Lecture 3 Flashcards
What are overheads
In accounting, overhead refers to indirect costs that cannot be directly attributed to a specific product, service, or department
What is overhead allocation
Overhead allocation is the process of assigning indirect costs (overhead) to a specific cost object
Allocated overhead =
AllocatedOverhead=TotalOverheadCostXTotalBase/BaseforSpecificCostObject
What does Overhead apportionment involve
Overhead apportionment involves dividing the total overhead costs among different cost centres or departments based on a fair and reasonable basis
When is overhead apportionment done
Overhead apportionment is done when the overhead costs cannot be directly traced to specific departments
When does apportionment generally occur
Apportionment generally occurs when there are shared costs that need to be divided among various departments
ApportionedOverhead=
ApportionedOverhead=TotalOverheadCost×
Department’sRelevantShare/TotalShare
What is overhead reapportionment
Overhead reapportionment is the process of redistributing the overhead costs from one department to others
When is overhead reapportionment typically done
Overhead reapportionment is typically done when the overhead costs have initially been apportioned to service or support departments
What methods does overhead reapportionment typically follow
Overhead reapportionment usually follows a step-down or reciprocal method
What is the step down method
The step down method is when one service department’s costs are allocated to other departments in a set order
How does the reciprocal method work
The reciprocal method works as service departments’ costs are allocated to each other based on the level of service provided
What is absorption costing
Absorption costing is a method where all costs are absorbed into the cost of a product
Where are fixed manufacturing overheads allocated with absorption costing
With absorption costing fixed manufacturing overheads are allocated to each unit produced, along with variable costs
What are the key features of absorption costing
Key features of absorption costing are:
- All costs are included
- Required by GAAP
- Fixed costs are treated as product costs
Formula for absorption costing
Formula for Absorption Costing:
UnitCost = DirectMaterials + DirectLabour + VariableManufacturingOverhead+ Allocate FixedManufacturingOverhead
What is marginal costing
Marginal costing is a method where only variable manufacturing costs are assigned to a product
What are fixed manufacturing costs treated as with marginal costing
With marginal costing fixed manufacturing costs are treated as period costs and are not allocated to the product cost
What are the key features of marginal costing
Key features of manufacturing costing are:
- Only variable costs included
- Fixed costs as period costs
- Useful for decision making
Why is marginal costing often used for internal decision making
Marginal costing is often used for internal decision-making because it clearly shows how variable costs change with production levels
Formula for marginal costing
Marginal cost = Direct materials + Direct labour + Variable manufacturing overhead
Does absorption or marginal costing have a higher unit cost
Absorption costing has a higher unit cost as fixed costs are included
Does absorption or marginal costing have a higher break even point
Absorption costing has a higher break-even point is higher as fixed costs are spread over fewer units
When should you typically use absorption costing
Absorption costing is typically used for external financial statements and long-term pricing decisions
When should you use marginal costing
Marginal costing is often used for internal management decisions
Fixed manufacturing overhead per unit =
Fixed manufacturing overhead per unit = Fixed manufacturing overheads / Units produced
COGS per unit =
COGS per unit = Direct materials + Direct Labour + Variable manufacturing overhead + Fixed manufacturing overhead per unit
Total COGS =
Total COGS = COGS per unit X Units sold
Gross profit =
Gross profit = Sales revenue - COGS
Contribution margin =
Contribution margin = Sales revenue - COGS
Operating profit =
Operating profit = Contribution margins - Fixed costs
Arguments for absorption costing
Arguments for absorption costing are:
- Compliance with accounting standards
- Accurate product costing
- Profitability representation
- Inventory valuation
Why is compliance with accounting standards an argument for absorption costing
Compliance with Accounting Standards is an argument for absorption costing because:
- Absorption costing is required by Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS)
-
How does absorption costing have accurate product costing
Absorption costing has accurate product costing because:
- All manufacturing costs are allocated to the product
- As it helps determine the full cost of the product it is good for pricing decisions
Why is absorption costing good for profitability representation
Absorption costing is good for profitability representation because:
- It spreads fixed costs over all units produced, helping in assessing the overall financial health of a company
- Absorption costing can show a clearer picture of profitability from a long-term perspective
How is absorption costing good for inventory valuation
Absorption costing is beneficial when valuing closing inventory and work in progress
What are some arguments against absorption costing
Arguments Against Absorption Costing:
- Distortion in decision making
- Potential for profit manipulation
- Not ideal for internal decision making
- Complexity
How can absorption costing distort decision making
Absorption costing can distort decision-making because it includes fixed costs in the cost of goods sold
What can absorption costing including fixed costs lead to
Absorption costing including fixed costs can lead to incorrect pricing decisions or cost-benefit analyses
How can profits be manipulated with absorption costing
Profit can be manipulated under absorption costing by producing more units to spread fixed costs over a larger number of units
Why isn’t absorption costing the best method for internal short term decisions
Absorption costing the best method for internal short term decisions:
- For internal short-term decision making, absorption costing may not be the best method because it can obscure the true impact of variable costs and fixed costs
- Managers may focus more on the absorption of fixed costs rather than the marginal impact of production on profitability
Why can absorption costing be complex
Absorption costing can be complex and time-consuming to apply because it requires tracking and allocating both fixed and variable overheads to products
What are the arguments for marginal costing
Arguments for marginal costing are:
- Better for decision making
- Fixed costs treated separately
- Simplified costing
- Useful for short-term planning
Why is marginal costing good for decision making
Marginal costing is particularly useful for decision-making because it focuses on the marginal cost of producing an additional unit
What does marginal costing help understand
Marginal costing helps in understanding the variable costs of production, which are more relevant for decisions about pricing, product mix, and cost control
How can marginal costing make it easier to conduct break even analysis or assess profitability
It highlights how changes in production levels affect the overall cost structure, making it easier to conduct break-even analysis or assess profitability
Why is it good that marginal costing includes fixed costs separately
It separates fixed and variable costs, making it easier to analyse the contribution margin and assess how each product or decision contributes to covering fixed costs
Why is marginal costing simpler to apply
Marginal costing is simpler to apply because it only includes variable costs in the calculation of the cost of goods sold
What does marginal costing make it easier for managers to understand
Marginal costing makes it easier for managers to understand and focus on variable cost control
Why is marginal costing helpful for making pricing decisions
Marginal costing is used to calculate the contribution margin, which is helpful for making pricing decisions
What are arguments against marginal costing
Arguments against marginal costing are:
- Not suitable for external reporting
- Ignores full product costing
- Can be misleading for large fixed costs
- Limited use for inventory valuation
Why isn’t marginal costing allowed for external financial reporting under GAAP or IFRS
Marginal costing is not allowed for external financial reporting under GAAP or IFRS. It does not provide a full picture of the product cost, as it excludes fixed manufacturing overheads
Why is absorption costing required for external stakeholders
For external stakeholders, absorption costing is required to ensure that all manufacturing costs are included in the financial statements
How doesn’t marginal costing show the full cost of production
Marginal costing does not allocate fixed manufacturing overheads to products, which means that it does not show the full cost of production
What can marginal costing ignoring full product costing lead to
Marginal costing ignoring full product costing can lead to an understatement of product costs in the financial statements
What can marginal costing lead to companies overestimating
Marginal costing may lead to overestimating the profitability of a product, especially if sales are lower than expected and fixed costs need to be absorbed by fewer units
How can marginal costing causing limited use for inventory valuation be problematic
Marginal costing causing limited use for inventory valuation can be problematic when inventory is high, as fixed manufacturing costs that are incurred regardless of production levels are not included in inventory valuation
