QUESTION ONE:

Calculate the total costs for each product if all overheads are absorbed on a machine hour basis.

Overhead absorption is the means of attributing overheads to a product, or service based on direct labour costs, direct labour hours, or machine hours. The treatment of the indirect costs will be examined in this question.

In this question total costs for each product will be calculated using the Overhead Absorption Method.

Total Costs per each product

Overhead Absorption Tare (OAR) on a machine hour basis:

Total Cost Centre Cost . = 26,000 = £20

Total No of Machine Hours 13,000

Costs per Unit for each product

Product A B C D

Direct Costs:

Materials: 40.00 50.00 30.00 60.00

Labour: 28.00 21.00 14.00 21.00

Prime Cost 68.00 71.00 44.00 81.00

Add: Production

Overheads: 80.00 60.00 40.00 60.00

_____ _____ _____ _____

Total Cost 17,760.00 13,100.00 6,720.00 16,920.00

QUESTION TWO

Calculate the total costs for each product, using activity based costing.

Calculate Cost per Unit using driver

Cost (£) Driver Cost per Unit (£)

Set-up costs 5,250 No of Production Runs 250.00

Stores receiving 3,600 Requisitions raised 45.00

Inspection/quality control 2,100 No of production runs 100.00

Materials handing and dispatch 4,620 Orders executed 110.00

Machine related costs 10,430 Total Machine hours 8,023.00

Calculate Total Overheads Cost

Product A B C D

Set-up costs 1,500.00 1,250.00 1,000.00 1,500.00

Stores receiving 900.00 900.00 900.00 900.00

Inspection/quality control 600.00 500.00 400.00 600.00

Materials handing and dispatch 1,320.00 1,100.00 1,284.00 2,888.00

Total Overheads 8,170.00 6,157.00 4,464.00 7,208.00

Calculate Unit Costs (CPU)

Product A B C D

Prime cost 68.00 71.00 44.00 81.00

Cost Overheads 68.08 61.57 55.80 60.07

Total Cost per Unit 136.08 132.57 99.80 141.07

Calculate Total Production Cost

Product A: 136.08 x 120 = 16,329.6

Product B: 132.57 x 100 = 13,257

Product C: 99.80 x 80 = 7,984

Product D: 141.07 x 120 = 16,928.4

Question Three

Question Five

You should include in your report a discussion on the appropriateness of other traditional methods of absorbing overheads and the effectiveness of Activity based costing.

These methods involve the calculation of overhead rates that are designed to ensure that overheads are absorbed by products.

1. Direct Labour Hours OAR Method:

This method is highly acceptable, the use restricted to production cost centres that are labour intensive, rather than machinery intensive. The Direct Labour Hour method is very suitable in order that the time spent in production is related to the cost of overhead incurred.

(in some cases it may cause an overcharge of overhead costs to products which relatively unskilled labour using)

2. Direct Wages (Labour Costs) OAR Method:

Overhead tend to relate to the amount of time that unit spends in production, so this method may be particularly suitable since the direct labour is a combination between hours that worked and rates paid. When skilled workers use costly machinery and unskilled workers perform tasks that do not require similar capital investments, the use of this method will be suitable.

The cases that Direct wages will not be appropriate are where the cost will not relate very closely to time spent in production, like where the total Direct Labour Cost consists of a relatively of a high labour rate per hour and low level of hours worked.

Production works that require more skilled labour would be charged a proportionately greater share of overheads.

In this method the main information is the Labour Cost that is usually available and make the Direct Wages method easy to use.

3. Direct Material (Cost) OAR Method:

Direct Materials Costs might be an appropriate basis when overhead costs are closely related to the volume of materials that handled.

This method rarely used since there is no comparison between the direct material costs entering into different products (products using the most expensive materials will absorb the greater proportion of production cost centre overhead costs).

In case where many of the costs correspond to the quantity of the materials using, it will be appropriate to assign overhead on the basis of direct materials costs.

