Paper F2 Management Accounting 2019/1/1

Chapter 8 Accounting for overheads 2019/1/1

Accounting for OHs Chapter Preview Absorption costing (3-stage approach) Absorption Allocation Apportionment Predetermined OAR Under/Over absorbed 2019/1/1 Ji Weili, JXUFE

Aim – to find the full cost of one unit Cost card Aim – to find the full cost of one unit $/unit Direct materials 4kg @ $2/kg X Direct labour 3 hrs @ $7/hr X Prime cost X Overheads X Full Product cost X Trace (Allocate) 3 Steps 2019/1/1 Ji Weili, JXUFE

Types of overheads Overhead is … cannot be traced directly and in full to the product, service or department. Overheads include the following items: Indirect materials + Indirect labour Indirect expenses Production OHs + Administration OHs Selling &distribution OHs 2019/1/1 Ji Weili, JXUFE

Methods of dealing with OHs One of the most difficult tasks in computing accurate unit costs lies in determining the proper amount of overhead cost to assign to each unit produced. Assigning overhead is difficult. I agree! 2019/1/1 Ji Weili, JXUFE

Absorption costing method Total Production Costs Direct Costs Indirect Costs (overheads) COST UNIT Allocate Allocate & Apportion COST CENTRES Production 1 Production 2 Service Production 1 Production 2 Reapportion Absorb 2019/1/1 Ji Weili, JXUFE

Is absorption costing necessary Practical reasons --Inventory valuation --Pricing decisions --Profitability of different products Accounting regulations --IAS 2 2019/1/1 Ji Weili, JXUFE

Three-Stage absorption costing Stage One: OHs allocated to cost centers Indirect Labor Indirect Materials Indirect Expenses Pro. Dept. Pro. Service Dept. Adm. Dept. SellingDept. OH cost center 2019/1/1 Ji Weili, JXUFE

Three-Stage absorption costing Stage One: OHs allocated to cost centers Indirect Labor Indirect Materials Indirect Expenses Pro. Dept. Pro. Service Dept. Adm. Dept. SellingDept. OH cost center 2019/1/1 Ji Weili, JXUFE

Three-Stage absorption costing Stage One: OHs allocated to cost centers Indirect Labor Indirect Materials Indirect Expenses Pro. Dept. Pro. Service Dept. Adm. Dept. SellingDept. OH cost center 2019/1/1 Ji Weili, JXUFE

Three-Stage absorption costing Stage Two: Costs apportioned to departments Indirect Labor Indirect Materials Indirect Expenses Pro. Dept. Pro. Service Dept. Adm. Dept. SellingDept. OH cost center Apportion 2-costs of service cost center Apportion 1-general OH 2019/1/1 Ji Weili, JXUFE

Three-Stage absorption costing Stage One: OHs allocated to cost centers Indirect Labor Indirect Materials Indirect Expenses Stage Two: Costs apportioned to departments Pro. Dept.1 Pro. Dept. 2 Pro. Dept. 3 Stage Three: Costs absorbed to cost units cost units 2019/1/1 Ji Weili, JXUFE

Three-Stage absorption costing Stage One: OHs assigned To cost centers Indirect Labor Indirect Materials Indirect Expenses Stage Two: Costs absorbed to departments Pro. Dept. 1 Pro. Dept. 2 Pro. Dept. 3 Direct Labor Hours Machine Hours Rate per unit Stage Three: Costs absorbed to cost units cost units Absorption Bases 2019/1/1 Ji Weili, JXUFE

Total Production Costs Overheads – step 1 & 2 Total Production Costs Direct Costs Indirect Costs (overheads) COST UNITS Allocate & Apportion COST CENTRES Production 1 Production 2 Service Allocate 2019/1/1 Ji Weili, JXUFE

Step 1 -- Allocation Allocation is the process by which whole cost items are charged direct to a cost unit or cost centre. Cost centre: When costs are incurred, they are generally allocated to a cost centre. A cost centre acts as a collecting place for certain costs. 2019/1/1 Ji Weili, JXUFE

Example Why we need three cost centres rather than two? Wages of the foreman of department A…………$200 Wages of the foreman of department B…………$150 Indirect materials consumed in department A…………$50 Rent of the premises shared by department A and B $300 The cost accounting system might include three cost centres: Cost centre 101 Department A 102 Department B 201 Rent Why we need three cost centres rather than two? 2019/1/1 Ji Weili, JXUFE

Step 2 – Apportion general OHs The costs called general OHs for heat and light, rent and rates, the canteen and so on must be shared out between the other cost centres. Basis of apportionment Example: 4.1 & 4.2.2 2019/1/1 Ji Weili, JXUFE

Total Production Costs Overheads – step 3 Total Production Costs Direct Costs Indirect Costs (overheads) COST UNITS Allocate & Apportion COST CENTRES Production 1 Production 2 Service Allocate Production 1 Production 2 Reapportion 2019/1/1 Ji Weili, JXUFE

Sept 3 -- Reapportionment To reapportion service cost centre overheads to production cost centres there are several methods Direct Method Inter-service department work is ignored ReciprocalMethod All inter-service department work is recognised 2019/1/1 Ji Weili, JXUFE

The reciprocal method of apportionment There two ways to work out—repeated distribution & algebraic method Basis of apportionment Example: 4.4.1 & 4.5.1 Exercise: 4.6 2019/1/1 Ji Weili, JXUFE

