the canteen, but not to itself. The canteen provides services to all production departments and to the maintenance department, but not to itself. Required: Allocate and apportion overheads to production departments using appropriate apportionment bases.
16 Apportionment bases The company has provided data on one of its lines, "The Moreton" as shown below: The company expects to manufacture 5,000 units of this product Details per unit are: Direct materials4 Kg of materials @ £1.50 per Kg Direct labour Cutting Dept2 hours @ £6.00 per hour Painting Dept3 hours @ £4.00 per hour Assembling Dept5 hours @ £5.50 per hour Machine use in the Cutting Dept is expected to be 10,000 hours (ie 2 hours per unit) Required: Calculate the overhead absorption rates for each production department using the most appropriate apportionment base.
17 Solution – appropriate apportionment bases Cutting Dept85,137/10,000= £8.51 per machine hour Painting Dept56,749/15,000= £3.78 per labour hour Assembling Dept86,114/25,000= £3.44 per labour hour Then: On the basis of the information you have been given and have calculated Calculate the full cost of ONE unit of this product.
18 £ £ Direct Materials4 Kg @ £1.50 per Kg6.00 Direct Labour Cutting2 hrs @ £6.0012.00 Painting3 hrs @ £4.0012.00 Assembling5 hrs @ £5.5027.50 51.50 Overheads Cutting2 mach. hrs @ £8.5117.02 Painting3 labour hrs @ £3.7811.34 Assembling5 labour hrs @ £3.4417.20 45.56 Total unit cost103.06 Solution – Full (absorbed) cost of one unit of product
19 Details for 1 month's activity on Production Line "A" is listed below: Labour Maintenance HoursTotalStoresHoursSpareBatch ProductVolumeper unitHoursRequisitionsAttendedPartsSet-ups W5,0000.753,7504014 62 X8001.51,2001027184 Y2,5000.51,250 630 45 Z7501.075010 6 41 6,9506677 3212
20 Overhead Costs for Production Line "A" for the month were: £ Stores costs7,590 Maintenance costs3,003 Spares administration3,456 Set-up costs4,176 18,225 Required: Calculate the overhead absorption rate PER UNIT for each product on a Labour Hours Basis on an Activity Basis
21 Labour hours basis Overhead Product OverheadUnitsper unit £ £ W(3,750/6,950) X 18,225 =9,834 5,000 1.97 X(1,200/6,950) X 18,225 =3,147 800 3.93 Y(1,250/6,950) X 18,225 =3,278 2,500 1.31 Z(750/6,950) X 18,225 =1,967 750 2.62 18,225
23 ABC and Absorption comparison (another example) Product Product Product X Y ZTotal Labour Hours20,000 25,000 30,00075,000 Set ups 15 10 5 30 Stores Requisitions 500 250 250 1,000 Maintenance man hours 5,000 5,000 10,00020,000 Overheads £ Set up costs100,000 Stores costs200,000 Maintenance costs 50,000 Total350,000
24 Results Apportion costs ProductProductProduct X Y ZTotal On labour hours basis93,333116,667140,000350,000 Using ABC - by cost driver Set up costs50,00033,33316,667100,000 Stores costs100,00050,00050,000200,000 Maintenance costs12,50012,50025,00050,000 162,50095,83391,667350,000 Difference (over/under costed)-69,16720,83448,333
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