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Week 09

Accounting for overheads and product costs

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Objectives

• To introduce

- The process for dealing with overhead costs- Marginal costing - Absorption costing- Activity based costing

• To compare the three costing systems

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Key concept 16.1 – Direct and indirect costs

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Key concept 16.2 – Full costing

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Figure 16.1 – components of cost of goods sold

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Key concepts – Stages in the apportionment process

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Key concept 16.3 – Activity based costing

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Key concept 16.4 – Marginal costing

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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

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Costing systems

• Job costing

• Process costing

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Inventory valuations

• Marginal costing of inventory excludes production overheads

• Full costing of inventory includes production overheads

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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.

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Overhead information

Allocated overheads £

Cutting 20,000Painting 15,000Assembling 30,000Maintenance 10,000Canteen 8,000

Other overheads £

Rent & Rates 50,000Insurance 70,000Depreciation 25,000

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Other production data

Floor area Number of Value of Maintenance(sq mtrs) employees machines (£) Services (%)

Cutting 2,500 8 100,000 40Painting 1,500 10 50,000 20Assembling 2,000 14 70,000 25Maintenance 1,000 6 10,000Canteen 1,500 20,000 15

8,500 38 250,000 10

NOTE The 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.

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Solution – charging overheads to departments

Cutting Painting Assembling Mtce CanteenAllocate 20,000 15,000 30,000 10,000 8,000Rent & Rates (floor area) 14,706 8,824 11,765 5,882 8,823Insurance (floor area) 20,588 12,353 16,471 8,235 12,353Depreciation (mach value) 10,000 5,000 7,000 1,000 2,000

65,294 41,177 65,236 25,117 31,176

Re-apportion 6,563 8,204 11,486 4,923 -31,17612,016 6,008 7,510 -30,040 4,506949 1,186 1,660 711 -4,506284 142 178 -711 10723 28 39 17 -1078 4 5 -1785,137 56,749 86,114

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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 materials 4 Kg of materials @ £1.50 per Kg

Direct labourCutting Dept 2 hours @ £6.00 per hourPainting Dept 3 hours @ £4.00 per hourAssembling Dept 5 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.

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Solution – appropriate apportionment bases

Cutting Dept 85,137/10,000 = £8.51 per machine hourPainting Dept 56,749/15,000 = £3.78 per labour hourAssembling Dept 86,114/25,000 = £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.

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£ £Direct Materials 4 Kg @ £1.50 per Kg 6.00

Direct LabourCutting 2 hrs @ £6.00 12.00Painting 3 hrs @ £4.00 12.00Assembling 5 hrs @ £5.50 27.50

51.50

OverheadsCutting 2 mach. hrs @ £8.51 17.02Painting 3 labour hrs @ £3.78 11.34Assembling 5 labour hrs @ £3.44 17.20

45.56

Total unit cost 103.06

Solution – Full (absorbed) cost of one unit of product

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Details for 1 month's activity on Production Line "A"

is listed below:

Labour Maintenance Hours Total Stores Hours Spare Batch Product Volume per unit Hours Requisitions Attended Parts Set-ups W 5,000 0.75 3,750 40 14 6 2 X 800 1.5 1,200 10 27 18 4 Y 2,500 0.5 1,250 6 30 4 5 Z 750 1.0 750 10 6 4 1 6,950 66 77 32 12

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Overhead Costs for Production Line "A"

for the month were: £

Stores costs 7,590Maintenance costs 3,003Spares administration 3,456Set-up costs 4,176

18,225

Required:

Calculate the overhead absorption rate PER UNIT for each product

on a Labour Hours Basison an Activity Basis

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Labour hours basis

Overhead

Product Overhead Units per 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

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By Activity

Stores Maint Spares Set-up

OverheadCosts Costs Admin. Costs Total Units per unit

£

W 4,600 546 648 696 6,490 5,000 1.30X 1,150 1,053 1,944 1,392 5,539 800 6.92Y 690 1,170 432 1,740 4,032 2,500 1.61Z 1,150 234 432 348 2,164 750 2.89

7,590 3,003 3,456 4,176 18,225 9,050

Summary of differences:

W X Y Z

Labour 1.97 3.93 1.31 2.62

Activity 1.30 6.92 1.61 2.89

(0.67) 2.99 0.30 0.27

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ABC and Absorption comparison (another example)

Product Product Product X Y Z Total

Labour Hours 20,000 25,000 30,000 75,000Set ups 15 10 5 30Stores Requisitions 500 250 250 1,000Maintenance man hours 5,000 5,000 10,000 20,000

Overheads £

Set up costs 100,000Stores costs 200,000Maintenance costs 50,000Total 350,000

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Results

Apportion costsProduct Product Product

X Y Z Total

On labour hours basis 93,333 116,667 140,000 350,000

Using ABC - by cost driverSet up costs 50,000 33,333 16,667 100,000Stores costs 100,000 50,000 50,000 200,000Maintenance costs 12,500 12,500 25,000 50,000

162,500 95,833 91,667 350,000

Difference (over/under costed) -69,167 20,834 48,333