Full costing

Question 1

What is full costing?

Answer 1

• Deducing the total direct and indirect (overhead) costs of pursuing some objective or activity of the business
• How to allocate costs to products
• Concerned with all costs involved with achieving some objective

Question 2

What is the need for cost information (full costing)?

Answer 2

• To control costs
• To aid planning
• To value inventories
• To aid the setting of selling prices
• To ascertain the relative profitability of products

Question 3

How are full costs derived for a single product/service organisation?

Answer 3

Add all of the costs of production and divide by the number of units produced

Question 4

What is the full cost of a unit for a multi-product organisation?

Answer 4

The full cost of a cost unit is the sum of direct costs and a fair share of indirect costs

Question 5

What are the components of full costing for a multi product organisation?

Answer 5

• Cost unit
• Direct costs
• Indirect costs

Question 6

What is a cost object?

Answer 6

• aka cost object
• The objects for which the cost is being deducted
• Products, customers, departments, projects, an activity

Question 7

What are direct costs?

Answer 7

In full costing, costs which can be identified with specific cost units, to the extent that the effect of the cost can be measured in respect of each particular unit of output

Question 8

What are indirect costs?

Answer 8

• aka overheads
• In full costing, costs that cannot be traced easily or accurately to a cost unit, or it is not economically feasible to do so
• Factory heating, lighting costs

Question 9

What are the considerations when deciding whether a cost is direct or indirect?

Answer 9

• Although fixed costs tend to be indirect costs and variable costs tend to be direct costs, there are many exceptions
• The same cost can be direct cost to one object but indirect to another - lecturers’ salary to school vs single course

Question 10

What are the steps to full costing a multi product organisations production?

Answer 10

• 1. Ascribe all possible direct costs to individual products or services
• 2. Allocate indirect/overhead costs to individual products or services

Question 11

What are the methods of allocating indirect costs to a multi product organisations production?

Answer 11

• Absorption costing

* Activity Based Costing

Question 12

What are cost drivers in and examples?

Answer 12

Drivers are factors that cause changes in the use of resources

• Labour hours
• Machine hours

Question 13

What is absorption costing?

Answer 13

• Costing approach where direct costs are attributable to cost objects & indirect costs are allocated to cost objects on the basis of volume-based cost drivers such as direct labour hours or machine hours
• As it is not accurate due to the subjective nature of allocating overheads, is best when indirect costs account for a small portion of total costs i.e. labour intensive

Question 14

What is overhead absorption?

Answer 14

• The process of sharing out indirect costs to products
• To share indirect costs between products equitably
• Must take into account the amount of indirect costs used to support the manufacture of products

Question 15

What are the components of overhead absorption?

Answer 15

• Absorption rate

* Activity measures

Question 16

What is an absorption rate and how is it calculated?

Answer 16

• The rate at which overheads are charged to cost unit

- total overheads / total level of activity

Question 17

What are activity measures, what are examples of and how is one selected?

Answer 17

• The share of total activity that a particular production uses.
• Direct labour hours
• Direct labour costs
• Machine hours
• Cost of materials
• Normally use the factor that drives the cost most - labour intensity vs labour expense

Question 18

What is true of overhead absorption in absorption costing?

Answer 18

Any allocation is arbitrary - there are many ways that indirect costs can be allocated and they will all yield different results

Question 19

What is the process of overhead absorption in absorption costing?

Answer 19

• Identify and collect overhead costs
• Ascertain the absorption rate for the activity measure (e.g. total overheads / total direct labour)
• Multiply the absorption rate by each products activity measure to work out that products allocation
• Sum all direct costs with allocated overheads for total cost

Question 20

What is prime cost and how is it utilised in full costing?

Answer 20

• The sum of direct labour & direct materials
• Level of activity = total direct prime costs (e.g. all products direct materials cost + all products direct labour cost)
• Multiply absorption rate by each products prime cost

Question 21

What is activity based costing and why does it exist?

Answer 21

• A technique for more accurately relating overheads to cost objects
• Allocates indirect costs on a more realistic basis that takes account of the activity and transactions that drive the costs
• Based on acceptance of the fact that many overheads do not just occur; they are caused by activities such as setting up machines and handling order
• Developed as capital intensive production has replaced labour intensive and overheads have become a more substantial part of total cost

Question 22

In ABC costing, what are cost drivers and examples?

Answer 22

• Activities that cause costs
• Kilometers traveled
• Machine hours
• Number of orders
• Number of set-ups

Question 23

What is the activity cost pool in ABC costing and examples?

Answer 23

• The sum of overhead costs that are seen as being caused by the same cost driver
• Costs relating to motor vehicle activity
• Costs relating to machine activity (depreciation and maintenance)
• Cost of handling orders
• Cost of setting up machine

Question 24

What are the steps to ABC costing?

Answer 24

• Identify significant actives and assign overhead costs to these activities - activity cost pool
• Identify cost drivers and allocate the cost for each activity to each cost unit

Question 25

What is the working for ABC costing?

Answer 25

• Ascertain cost drivers for each overhead (kilometres for delivery costs, hours for machine use)
• Calculate allocation rate for each cost pool (total cost of delivery / total km driven)
• Multiply each allocation rate by the share of the cost driver (allocation rate x product A km driven)

Question 26

What are the limitations of ABC costing?

Answer 26

Trying to identify cost drivers, measuring and allocating expenses can be very costly and the benefits may not justify the cost.