3. Calculating Unit Cost (Part 2)

Question 1

With regards to calculating the the production cost of one unit of our product, what part of the costs will we look at in this chapter?

Answer 1

Calculate the amount of Fixed production overheads that should be given to each unit of our product

Question 2

What method of allocating overhead costs that should be given to each unit of our product will we look at in this chapter?

Answer 2

Absorption costing (or full costing)

Question 3

What are the three stages to determining the share of overhead to be attributed to a cost unit using the absorption costing method?

Answer 3

1. Overhead allocation & apportionment (to split overheads between departments)
2. Overhead re-apportionment (to move overheads from service departments to production departments)
3. Overhead absorption (to record an amount of overheads against each cost unit)

Question 4

Describe what is meant by overhead allocation

Answer 4

Allocation is the process by which whole fixed cost items are charged direct to a specific cost centre.

For example, the salary of the mixing department supervisor would be allocated to the mixing department (as it only relates to that department).

Question 5

Outline the method for overhead allocation

Answer 5

1. Determine which overheads relate to a specifc cost centre only
2. Allocate these costs to those centres

Question 6

Describe what is meant by overhead apportionment

Answer 6

Apportionment is giving portions of a specific shared overhead cost to several different cost centres on a fair basis. The basis of apportionment will be dependent on the type of overhead

Question 7

Outline the table for basis of apportionment for the common overheads

Answer 7

Question 8

Outline the equation for the amount of overhead to be apportioned to a cost centre

Answer 8

Question 9

Outline the method for overhead apportionment

Answer 9

1. Determine which overheads are shared between cost centres and the cost centres they are to be shared between
2. For each overhead to be apportioned, determine a suitable basis for apportionment using the table
3. Using the equation, calculate the share of each overhead cost relating to the relevant cost centres

Question 10

Describe what is meant by overhead re-apportionment

Answer 10

Reassigning the the overheads currently sitting in the service cost centres into the production cost centres.

Question 11

Outline the method for overhead re-apportionment

Answer 11

1. Determine which cost centres are service cost centres and order them in decreasing order of overhead value
2. Starting with the service cost centre with the largest overhead value, distribute this overhead value amongst the production cost centres adn remaining service cost centres, based on the extent to which they make use of the service cost centre (e.g. based on number of employees)
3. Repeat this for each of the remaining service cost centres in decreasing overhead size order, remembering to recalculate the overhead totals after each re-apportionment

Question 12

Describe what is meant by overhead absorption

Answer 12

The process by which each cost unit is given a fair share of each production cost centre’s costs

Question 13

What value will dictate how much overhead is attributed to each cost unit.

Answer 13

Overhead Absorption Rate (OAR)

Question 14

Define the equation for OAR

Answer 14

Where the total budgeted production overhead cost will be in £ and the activity level in ‘activity level’ (e.g hours) so will give the OAR in £/activity

Question 15

Why do we use budgeted values to calculate OAR not actual?

Answer 15

In order to be able to calculate the production cost of cost units on a daily / weekly basis, we need to calculate OARs for each production cost centre at the beginning of the period (e.g. the start of the month / quarter).

Hence, when calculating the OARs for the period, we will use the budgeted overhead costs and the budgeted activity levels for the coming period (hence they are referred to as ‘predetermined OARs’).

This is more convenient and avoids OAR fluctuations during the period.

Question 16

What activity level do we use in the OAR calculation and what must we consider?

Answer 16

Management should try to establish an absorption rate that provides a reasonably accurate estimate of overhead costs for jobs, products or services.

Hence the activity level (absorption base) used in the OAR calculations should reflect the nature of the activities in that cost centre (the ‘cost driver’).

Question 17

Outline the table of absorption bases to use in the OAR calculation and when to use them

Answer 17

Question 18

What are blanket absorption rates? When can they be used?

Answer 18

One OAR that is calculated for the entire factory (rather than calculating separate OARs for each production centre).

These are only suitable where there are no major differences between the nature of the work in each of the different production cost centres.

Question 19

Outline the equation for calculating the amount of actual fixed overhead absorbed

Answer 19

Where the OAR will be in £/activity and the activity level in activity/unit so will give the actual overhead absorbed in £/unit

Question 20

What can using a predetermined OAR lead to with regards to the overhead actually absorbed?

Answer 20

Having calculated a predetermined OAR for each production cost centre, we will use this OAR to record the production costs of each cost unit produced in our accounting ledger during the period.

However, it is likely that the use of a pre-determined OAR (based on budgeted numbers) to record costs in our accounting ledger will lead to the over or under-recording of costs (known as ‘over/under absorption’)

Question 21

Outline the equation for the amount of over head that is over or under absorbed

Answer 21

• If the result is negative then overheads have been under-absorbed (so the income statement must be debited with an adjustment to increase costs / reduce profits).
• If the result is positive then the overheads have been over-absorbed (so the income statement must be credited with an adjustment to reduce costs / increase profits).

Question 22

For the following factors, determine if they would lead to over or under absorption of overhead:
1. Over-estimation of the overhead cost in the budget
2. Under-estimation of the overhead cost in the budget
3. Over-estimation of the activity level in the budget
4. Under-estimation of the activity level in the budget

Answer 22

Question 23

What are the four types of specific order costing methods?

Answer 23

• Job costing
• Contract costing
• Batch costing
• Process (continuous operation) costing

Question 24

Describe job costing

Answer 24

Job costing is appropriate where each separately identifiable cost unit or job is of relatively short duration, such as plumbing services

Question 25

Describe contract costing

Answer 25

Contract costing is appropriate where each separately identifiable cost unit is of relatively long duration, such as the building of the school or hospital

Question 26

Describe batch costing

Answer 26

Batch costing is similar to job costing except that each separately identifiable cost unit would be a batch of identical items.

Question 27

Describe process (continuous operation) costing

Answer 27

Some organisations have a continuous flow of operations and produce a large number of identical products. Food processing, paint production and oil refining are all examples. Such operations often consist of a number of consecutive processes where the output of one process becomes the input of the subsequent process and so on until the finished output is produced.