The Direct Materials method ignores salaries, the one of the most important part from the overhead cost and it is unlikely that there will normally be a strong relationship between the Direct Material Cost and level of overheads. There might be some special cases but, they are probably quite unusual.

4. Prime Cost OAR Method:

The Prime Cost method assumes that there is a close relationship between prime cost and overheads but, actually this is unlikely to be true.

The information needed to use Prime Cost method is available, therefore it is make it simple to apply.

Prime Cost is suitable to use when Direct Labour and Direct Material Costs do not vary significantly, and any variation in costs is roughly the same for both. However, the Prime Cost method combine the disadvantage of both, the Direct Materials and the Direct Labour Cost methods. Just without having any real advantage of its own.

5. Machine Hour OAR Method:

This is a most appropriate method to use in those departments that are machine intensive.

It’s reflects the case of overhead costs that incur in time, there is probably quite a strong correlation between the amount of overhead incurred and amount of machine time taking by producing every unit.

Activity Based Costing

“ABC is an approach to the costing and monitoring of activities which involves tracing resource consumption and costing final outputs”

(Accounting for Non-Accounting Students. 1997. J R Dyson P.450)

ABC is technique, which attempts to increase the accuracy of preparing product cost information for management. This information can be used for assessing product profitability, valuing stock and pricing.

Absorption costing suffered from subjective and arbitrary apportionments of overhead cost whilst variable costing simply ignored the overhead costs.

Variable costing could not be use for stock valuation or pricing as significant overhead costs were ignored and absorption costing tended to be unsuitable for decision making on account of the arbitrary apportionment of overhead costs.

ABC objective was developing a system of costing which would be more suitable for pricing and decision-making.

BIBLIOGRPHY

1. J. R. Dyson. pp.311-319, 450-451. Accounting for Non-Accounting Students. 1997. ISBN 0-273-62575-6.

2. MWE. Glautier & B. Underdown. pp. 456-457. Accounting Theory & Practice 1994. ISBN 0-273-60472-4.

3. T.Lucey Cost & Management Accounting. ISBN 1-85805-041-6.

4. Lecturer and Seminar Notes.

QUESTION ONE:

Calculate the total costs for each product if all overheads are absorbed on a machine hour basis.

Overhead absorption is the means of attributing overheads to a product, or service based on direct labour costs, direct labour hours, or machine hours. The treatment of the indirect costs will be examined in this question.

In this question total costs for each product will be calculated using the Overhead Absorption Method.

Total Costs per each product

Overhead Absorption Tare (OAR) on a machine hour basis:

Total Cost Centre Cost . = 26,000 = £20

Total No of Machine Hours 13,000

Costs per Unit for each product

Product A B C D

Direct Costs:

Materials: 40.00 50.00 30.00 60.00

Labour: 28.00 21.00 14.00 21.00

Prime Cost 68.00 71.00 44.00 81.00

Add: Production

Overheads: 80.00 60.00 40.00 60.00

_____ _____ _____ _____

Total Cost 17,760.00 13,100.00 6,720.00 16,920.00

QUESTION TWO

Calculate the total costs for each product, using activity based costing.

Calculate Cost per Unit using driver

Cost (£) Driver Cost per Unit (£)

Set-up costs 5,250 No of Production Runs 250.00

Stores receiving 3,600 Requisitions raised 45.00

Inspection/quality control 2,100 No of production runs 100.00

Materials handing and dispatch 4,620 Orders executed 110.00

Machine related costs 10,430 Total Machine hours 8,023.00

Calculate Total Overheads Cost

Product A B C D

Set-up costs 1,500.00 1,250.00 1,000.00 1,500.00

Stores receiving 900.00 900.00 900.00 900.00

Inspection/quality control 600.00 500.00 400.00 600.00

Materials handing and dispatch 1,320.00 1,100.00 1,284.00 2,888.00

Total Overheads 8,170.00 6,157.00 4,464.00 7,208.00

Calculate Unit Costs (CPU)

Product A B C D

Prime cost 68.00 71.00 44.00 81.00

Cost Overheads 68.08 61.57 55.80 60.07

Total Cost per Unit 136.08 132.57 99.80 141.07

Calculate Total Production Cost

Product A: 136.08 x 120 = 16,329.6

Product B: 132.57 x 100 = 13,257

Product C: 99.80 x 80 = 7,984

Product D: 141.07 x 120 = 16,928.4

Question Three

Question Five

You should include in your report a discussion on the appropriateness of other traditional methods of absorbing overheads and the effectiveness of Activity based costing.

