Job Costs and Overhead Allocation (LECTURE 2)

Question 1

ABSORPTION COSTING SYSTEM

Answer 1

A costing system that allocates all manufacturing costs, including fixed manufacturing costs, to products and values unsold stocks at their total cost of manufacture.

Question 2

ACTIVITY

Answer 2

The aggregation of different tasks, events or units of work that cause the consumption of resources.

Question 3

ACTIVITY COST CENTRE

Answer 3

A cost centre in which costs are accumulated by activities.

Question 4

ACTIVITY-BASED COSTING (ABC)

Answer 4

A system of cost allocation that aims to use mainly cause-and-effect cost allocations by assigning costs to activities.

Question 5

ALLOCATION BASE

Answer 5

The basis used to allocate costs to cost objects.

Question 6

ARBITRARY ALLOCATION

Answer 6

The allocation of costs using a cost base that is not a significant determinant of cost.

Question 7

BLANKET OVERHEAD RATE / PLANT-WIDE RATE

Answer 7

An overhead rate that assigns indirect costs to cost objects using a single overhead rate for the whole organisation.

Question 8

BUDGETED OVERHEAD RATE

Answer 8

An overhead rate based on estimated annual expenditure on overheads and levels of activity.

Question 9

CAUSE-AND-EFFECT ALLOCATION / DRIVER TRACING

Answer 9

The use of an allocation base that is a significant determinant of cost.

Question 10

COST ALLOCATION

Answer 10

The process of assigning costs to cost objects where a direct measure of the resources consumed by these cost objects does not exist.

Question 11

COST CENTRE / COST POOL

Answer 11

A location to which costs are assigned.

Question 12

COST DRIVER

Answer 12

The basis used to allocate costs to cost object in an ABC system.

Question 13

DIRECT COST TRACING

Answer 13

The process of assigning a cost directly to a cost object.

Question 14

DIRECT COSTING SYSTEM / VARIABLE COSTING SYSTEM / MARGINAL COSTING SYSTEM

Answer 14

A costing system that assigns only direct manufacturing costs, not fixed manufacturing cost, to products and includes them in the inventory valuation.

Question 15

DIRECT LABOUR HOUR RATE

Answer 15

An hourly overhead rate calculated by dividing the cost centre overheads by the number of direct labour hours.

Question 16

FIRST-STAGE ALLOCATION BASE

Answer 16

The various bases, such as area, book value of machinery and number of employees, used to allocate indirect costs to production and service centres.

Question 17

FIXED OVERHEAD EXPENDITURE VARIANCE

Answer 17

The difference between the budgeted fixed overheads and the actual fixed overhead spending.

Question 18

JOB CARDS

Answer 18

A source document that records the amount of time spent on a particular job, together with the employee’s hourly rate, so that direct labour costs can be assigned to the appropriate cost object.

Question 19

JOB-ORDER COSTING SYSTEM

Answer 19

A system of assigning costs to products and services that is used in situations where many different products or services are produced.

Question 20

MACHINE HOUR RATE

Answer 20

An hourly overhead rate calculated by dividing the cost centre overheads by the number of machine hours.

Question 21

MATERIALS REQUISITION

Answer 21

A source document that records the cost of acquisition of the materials issued for manufacturing a product, or providing a specific service, so hat the cost of the materials can be assigned to the appropriate cost object.

Question 22

OVERHEAD ANALYSIS SHEET

Answer 22

A document used to assign manufacturing overheads to production and service cost centres.

Question 23

OVERHEADS

Answer 23

Another term for indirect costs, which are costs that cannot be specifically traced to a particular cost object.

Question 24

SEQUENTIAL ALLOCATION METHOD / STEP ALLOCATION METHOD

Answer 24

A method of allocating service departments’ overheads to production departments in a certain order.

Question 25

SERVICE DEPARTMENTS / SUPPORT DEPARTMENTS

Answer 25

Departments that exist to provide services to other units within the organisation.

Question 26

TIME SHEETS

Answer 26

Source documents that record the time spent by an employee on particular jobs which can be used to allocate direct labour costs to the appropriate cost objects.

