Calculating unit costs (3) Flashcards
Define a standard cost
A standard cost is the expected, or budgeted, cost per unit of output. A standard cost card is drawn up in advance of a period and shows the expected usage of resources and price of resources for each cost unit
What are the two methods for determining the value of inventory?
(1) Absorption costing - Inventory is valued at full production cost i.e. including both variable and fixed elements of production cost
(2) Marginal costing - Inventory is valued at variable production cost only
Neither method includes non-production costs in the inventory value
Define marginal costing
Marginal costing values a cost unit at prime cost plus variable production overheads i.e. variable production cost
Define absorption costing
Absorption costing values a cost unit at prime cost plus variable production overheads plus an estimate of the fair share of fixed production overheads. This is the same as marginal cost plus an estimate of the fair share of fixed production overheads.
What are the three stages to assigning fixed production overheads to a cost unit under absorption costing?
(1) Allocate and apportion
(2) Reapportion
(3) Absorb
Define stage one of assigning fixed production overheads to a cost unit under absorption costing
Allocate and apportion - There are two types of fixed production overhead: overheads that arise in a department and overheads that are factory wide
Allocation is the process of charging whole cost items directly to a cost centre. This is only appropriate for overheads which arise solely in one cost centre.
Apportionment is the process of sharing cost items between cost centres. This is appropriate for overheads which are factory wide. Overheads should be apportioned on a fair basis so that the charge to a specific centre will reflect, with reasonable accuracy, the benefit obtained by that cost centre.
Define stage two of assigning fixed production overheads to a cost unit under absorption costing
Reapportion - Costs allocated and apportioned to service cost centres must be reapportioned to production cost centres on a fair basis.
Production cost centres physically work on the cost unit. Service cost centres support the production activities but do not physically work on the cost unit.
If there is more than one service centre for which costs need to be reapportioned, either:
(1) Firstly reapportion service cost centre with the biggest costs, or;
(2) First reapportion the service cost centre which gives the biggest proportion of its services to other cost centres
Define stage three of assigning fixed production overheads to a cost unit under absorption costing
Absorb - All production overheads, now only included in production cost centres, are then absorbed into cost units using a predetermined Overhead Absorption Rate (OAR).
OAR = Budgeted overhead cost/ Budgeted level of activity
Predetermined, or budgeted, figures are used so that cost can be determined at the start of the period. This is necessary as business usually use costs to set sales prices for the period i.e. before actual overhead costs are known
The level of activity chosen should realistically reflect the characteristics of that cost centre and thereby provide a reasonably accurate estimate of overhead costs for cost units. This is a matter of judgement, possible measures of activity are: Number of cost units, prime cost, direct labour cost etc.
Define blanket absorption rate
A blanket absorption rate uses the same absorption rate for all cost units irrespective of the department in which they were produced.
A blanket absorption rate is only appropriate if individual departmental OARs would be similar to an overall company OAR
This method is not appropriate if there are a number of departments and different cost units do not spend an equal amount of time in each department
Define over and under absorption of overheads
The OAR is calculated at the start of the period based on budgeted figures. It is likely that actual overheads and actual levels of activity are different to what was budgeted. Therefore total overheads absorbed will be different to total actual overheads.
(a) Over absorption occurs if absorbed > actual
(b) Under absorbed occurs if absorbed < actual
Define job costing
Job costing is appropriate for specific one-off jobs of relatively short duration
Job cost includes prime cost and absorbed overheads
Define contract costing
Contract costing is appropriate for specific pone-off jobs of relatively long duration
Contract cost includes prime cost, allocated overheads and absorbed overheads
Define batch costing
Batch costing is appropriate for a group of identical cost uits
Total batch cost includes prime costs and absorbed overheads
Unit cost = total batch cost/number of units
Define process costing
Process costing is appropriate if there is a continuous flow of operations which produces identical products
Total process cost includes prime costs and absorbed overheads
Unit cost = total process cost/number of units
Define life cycle costing
Life cycle costing tracks and accumulates actual costs and revenues attributable to each product over its entire life cycle. The life cycle runs from research and development through to withdrawal from the market.
Analysing the life cycle cost avoids decisions being made solely on initial costs.
