Lecture 2 - Traditional absorption costing

Question 1

What are the benefits and limitations of Simplistic systems?

Answer 1

Benefits: 
-Inexpensive to operate 
-Extensive use of arbitrary cost allocations 
Limitations:
-Low levels of accuracy
-High cost of errors

Question 2

What are the benefits and limitations of highly sophisticated systems?

Answer 2

Benefits:
-High levels of accuracy
-Low cost of errors 
-Extensive use of cause-and-effect cost allocations 
Limitations:
-Expensive to operate

Question 3

Blanket overhead rates/ Plant-wide rates - Example

Answer 3

Total overheads = 900,000
Direct labour = 60,000
Overhead rate = £15 per hour

Question 4

The two stage allocation process allows for the establishment of….

Answer 4

Departmental or cost centre overhead rates

Question 5

What are the two stages of the allocation process?

Answer 5

Stage 1 - Assign overheads initially to cost centres

Stage 2 - Allocate cost centre overheads to cost objects (e.g. products) using cost drivers

Question 6

Applying the two-stage allocation process requires which 4 steps?

Answer 6

Step 1 - Assigning all manufacturing overheads to production and service cost centres
Step 2 - Reallocating the costs assigned to service cost centres to production cost centres
Step 3 - Computing separate overhead rates for each production cost centre
Step 4 - Assigning cost centre overheads to products or other chosen cost objects

Question 7

Arguments for Traditional absorption costing:

Answer 7

• It considers the importance of all costs in producing a product/service
• It is consistent with external reporting purposes
• Requires less reporting effort when compared with ABC

Question 8

Arguments against absorption costing:

Answer 8

• Very old system - 100 years - Times have changed
• New companies use a lot of tech - high maintenance
• More suited for less complex businesses
• Determining basis of apportionments is very arbitrary and will have a direct impact on other decisions such as price setting