Absorption Costing AA

Question 1

What are the four stages of absorption costing?

Answer 1

1) Allocation and apportionment of overheads to production and service departments.
2) Reapportionment of service cost center overheads to production departments.
3) Absorption of overheads.
4) Calculation of over or under-absorption.

Question 2

What are some of the basis of apportionment?

Answer 2

1) Floor area.
2) Cost or Net Book Value of Equipment.
3) Number of machines/ machine hours.
4) Number of employees or direct labor hours.

Question 3

How to calculate OAR

Answer 3

Budgeted production overhead / budgeted total of absorption basis.

Question 4

How to calculate overheads absorbed

Answer 4

Predetermined OAR x Actual level of activity.

Question 5

What is a blanket OAR?

Answer 5

This uses one absorption rate that is calculated for the entire factory regardless of the departments involved in production.

Question 6

How to calculate over or under-absorption?

Answer 6

Actual overhead - absorbed overheads.

Question 7

How is under-absorption treated

Answer 7

It is treated as a debit to the P&L whereas an over absportion is treated as a credit.

Question 8

Definition for under-absorption

Answer 8

Where we do not absorb enough overhead to cover our overheads. Our profit will be lower than forecast.

Question 9

Definition for over-absorption

Answer 9

Where we absorb more overhead than we need to. Our profit will be higher than forecast.

Question 10

Advantages of absorption costing

Answer 10

1) Useful to analyze the under/ over absorption of overheads and control costs accordingly.
2) For small organizations it is the best way of estimating the costs of jobs/ profit on jobs.
3) Takes into account the importance of fixed costs.
4) Accepted by IAS 2.
5) Avoids fictitious losses being reported.

Question 11

Disadvantages of absorption costing

Answer 11

It is more complicated to calculate and is not as helpful in decision-making.

Question 12

Profit statement for absorption costing

Answer 12

Revenue
- VC (Production)
- FC (Production)
= Estimated Profit

Estimated Profit
-/+ Under/ over absorption
- VC (Non-production)
- FC (Non-production)
=Profit

Question 13

Difference between the profit of MC and AC

Answer 13

If there is no stock movement these profits will be the same.

Question 14

How to reconcile profits between AC and MC when there is stock movement.

Answer 14

Marginal Costing Profit X
Stock Movement x FOAR X
Absorption Costing Profit X

Whether the stock movement is added or subtracted depends on whether it was an increase or decrease in stock.

Question 15

What is the stock movement?

Answer 15

The difference between the opening and closing stock.

Question 16

Profit comparisons between AC and MC.

Answer 16

When production exceeds sales the absorption costing system produces higher profits. When sales exceed production the marginal costing system produces higher profits. With an absorption costing system, profits can decline when sales volume increases and costs remain unchanged.

Question 17

What adjustment must be made for under/over absorption in costing statements?

Answer 17

If production is different from the normal times it by the OAR to find OH absorbed. Then times the original production by the OAR to find the actual OH. The difference is the under/over absorption.

Question 18

Conclusion for AC or MC

Answer 18

1) Depends on the circumstance as volatile sales and changing stock levels favor MC while seasonal sales where stock is built up favor AC.
2) IAS 2 requires AC for external reporting.

Question 19

What is traditional costing (AC) suited for?

Answer 19

1) Narrow range of products
2) Direct labour
3) Direct materials