Week 2 Flashcards
What is job (order) costing?
Fpcus: specific orders: readily identified (unique) units
ex:construction, aircraft, special-purpose machinery, ships, costum-designed buildings, meet customers special needs …
Industries which manufacture products or render
services against specific orders use this method. (specialised or made-to-order products)
Also called: specific order costing/ production or costing/job lot costing
-the cost unit is an individual order or a batch of a distinct product or a service.
What is batch costing?
Another form of job costing. Group of identical or similar units. The only difference is that a number of items are being costed together, instead of a single item or service.
Manufacture of furniture,
IPhone 11 Pro Max, Airbus
orders of 40 A330neo and
30 A350s by Emirates.
cost per unit in batch: total production cost of batch/ nb of units in the batch
What is process costing?
Continuous operations:
Large numbers/ quantities
of nearly identical products
ex: Chemicals, oil, textiles,
plastics, flour, food
processing, mining, cement
Average cost per unit: net cost of inputs/expected output
Average cost per unit= (total cost of inputs-scrap value of normal loss) / expected output
What are the cost apportionment bases for job costing?
A cost apportionment base is the basis used by a business to apportion its overhead costs.
– Direct labour hours (most frequently used)
– Direct labour costs
– Machine hours
– Direct materials percentage (or Direct material cost)
– Units of output
– Floor area occupied, etc
What is scrap value?
In cost accounting, scrap value refers to a relatively insignificant amount that a manufacturer receives from the sale of production materials that remain after the manufacture of its products.
Describe overheads
Indirect costs or overheads do not belong to any specific product. They have to be shared amongst a range of products
What is absorption costing?
-cost absorbed into each product
– The overheads are normally charged to the cost centres
(normally departments) that use them
– The departments then charge the overheads to the cost
units (products) they work on
What are the 3 methods to re-apportion the costs of service departmets to production departments?
1) direct method:
Reapportions support costs only to the main
operating/production departments.
This is the simplest method and is to use
when service cost centres provide
services to production cost centres, but
NOT to each other.
2)step-down method
Reapportions support costs only to the main
operating/production departments.
(3:Reciproca method)
What is apportioning?
Apportioning - Overheads will be charged to all cost
centres/ departments
What is re-apportioning?
Re-apportioning – Service department costs are charged
to production departments
How would you apportion depreciation?
Basis: machnery cost
How would you apportion suppervison?
Basis: number of employees
Describe the step-down method
1) allocate/ apportion all OH to the cost centres (departments)
2) service centres to
charge (reapportion) the overheads to the main
production centres. Why?
The service departments do not work on any of the
products so cannot charge or absorb the overhead
costs
3)absorption
How do we reapportion OH of service centres?
The service departments’ overheads will be
reapportioned on the basis of the amount of work
done for the other departments
Which service departments de we re-apportion first?
- the one which serves all departments
- has the greater costs
What is Overhead absorption rate?
When all costs are reapportioned to production departments, they must absorb their OH to the products they produce.
OAR= budgeted expenditure/ budgeted activity
Here activity could be the amount of work carried out: machine hours, labour hours
OAR tells us how much cost of OH is caused per h in each department
Which absorption basis to choose?
The choice of an absorption basis is a matter of judgement
and common sense. There are no strict rules or formulae
involved. But the basis should realistically reflect the
attributes of a given production centre.
Some examples of absorption basis:
Percentages of direct materials cost, direct labour cost, prime
cost, rate per machine hour, per direct labour hour etc.
How do we caculate under/over-absorption
Total overheads absorbed = OAR x actual activity
Over-absorption = Total overheads absorbed > Total actual overhead
Under-absorption = Total overheads absorbed < Total actual overhead
What is the impact of using different absoption baes?
-As a worst case, people’s jobs could be at stake
• Costing methods could potentially be a political
tool within organisations.
• They can affect organisations’ capacity to
understand costs and make appropriate decisions
accordingly
-Choice of basis can make a difference.
What are the advantages of absorption costing?
Improved managerial awareness of total costs
sustained by cost centre
Selling prices can be established to cover full
“product” cost
Absorption costing must be used to value closing
inventory for financial accounts
Overhead absorption rate is used for budgeting
purposes (discussed in later lectures)
What are the problems of absorption costing?
