Chapter 3 Calculating unit costs Flashcards
1.1 Standard costing
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.
Standard costing aids more accurate budgeting and timetabling of production in advance of the period. At the end of the period, it is then useful to compare standard and actual costs incurred. This allows control actions to be taken by management.
2.1 Inventory valuation
There are two methods for determining the value of inventory:
- Absorption costing: inventory is valued at full production cost (including both variable and fixed elements of production cost)
- Marginal costing: inventory is valued at variable production cost only
Neither method includes non-production costs in the inventory value.
3.1 Marginal costing
Marginal costing values a cost unit at prime cost-plus variable production overhead.
4.1 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. Absorption costing is also called full costing.
There are 3 stages to assigning fixed production overheads to a cost unit under absorption costing:
- Allocate and apportion
- Reapportion
- Absorb
4.2 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 (only appropriate when costs arise solely in one cost centre).
Apportionment is the process of sharing cost items between cost centres. Overheads are apportioned on a fair basis so that the charge to a specific centre will reflect, with reasonable accuracy, the benefit obtained by that centre from the cost incurred. Usually, a different fair basis is applicable for each overhead.
4.3 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:
- Firstly, reapportion service cost centre with the biggest costs, or
- Firstly, reapportion the service cost centre which gives the biggest proportion of its services to other service cost centres
4.4 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 is budgeted overhead cost divided by budgeted level of activity.
Predetermined, or budgeted figures are used so that cost can be determined at the start of the period, so businesses can set sales prices. The level of activity chosen should 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
- Direct materials cost
- Labour hours
- Machine hours
Absorption based on number of cost units – this is effective if all cost units are identical in resources utilised in each cost centre.
Absorption based on prime cost –
Absorption based on direct labour cost –
Absorption based on an hourly rate – this can refer to machine hours or labour hours. A direct labour hour basis is most appropriate in a labour-intensive environment. A machine hour rate is most appropriate in cost centres where production is controlled or heavily dictated by machines.
4.5 Blanket absorption rate
A blanket absorption rate uses the same 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 like 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. Blanket absorption rates are also called a single factory absorption rate.
5.1 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, overheads absorbed will be different to total actual overheads.
- Over absorption occurs if absorbed > actual
- Under absorption occurs if absorbed < actual
To calculate over or under absorption use the following steps:
- OAR = budgeted overhead cost / budgeted level of activity
- Actual overhead incurred
- Overhead absorbed = actual activity x OAR
- Actual overhead incurred less overhead absorbed = under/(over) absorbed
6.1 Activity based costing – calculating product costs
- identity a business’ major activities
- identify the cost drivers – these are the factors causing activity costs to be incurred. These can be volume related or transaction related
- collect the costs associated with each activity into cost pools
- calculate an activity absorption rate and absorb overheads into cost units
7.1 Costing methods
Job costing is appropriate for specific one-off jobs of relatively short duration. Job cost includes prime cost and absorbed overheads.
7.2 Contract costing
Contract costing is appropriate for specific one-off jobs of relatively long duration. Contract cost includes prime cost, allocated overheads, and absorbed overheads.
7.3 Batch costing
Batch costing is appropriate for a group of identical cost units. Total batch cost includes prime costs and absorbed overheads. Unit cost is the total batch cost / number of units
7.4 Process costing
Process costing is appropriate if there is a continuous flow of operation which produces identical products. Each cost centre is usually one stage in a bigger production process. Total process cost includes prime costs and absorbed overheads. Unit cost is total process cost divided by number of units.
7.5 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 costs avoids decisions being made solely on initial costs.