Total Production Costs Overheads – step 4 Total Production Costs Direct Costs Indirect Costs (overheads) COST CENTRES Production 1 Production 2 Service Allocate & Apportion Reapportion COST UNIT Allocate Absorb 2019/1/1 Ji Weili, JXUFE

What activity level should you use? Step 4 -- Absorbtion The final step is to charge these overheads to cost units. This is called absorption. Production overhead _______________ Activity level OAR (overhead absorption rate) = What activity level should you use? 2019/1/1 Ji Weili, JXUFE

Absorption bases (a) Per unit OAR/unit (b) Per labour hr OAR/lab hr (c) Per machine hr OAR/mach hr (d) % Direct Labour cost OAR/$ labour (e) % Direct material cost OAR/$ mats (f) % Prime cost OAR/$ prime cost 2019/1/1 Ji Weili, JXUFE

Pre-determined OARs Businesses estimate (or pre-determine) their OAR at the start of the year OAR = __________________ Activity level Production Overhead Budgeted overhead Pre-determined OAR = _________________ Budgeted activity level 2019/1/1 Ji Weili, JXUFE

Businesses want to record overheads regularly during the year Cont. Businesses want to record overheads regularly during the year Overhead Absorbed = Actual Activity (eg labour hrs) x Pre-determined OAR 2019/1/1 Ji Weili, JXUFE

Reasons for using a predetermined overhead rate Cont. Reasons for using a predetermined overhead rate Overhead is not incurred uniformly during the year. Actual overhead rate might vary from month to month. Predetermined rate makes it possible to estimate job costs sooner. 2019/1/1 Ji Weili, JXUFE

Adjusting of Under/over absorbed OH The POHR is based on estimates. What happens if actual results differ from the estimates? The result will be either under-absorbed or over-absorbed overhead and we will adjust Profit and Loss account at the end of the period. Here, let me show you. 2019/1/1 Ji Weili, JXUFE

Adjusting of Under/over absorbed OH Overhead is over-absorbed. Overhead absorbed to Work in Process (POHR × actual activity) Actual overhead costs incurred 2019/1/1 Ji Weili, JXUFE

Adjusting of Under/over absorbed OH Overhead is under-absorbed. Actual overhead costs incurred Overhead absorbed to Work in Process (POHR × actual activity) 2019/1/1 Ji Weili, JXUFE

Question FishCo had actual production overhead costs of $180,000. FishCo absorbed $192,000 of production overhead to jobs based on a POHR of $8.00 per direct labor hour. FishCo’s production overhead is: a. $12,000 over-absorbed. b. $12,000 under-absorbed. c. $96,000 over-absorbed. d. $96,000 under-absorbed. 2019/1/1 Ji Weili, JXUFE

Question FishCo had actual production overhead costs of $180,000. FishCo absorbed $192,000 of production overhead to jobs based on a POHR of $8.00 per direct labor hour. FishCo’s production overhead is: a. $12,000 over-absorbed. b. $12,000 under-absorbed. c. $96,000 over-absorbed. d. $96,000 under-absorbed. 2019/1/1 Ji Weili, JXUFE

Question The difference between FishCo's actual and absorbed overhead will result in an adjustment that increases profit. a. True b. False 2019/1/1 Ji Weili, JXUFE

Question The difference between FishCo's actual and absorbed overhead will result in an adjustment that increases profit. a. True b. False If overhead is over-absorbed, cost of goods sold is too high. The adjustment will increase profit. 2019/1/1 Ji Weili, JXUFE

Adjusting of Under/over absorbed OH At the end of the year actual overheads will be known Overhead Absorbed  Actual Overhead Difference = under or over absorption Discuss why there are differences – actual volume and expenditure may differ from budget 2019/1/1 Ji Weili, JXUFE

Reasons for under/over absorption Why do we get an under or over absorption? Pre-determined OAR Budgeted overhead _________________ Budgeted activity level = Expenditure variance Budgeted overhead  Actual overhead Volume variance Budgeted activity  Actual activity 2019/1/1 Ji Weili, JXUFE

Under-/over-absorbed OHs Ledger entries relating to OHs Work in process Production OHs Actual Absorbed Balance (over) Balance (under) Profit and loss Under-/over-absorbed OHs 2019/1/1 Ji Weili, JXUFE

Non production overheads For internal reporting non-production overheads can also be allocated to units One approach may be: Production overhead OAR = Non-Production Overhead 2019/1/1 Ji Weili, JXUFE

Outline: Absorption costing--3A Procedure Product X Costs incurred Allocate Apportion 1 Apportion 2 Absorb Production overhead Service department General service Administration Selling Distribution 2019/1/1 Ji Weili, JXUFE

Tips 这一方法习惯上被称为“完全成本法”或“全部成本法”，重点在于如何将归集起来的制造费用分配到产品成本中去，分配的基本原则是受益原则—— “谁受益，谁承担”；在分配标准的选择上应体现 “受益多，多承担，受益少，少承担” 解题时牢记三个问题： 分什么？——明确待分配费用 分给谁？——明确分配对象 按什么分？——选择恰当的分配标准 2019/1/1 Ji Weili, JXUFE

End of Chapter 8 2019/1/1