Arbitrary re-apportionment of overheads can lead to
incorrect decisions being taken
Costs are absorbed based on the budgeted overhead
absorption rate and therefore an under/over
absorption adjustment must be made
Ignores the distinction between fixed and variable
costs
Assuming an audit firm such as PwC decides to
use the traditional Absorption costing method to
work out its cost on one audit assignment. How can
they work out the budgeted cost of an audit for say
Bank of America or Goldman Sachs (two of their
known clients)?
In addition to the direct costs of the audit:
Establish the indirect costs – e.g. Audit support including
secretarial, databases charges etc.
Use budgeted chargeable audit hours as budgeted activity
(denominator for OAR). Numerator being the overhead costs.
Calculate OAR –
Total budgeted overheads/Total chargeable hours
Budgeted cost of one audit “job”:
(Overhead absorption rate x number of professional hours) +
Traceable direct professional audit team hours
How would you reaportion maintennabce?
basis: service hours
What is the advantage that is claimed for charging OH to jobs on a cost centre basis and why is it claimed?
-charging OH tojobs on a department basis involves picking up OH that are specific to each department and adding to them a share of OH that are general to a business as a whole. Oh of servicde departments are then reapportionned to production departments. At the end stage the OH of the whole business eqauls to the sum of OH aportioned to the production departments.
In theory dealing with OH on a departmental basis is more costly than on a business-wide basis. In practice, however, it may not make much difference to the cost of collecting the information. This is because these different departments may have different OH. Assigning Oh on a departmental basis takes this into account when calculating the cost of job.
departmental or factory wide (single) OAR?
conditions for factory wide absorption: only on type of product produced, tus oH charged is the same for all departments=same rate applies for a business as a whole
departmetal OAH: different producing departments
In practice, departmentalising overheads may not provide information that is significantly different from that when OH are cahrged to jobs on a factory-wide basis.
What are revelavnt costs? (3)
1) relate to the objective of the business and has an effect on wealth creation. Those costs that will be affected by a decisions
2) future cost
3) vary with decisions (potential costs and benefits associated with different decisions)
Relevant costs are Avoidable costs that are incurred only when making specific business decisions.
Through relevant cost approach unnecessary data is eliminated that could complicate the decision-making process
• Other things being equal, in deciding
between two options one with the lower
total relevant cost would be chosen.
ex: manufacturing labour, rearrangement costs
What are sunk costs?
- actual costs incured in past period
- irrelevant because they cannot be changed by any decision
- shown in financial accounts as asset (capitalised) or expense
ex: market survey already taken
What are opportunity costs?
- describes the value (in monetary terms) of being dprived of the nexr best opportunity in order to pursue a particular objective
- relevant to a particular decision if they differ between alternative courses of action
ex: loss of income to students by deciding to study
or loss ov return that could be made of 1000 pounds in a company stock A when placing them in a mutual fund B for one year
‘The value of the benefit sacrificed when one
course of action is chosen, in preference to an
alternative. The opportunity cost is represented
by the forgone potential benefit from the best
rejected course of action.’
E.g. return expected from an investment other
than the present one.
It is the cost of being deprived of the next best
option.
-Never recorded in formal accounting records
since they do not generate cash outlays.
Describe how to choose an allocation basis
- would not make sense to choose depending on level OH allocated to particular job
- Total OH will remain the same irrespective of how they are apportioned between jobs
- OH are dominated by machine-related costs (power, maintenance, depreciation and so on) : can be argued that the machine-hours basis gives more relevant costs
-Possible alternative
: dealing with machine related OH costs (power) on a machine-basis
: dealing with more “people related” OH (light and heat) on a direct labour hour
What is the formula for reaporshionment for the direct method?
(portion x cost) / (portion + other cost centre position)
What are non relevant costs?
Non-relevant costs will remain unaltered
regardless of a decision. They do not necessarily depict true loss in the value of an asset due to the decision.
Some examples are:
• Sunk or past costs
• Total Fixed overheads that will not increase
or decrease
-absorbed fixed cost
-depreciation charge
• Expenditure that will be incurred in the future,
but as a result of decisions taken in the past
that cannot now be changed.
What is a replacement cost?
The relevant cost of a material that is used regularly is its
replacement cost.
Is a driectly attributable fixed cost relevant?
yes
Besides cost what other factors should be considered?
– Non-financial quantitative factors
e.g. on-time flight arrivals for an airline company (or
even A&E hospital waiting times)
– Qualitative factors
i.e. outcomes that cannot be measured in numerical
terms. Examples: employee morale, customer
satisfaction.