Question 27

TRADITIONAL COSTING SYSTEM

Answer 27

Widely used costing systems that tend to use arbitrary allocations to assign indirect costs to cost objects.

Question 28

UNDER/OVER RECOVERY OF OVERHEADS

Answer 28

The difference between the overheads that are allocated to products or services during a period and the actual overheads that are incurred.

Question 29

VOLUME VARIANCES

Answer 29

The difference between actual activity or overhead expenditure and the budgeted overheads and activity used to estimate the budgeted overhead rate, also known as under/over recovery of overheads.

Question 30

What is a simple way of allocating overheads?

Answer 30

Overheads divided by on allocation base per annum.

Question 31

What is the problem with simple allocation of overheads? (Blanket system)

Answer 31

Usually forecasts- not guaranteed.
Won’t be a single overhead rate for each job.
Inadequate for decision making purposes, acceptable for inventory valuation and profit measurement.

Adequate where we have one product or a few products which use equal amounts of overheads.
However it is inadequate in complex environments.

Unfair where different departments utilise differing amounts of O/H.
Some departments might be labour intensive; others machine intensive.

Question 32

More complex overhead allocation method.

Answer 32

Prepare separate departmental overhead rates. Done on annual basis.

Firstly need to identify our cost centres/cost pools. (where are the costs to be allocated?)

Question 33

OVERHEAD ALLOCATION EXAMPLE (COMPLEX):

Factory with a lighting bill of £120,000. Three production departments (Dept. A, B, and C).

Floor space; 
Dept. A - 30,000m2
Dept. B - 20,000m2
Dept. C - 10,000m2
Total - 60,000m2

Subsidises canteen with a grant of £270,000.

Employee numbers are;
Dept. A - 100
Dept. B - 150
Dept. C - 110

Some overheads already partly allocated.

TOTAL O/H:
Dept. A = £612,000
Dept. B = £490,000
Dept. C = £245,000

Dept. A machine hours = 136,000 and it’s machine intensive.

Dept. B labour hours = 252,000 and it’s labour intensive.

Answer 33

LIGHTING:
1. Dept. A accounts for (30,000/60,000) x £120,000 = £60,000

Dept. B accounts for (20,000/60,000) x £120,000 = 40,000

Dept. C accounts for (10,000/60,000) x £120,000 = £20,000

CANTEEN:
Dept. A - 100/360 x £270,000 = £75,000

Dept. B - 150/360 x £270,000 = £112,500

Dept. C - 110/360 x £270,000 = £82,500

Allocate overheads:
£612,000/136,000 = £4.5/machine hour in Dept. A

£490,000/252,000 = £1.9444/direct labour hour in Dept. B.

Question 34

Cost allocation example cont. (complex):

An item is being made for a customer. It will use £235 worth of material. It will need inputs from Dept. A & B only.

£4.5/machine hour in Dept. A

£1.9444/direct labour hour in Dept. B

Dept. A labour rate = £6.57/hour

Dept. B labour rate = £6.23/hour

Item requires 5 hours of work in Dept. A and 3 hours of work in Dept. B.

Company charges profit of 20%.

Answer 34

Materials                           £235
Labour (A) (6.57x5)           £33
Labour (B) (6.23x3)           £19
Overheads (A) (4.5x5)      £23
Overheads (B) (1.9444x3) £6 
Total                                   £316
Add profit (20%)                £63
COST TO BE CHARGED  £379

If asked for 20% profit on sale selling price would be:
£316 x 100/(100-20) = £395

Question 35

Why are estimates of overheads used?

Answer 35

Too much volatility in monthly rates. Too much effort for little reward.
To await actual figures would delay commercial activity.

Question 36

OVER/UNDER RECOVER EXAMPLE:

Product budget cost is; Material £10, 
Labour £8, 
Variable O/H £3
Fixed O/H £2
Total product cost £23

The fixed O/H charge is based on budgeted production of 200,000 item and budgeted expense of £400,000

Say 100,000 items were made and £150,000 of O/H was actually incurred.

Answer 36

We would have charged £(100,000 x £2) in our accounts = £200,000.

OVER-RECOVERY of fixed overhead by £50,000

Reduced expense.

