Overhead Absorption

Question 1

What is Overhead absorption ?

Answer 1

Methods for allocating overhead costs ( indirect costs) to products/services including absorption costing and activity based costing
- they are indirect costs that must be shared amongst all the units

Question 2

What is Capital Expenditure ?

Answer 2

Buying machinery or anything that business will use for a long period of time

Question 3

What is revenue expenditure

Answer 3

Expenses direct to our cost product or period cost
In that category are direct and indirect costs which both have a fixed and variable cost factor

Question 4

What is mixed costs ?

Answer 4

Separating fixed and variable parts

Question 5

What is the high/low method?

Answer 5

Where total costs are known for 2 levels pf output, fixed and variable costs can be worked out

Question 6

Formula for the high/low method ?

Answer 6

Variable cost per unit = (High output cost - low output cost) / (high output unit - low output unit)
Fixed cost = High Output cost - ( variable cost per unit x high output unit)
Fixed Cost= low output cost - ( variable cost per unit x low output unit)

Question 7

Example: Crazy Cutz hairdressing business set up by 2 workers. Estimated that total overheads ( rent & rates, GEW, telephone etc) will be about £27,000 for the first year. They expect to be working 1,500 hours each during the first year
How do they decide how to cost out a job?

Answer 7

Total Overheads = £27,000
Total working hours = 2workers x 1,500 hrs = 3,000
OAR= £27,000/3,000= 9
Each hour work should add £9.00

Question 8

What is job order costing ?

Answer 8

• Assume that there are individual/batches of products
• Each product/ batch incurs different costs therefore have to keep track of each product/batch

Question 9

What is process order costing ?

Answer 9

Used in industries where masses of the same product are produced in a flow process

Question 10

What is the cost assignment method for direct costs?

Answer 10

Direct costs = direct tracing = cost object

Question 11

What is the cost assignment method for indirect costs ?

Answer 11

Indirect costs =
- cause and effect allocations = cost object
- Arbitrary allocations ( based in labour/machine hours) = cost object

Question 12

How to calculate the overhead absorption rate (OAR) ?

Answer 12

OAR= Total overhead costs/ total allocation base ( eg. Units, labour/machine hours)

Question 13

OAR: what is the plant wide/ blanket overhead rate ?

Answer 13

This is the most simplest method as it applies overhead costs directly to a production department
- used by small businesses who don’t have complex departments or multiple products

Question 14

What are the advantages of plant wide/blanket overhead rate ?

Answer 14

Simple to calculate
Low cost to implement

Question 15

What are the disadvantages of plant wide rate/blanket overhead rate ?

Answer 15

Arbitrary: the allocation base may not reflect costs
Simplistic
Inaccurate

Question 16

OAR: what is 2 stage allocation process ?

Answer 16

• More complex method of allocating costs to overheads
• Applies to both traditional methods and activity based costing systems

Question 17

What is traditional costing system method?

Answer 17

Stage 1:
1. Assign all manufacturing overheads to production and service centres
2. Reallocate the costs assigned to service cost centres to production centres
Stage 2:
3. Compute separate overhead rates for each production cost centre
4. Assign cost centre overheads to cost objects

Question 18

What is activity based costing ?

Answer 18

More complex method of allocating overheads
- Identifies activities within a business and assigns costs based on those activities
Stage 1:
1. Activities are divided into activity cost centres
2. The total cost associated to each activity is allocated to the relevant activity cost centre
Stage 2:
3. The total cost in each cost centre is then charged to output using a cost driver