Job Costs and Overhead Allocation (LECTURE 2) Flashcards
ABSORPTION COSTING SYSTEM
A costing system that allocates all manufacturing costs, including fixed manufacturing costs, to products and values unsold stocks at their total cost of manufacture.
ACTIVITY
The aggregation of different tasks, events or units of work that cause the consumption of resources.
ACTIVITY COST CENTRE
A cost centre in which costs are accumulated by activities.
ACTIVITY-BASED COSTING (ABC)
A system of cost allocation that aims to use mainly cause-and-effect cost allocations by assigning costs to activities.
ALLOCATION BASE
The basis used to allocate costs to cost objects.
ARBITRARY ALLOCATION
The allocation of costs using a cost base that is not a significant determinant of cost.
BLANKET OVERHEAD RATE / PLANT-WIDE RATE
An overhead rate that assigns indirect costs to cost objects using a single overhead rate for the whole organisation.
BUDGETED OVERHEAD RATE
An overhead rate based on estimated annual expenditure on overheads and levels of activity.
CAUSE-AND-EFFECT ALLOCATION / DRIVER TRACING
The use of an allocation base that is a significant determinant of cost.
COST ALLOCATION
The process of assigning costs to cost objects where a direct measure of the resources consumed by these cost objects does not exist.
COST CENTRE / COST POOL
A location to which costs are assigned.
COST DRIVER
The basis used to allocate costs to cost object in an ABC system.
DIRECT COST TRACING
The process of assigning a cost directly to a cost object.
DIRECT COSTING SYSTEM / VARIABLE COSTING SYSTEM / MARGINAL COSTING SYSTEM
A costing system that assigns only direct manufacturing costs, not fixed manufacturing cost, to products and includes them in the inventory valuation.
DIRECT LABOUR HOUR RATE
An hourly overhead rate calculated by dividing the cost centre overheads by the number of direct labour hours.
FIRST-STAGE ALLOCATION BASE
The various bases, such as area, book value of machinery and number of employees, used to allocate indirect costs to production and service centres.
FIXED OVERHEAD EXPENDITURE VARIANCE
The difference between the budgeted fixed overheads and the actual fixed overhead spending.
JOB CARDS
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.
JOB-ORDER COSTING SYSTEM
A system of assigning costs to products and services that is used in situations where many different products or services are produced.
MACHINE HOUR RATE
An hourly overhead rate calculated by dividing the cost centre overheads by the number of machine hours.
MATERIALS REQUISITION
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.
OVERHEAD ANALYSIS SHEET
A document used to assign manufacturing overheads to production and service cost centres.
OVERHEADS
Another term for indirect costs, which are costs that cannot be specifically traced to a particular cost object.
SEQUENTIAL ALLOCATION METHOD / STEP ALLOCATION METHOD
A method of allocating service departments’ overheads to production departments in a certain order.
SERVICE DEPARTMENTS / SUPPORT DEPARTMENTS
Departments that exist to provide services to other units within the organisation.
TIME SHEETS
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.
TRADITIONAL COSTING SYSTEM
Widely used costing systems that tend to use arbitrary allocations to assign indirect costs to cost objects.
UNDER/OVER RECOVERY OF OVERHEADS
The difference between the overheads that are allocated to products or services during a period and the actual overheads that are incurred.
VOLUME VARIANCES
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.
What is a simple way of allocating overheads?
Overheads divided by on allocation base per annum.
What is the problem with simple allocation of overheads? (Blanket system)
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.
More complex overhead allocation method.
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?)
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.
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.
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%.
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
Why are estimates of overheads used?
Too much volatility in monthly rates. Too much effort for little reward.
To await actual figures would delay commercial activity.
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.
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.
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.
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
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
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
How does life cycle costing contrasts with traditional costing methods?
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.
What does life cycle costing help with?
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.
Describe life cycle costing.
- At early stages, most costs will be in DESIGN.
- 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. - In the GROWTH stage, sales and marketing costs will start to tail off.
- 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.
- 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.
How do we allocate overheads in non-manufacturing environments?
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.
What happens to over and under recoveries?
Treated as time-period cost item and do not allocate to products.