If actual fixed overhead incurred was £300,000 there would be UNDER RECOVERY.

Question 37

SERVICE DEPARTMENT ABSORPTION EXAMPLE:

Some departments in a business might not be revenue earning, but the business must still cover its costs.

A business with 3 production departments (M, N and P) and 2 service departments (S&T).

Dept M O/H = £2.1m
Dept. N O/H = £1.6m
Dept. P O/H = £0.8m
Dept. S O/H = £0.4m
Dept. T O/H = £0.48m

Dept S supplies services to each production dept. in ratio 1:2:1.
Dept. T supplies services to each production dept. in the ratio 3:3:2.

Answer 37

1. Dept. M:
All Depts: £2.1m
Dept S: £0.1m
Dept. T: £0.18m
TOTAL: £2.38m

Dept. N:
All Depts.: £1.6m
Dept S: £0.2m
Dept T: £0.18m
TOTAL: £1.98m

Dept. P:
All Depts.: £0.8m
Dept. S: £0.1m
Dept. T: £0.12m
TOTAL: £1.02m

Dept. S:
All Depts: £0.4m
Dept. S: £(0.4m)
Dept. T: £0
TOTAL: Nil

Dept T:
All Depts. £0.48m
Dept S: £0
Dept. T: £(0.48m)
TOTAL: Nil

Question 38

SIMULTANEOUS EQUATION METHOD EXAMPLE:

Dept M:
O/H (S): 20%
O/H (T): 20%

Dept N:
O/H (S): 30%
O/H (T): 30%

Dept P:
O/H (S): 30%
O/H (T): 40%

Dept S:
O/H (S): /
O/H (T): 10%

Dept T:
O/H (S): 20%
O/H (T): /

O/H Costs:
S: £400,000
T: £480,000

Answer 38

Let x = total O/H Dept. S
Let y = total O/H Dept. T
So x = 400,000 +0.2y
y = 480,000 + 0.1x

Rearrange as follows:
x - 0.2y = 400,000 (1)
-0.1x + y = 480,000 (2)

Multiply (1) by 5 to get
5x - y = 2,000,000 (3)

add equation 2

• 0.1x + y = 480,000 (2)
  4. 9x = 2,480,000

Therefore x = 506,122.449
5x = 2,530,612

Substitute in (3)

2,530,612 - y = 2,000,000
y = 530,612

So allocate as follows:

Dept. M:
O/H (S): 101,225
O/H (T): 106,122

Dept. N:
O/H (S): 151,837
O/H (T): 159,184

Dept. P:
O/H (S): 151,837
O/H (T): 212,245

Question 39

How does life cycle costing contrasts with traditional costing methods?

Answer 39

In traditional costing would write off design and development costs in the income statement.

By capturing committed costs of a product, it’s much easier to assess a product’s profitability.

Question 40

What does life cycle costing help with?

Answer 40

Helps us appraise profitability it also helps us identify areas where we might cut costs before it’s too late.

Think in terms of product not time period costs.

Question 41

Describe life cycle costing.

Answer 41

1. At early stages, most costs will be in DESIGN.
2. INTRODUCTORY stage - costs will be incurred in marketing and advertising.
   Sales revenue will be high.
   Production costs will be high but will decline as the product goes into GROWTH owing to increasing returns.
3. In the GROWTH stage, sales and marketing costs will start to tail off.
4. As the product approaches MATURITY, we expect sales revenue will stabilise. Competitors. might have “reverse engineered” the product by then. Sales and marketing costs will be relatively low.
5. DECLINE stage, there may be an increase in marketing costs, as manufacturers try and shift obsolete inventory to make way for the replacement.
   Sales prices low.
   Manufacturing costs are static, or even zero, as factories de-tool and get ready for next project.

Question 42

How do we allocate overheads in non-manufacturing environments?

Answer 42

Front-line service departments will allocate overheads in a way which is analogous to manufacturing environments.

Where this is not possible, a DIRECT COSTING system is used for profitability analysis purposes.

Certain service costs can be allocated where appropriate, using some of the familiar allocation bases already examined.

Question 43

What happens to over and under recoveries?

Answer 43

Treated as time-period cost item and do not allocate to products.