3. Calculating Unit Cost (Part 2) Flashcards
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?
Calculate the amount of Fixed production overheads that should be given to each unit of our product
What method of allocating overhead costs that should be given to each unit of our product will we look at in this chapter?
Absorption costing (or full costing)
What are the three stages to determining the share of overhead to be attributed to a cost unit using the absorption costing method?
- Overhead allocation & apportionment (to split overheads between departments)
- Overhead re-apportionment (to move overheads from service departments to production departments)
- Overhead absorption (to record an amount of overheads against each cost unit)
Describe what is meant by overhead allocation
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).
Outline the method for overhead allocation
- Determine which overheads relate to a specifc cost centre only
- Allocate these costs to those centres
Describe what is meant by overhead apportionment
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
Outline the table for basis of apportionment for the common overheads
Outline the equation for the amount of overhead to be apportioned to a cost centre
Outline the method for overhead apportionment
- Determine which overheads are shared between cost centres and the cost centres they are to be shared between
- For each overhead to be apportioned, determine a suitable basis for apportionment using the table
- Using the equation, calculate the share of each overhead cost relating to the relevant cost centres
Describe what is meant by overhead re-apportionment
Reassigning the the overheads currently sitting in the service cost centres into the production cost centres.
Outline the method for overhead re-apportionment
- Determine which cost centres are service cost centres and order them in decreasing order of overhead value
- 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)
- 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
Describe what is meant by overhead absorption
The process by which each cost unit is given a fair share of each production cost centre’s costs
What value will dictate how much overhead is attributed to each cost unit.
Overhead Absorption Rate (OAR)
Define the equation for OAR
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
Why do we use budgeted values to calculate OAR not actual?
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.
What activity level do we use in the OAR calculation and what must we consider?
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’).
Outline the table of absorption bases to use in the OAR calculation and when to use them
What are blanket absorption rates? When can they be used?
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.
Outline the equation for calculating the amount of actual fixed overhead absorbed
Where the OAR will be in £/activity and the activity level in activity/unit so will give the actual overhead absorbed in £/unit
What can using a predetermined OAR lead to with regards to the overhead actually absorbed?
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’)
Outline the equation for the amount of over head that is over or under absorbed
- 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).
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
What are the four types of specific order costing methods?
- Job costing
- Contract costing
- Batch costing
- Process (continuous operation) costing
Describe job costing
Job costing is appropriate where each separately identifiable cost unit or job is of relatively short duration, such as plumbing services
Describe contract costing
Contract costing is appropriate where each separately identifiable cost unit is of relatively long duration, such as the building of the school or hospital
Describe batch costing
Batch costing is similar to job costing except that each separately identifiable cost unit would be a batch of identical items.
Describe process (continuous operation) costing
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.
