Accounting for Overheads

Question 1

Why is it important for businesses to be able to ascertain full cost of making a product or service?

Answer 1

• profitability analysis
• determining selling price
• inventory valuation process - absorption costing must be used by IAS 2

Question 2

Absorption Costing Definition

Answer 2

• method for sharing overheads between different products on a fair basis using an overhead absorption rate (OAR)

Question 4

What are the steps involved in absorption costing ?

Answer 4

• allocate & apportion production overheads to cost centres
• reapportion overheads in service cost centres to production cost centres
• absorb overheads into cost units

Question 5

Allocation process

Answer 5

• whole cost items are charged direct to cost unit or cost centre

Question 6

Apportionment

Answer 6

• procedure whereby indirect costs are spread fairly between cost centres

Question 7

What are examples of different basis’ that can be used to apportion on a fair basis?

Answer 7

• rent/rates/heat/ light- floor area occupied by each cost centre
• depreciation/insurance on equipment- costs / net book value
• canteen/welfare/first aid - number employees/ labour hours worked

Question 8

Calculation for overhead apportioned by floor area

Answer 8

Overhead apportioned to department = (floor area occupied by department/total floor area) x total overhead

Question 9

Calculation for overhead apportioned by machinery value

Answer 9

overhead apportioned to department = (value of departments machinery/total value of machinery) x total overhead

Question 10

Overheads apportioned by number of employees calculation

Answer 10

Overhead apportioned to department = (number of employees/total employees) x total overhead

Question 11

Production cost centres

Answer 11

• through which cost units actually flow - they make them

Question 12

Service cost centres

Answer 12

• support /service production cost centres and each other
• stores
• canteen

Question 13

What situation complicates the reapportionment of overheads between production cost centres?

Answer 13

• when there is more than one service cost centre
• when the service centres do work for one another (inter-service department work)

Question 14

What are the three methods to reapportion service cost centres overheads to production cost centres?

Answer 14

• direct method- inter-service department work is ignored or doesn’t exist
• step down method - some inter-service department work recognised
• Reciprocal method/ repeated distribution- all inter service department work recognised

Question 15

What is the direct method to reapportion service centre costs?

Answer 15

Ignore all inter service department work

• just apportion the service cost centres by %s they do work for production departments

Question 16

What is the step down method for reapportion service centre costs?

Answer 16

• the service centre that does work that serves most other service centres are reapportioned first
• then other service centre reapportioned to production cost centres

Question 17

What is the repeated distribution method to reapportion service centre costs?

Answer 17

• start with reapportioning service centre that does most inter-service department work
• Then reapportion the next service centre down but to all production & service centres
• continue to reapportion the service centres in order until one is down to 1 and add this to largest ratio

Question 18

What is the algebraic method for reapportion service centre costs?

Answer 18

• have letter for amount to be reapportioned out of each service centre
• represent them as equations of each other using % work they do for each other
• add one equation into the other and solve
• sub into the other equation to find the other amount

Question 19

Overhead absorption definition

Answer 19

• process whereby overhead costs allocated and apportioned to production cost centres are added to unit, job or batch costs
• added using a predetermined OAR from budget

Question 20

Overhead absorption rate OAR =

Answer 20

= budgeted production overhead/ budgeted activity level

Question 21

What are the different activity levels that can be used in working out OAR?

Answer 21

• per unit - if all similar manufactured
• per labour hour - labour intensive
• per machine hour - machine intensive
• % of direct labour cost
• % of direct materials cost
• % of prime cost

Question 22

OAR per unit =

Answer 22

= OAR per activity level (machine hour) x activity level per unit

Question 23

Why does over or under absorption occur?

Answer 23

• predetermined OAR are based on estimates
• this will be adjusted at end of accounting year by either debit or credit P/L account

Question 24

Over absorption

Answer 24

• overheads charged to cost of sales are greater than overheads actually incurred
• debited to production overheads
• credited to adjustment P/L account

Question 25

under absorption

Answer 25

- insufficient overheads have been included in cost of sales are greater - credited to production overheads - debited to adjustment P/L account

Question 26

What is the calculation for over/under absorption?

Answer 26

actual overhead incurred (overhead absorbed(OARx actual units)) ————————————— under/over absorption

Question 28

Contribution =

Answer 28

selling price (less variable production costs) (less variable non production costs) - takes account of all variable costs - contribution towards fixed costs and profit

Question 29

Marginal Costing

Answer 29

- only variable costs are charged as cost of sale and contribution calculated - closing inventories are valued at variable production costs and - fixed costs are treated as period cost and charged in full to stmt P/L in period they are incurred - made up of direct materials, direct labour, variable overhead

Question 30

What is the layout of P/L under marginal costing ?

Answer 30

Sales Less variable cost of sales: Opening Inv - valued variable costs only Plus variable production costs Less Closing Inv Less variable selling/distribution/admin costs ———————— Contribution Less fixed costs of production/selling/distribution/ admin Net profit

Question 32

What is the layout of calculating a P/L under absorption costing?

Answer 32

Sales Less Cost of Sales: Opening Inv- full production cost Variable OHs Fixed OHs absorbed Adjustment over/under absorbed Less Closing Inv Gross Profit Less non production costs- selling/admin Net profit

Question 33

How are closing inventories dealt with in marginal vs absorption costing?

Answer 33

MC - valued at marginal production cost AC- valued at full production cost

Question 34

How are fixed costs dealt with in marginal vs absorption costing?

Answer 34

MC- they are period costs AC- absorbed into unit costs

Question 35

What does cost of sales include with marginal vs absorption costing?

Answer 35

MC- not include a share of fixed overheads AC- does include a share of fixed overheads - from previous period as carried forward in opening inventory values

Question 36

When will profit figures from marginal or absorption costing differ from each other?

Answer 36

- if any change in level of inventories in period

Question 37

If inventory levels increase in period what costing method will report higher profit?

Answer 37

- absorption costing - because some fixed production overhead incurred during period will be carried forward in closing inventory - reducing cost of sales - therefore increasing profit

Question 38

If inventory levels decrease in period what costing method will report lower profit?

Answer 38

- absorption costing - fixed production overheads which had been carried forward in opening inventory released - increases cost of sales - decreases profit

Question 39

Difference in profit =

Answer 39

= change in inventory in units x OAR per unit

Question 40

What is a way to work out which profit figure is greatest?

Answer 40

Production > Sales Closing Inventory > Opening Inventory AC Profit > MC Profit

Question 41

What are the advs of Absorption Costing?

Answer 41

advs - recognises selling price must cover all costs - compiles with IAS 2 - routine profit reporting

Question 42

What are the advs of Marginal Costing?

Answer 42

advs - highlights contribution so appropriate for decision making - fixed costs treated in accordance with nature - profit depends on sales & efficiency

Question 43

What are the disadvs of absorption costing?

Answer 43

disadvs - profits can be manipulated by change in production levels - based on assumptions that overheads are volume based

Question 44

What are the disadvs of Marginal Costing?

Answer 44

disadvs - danger that contribution fails to cover fixed costs - not comply with IAS 2 - requires analysis of mixed costs between fixed/variable