These methods involve the calculation of overhead rates that are designed to ensure that overheads are absorbed by products.

1. Direct Labour Hours OAR Method:

This method is highly acceptable, the use restricted to production cost centres that are labour intensive, rather than machinery intensive. The Direct Labour Hour method is very suitable in order that the time spent in production is related to the cost of overhead incurred.

(in some cases it may cause an overcharge of overhead costs to products which relatively unskilled labour using)

2. Direct Wages (Labour Costs) OAR Method:

Overhead tend to relate to the amount of time that unit spends in production, so this method may be particularly suitable since the direct labour is a combination between hours that worked and rates paid. When skilled workers use costly machinery and unskilled workers perform tasks that do not require similar capital investments, the use of this method will be suitable.

The cases that Direct wages will not be appropriate are where the cost will not relate very closely to time spent in production, like where the total Direct Labour Cost consists of a relatively of a high labour rate per hour and low level of hours worked.

Production works that require more skilled labour would be charged a proportionately greater share of overheads.

In this method the main information is the Labour Cost that is usually available and make the Direct Wages method easy to use.

3. Direct Material (Cost) OAR Method:

Direct Materials Costs might be an appropriate basis when overhead costs are closely related to the volume of materials that handled.

This method rarely used since there is no comparison between the direct material costs entering into different products (products using the most expensive materials will absorb the greater proportion of production cost centre overhead costs).

In case where many of the costs correspond to the quantity of the materials using, it will be appropriate to assign overhead on the basis of direct materials costs.

The Direct Materials method ignores salaries, the one of the most important part from the overhead cost and it is unlikely that there will normally be a strong relationship between the Direct Material Cost and level of overheads. There might be some special cases but, they are probably quite unusual.

4. Prime Cost OAR Method:

The Prime Cost method assumes that there is a close relationship between prime cost and overheads but, actually this is unlikely to be true.

The information needed to use Prime Cost method is available, therefore it is make it simple to apply.

Prime Cost is suitable to use when Direct Labour and Direct Material Costs do not vary significantly, and any variation in costs is roughly the same for both. However, the Prime Cost method combine the disadvantage of both, the Direct Materials and the Direct Labour Cost methods. Just without having any real advantage of its own.

5. Machine Hour OAR Method:

This is a most appropriate method to use in those departments that are machine intensive.

It’s reflects the case of overhead costs that incur in time, there is probably quite a strong correlation between the amount of overhead incurred and amount of machine time taking by producing every unit.

Activity Based Costing

“ABC is an approach to the costing and monitoring of activities which involves tracing resource consumption and costing final outputs”

(Accounting for Non-Accounting Students. 1997. J R Dyson P.450)

ABC is technique, which attempts to increase the accuracy of preparing product cost information for management. This information can be used for assessing product profitability, valuing stock and pricing.

Absorption costing suffered from subjective and arbitrary apportionments of overhead cost whilst variable costing simply ignored the overhead costs.

Variable costing could not be use for stock valuation or pricing as significant overhead costs were ignored and absorption costing tended to be unsuitable for decision making on account of the arbitrary apportionment of overhead costs.

ABC objective was developing a system of costing which would be more suitable for pricing and decision-making.

BIBLIOGRPHY

1. J. R. Dyson. pp.311-319, 450-451. Accounting for Non-Accounting Students. 1997. ISBN 0-273-62575-6.

2. MWE. Glautier & B. Underdown. pp. 456-457. Accounting Theory & Practice 1994. ISBN 0-273-60472-4.

3. T.Lucey Cost & Management Accounting. ISBN 1-85805-041-6.

4. Lecturer and Seminar Notes.

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