Part A 1.

. Costing We start with a revision of the more traditional cost accumulation techniques Cost Accumulation - Revision Costs are recorded and accumulated in a cost accounting system using one of two main approaches: Absorption costing - fixed costs (overheads) are charged to production units Marginal costing - fixed cost are treated as period costs and charged to the profit and loss in the period they are incurred; only costs directly variable with production are charged to production units Absorption costing !nder traditional absorption costing" costs must be allocated" apportioned and then absorbed Allocation: Apportionment: Costs that arise in a single cost centre (department for instance) are allocated in whole to that cost centre Costs common to more than one cost centre are shared out amongst the cost centres using an appropriate basis

After these two processes are complete" we have to consider the need for reapportionment #n order for the third process - absorption - to ta$e place" all overhead costs must be allocated or apportioned to production departments %hus" if costs have allocated&apportioned to service department they must now be re-allocated or re-apportioned %here are three possible methods: the direct method - ignoring any wor$ carried out by one service department for another the step method - accounting for the wor$ done by the service department that does the most wor$ for other service departments" but ignoring the rest the reciprocal method - recognising in full the wor$ each service department does for each of the other service department %here are in turn two different methods of calculation possible here

%hese are demonstrated using the following data: Illustration 'mar (td has four departments in their factory - the )ressing *epartment" the Assembly *epartment" the Canteen" and the Maintenance *epartment 'verheads have been allocated and apportioned to the four departments as follows: Pressing + ,-"--/"--,/"--Assembly + .-"--0"--.0"--Canteen + /"--1"--2"--Maintenance + 0"--1"--3"---

Allocated Apportioned

%he canteen is used /-4 by )ressing" 1-4 by Assembly and .-4 by Maintenance %he Maintenance department is used //4 by )ressing" 5-4 by Assembly and /4 by the canteen Direct method Pressing + ,-"--/"--,/"--/"--/".,, ./".,, Assembly + .-"--0"--.0"--1"--1"623 1."623 Canteen + /"--1"--2"--(2"---) (3"---) Maintenance + 0"--1"--3"---

Allocated Apportioned Canteen (/-&2-:1-&2-) Maintenance (//&3/:5-&3/) Step Method

Allocated Apportioned Canteen: (/-:1-:.-) Maintenance: (//:5-)

Pressing + ,-"--/"--,/"--5"--0",16 ./",16

Assembly + .-"--0"--.0"--."5-5"501 1."201

Canteen + /"--1"--2"--(2"---) -

Maintenance + 0"--1"--3"--,"0-,-"0-(,-"0--) -

Reciprocal Method Repeated distribution Pressing + ,-"--/"--,/"--5"--/"21.0/ /2 5 ./",/6 Assembly + .-"--0"--.0"--."5-5".5,/3 5. . 1."251 Canteen + /"--1"--2"--(2"---) /1/1(/1-) 0 0 (0) Maintenance + 0"--1"--3"--,"0-,-"0-(,-"0--) ,-0 ,-0 (,-0) -

Allocated Apportioned Canteen (/-:1-:.-) Maintenance: (//:5-:/) Canteen: (/-:1-:.-) Maintenance (//:5-:/) Canteen (/-:1-) Algebraically

(et x 7 total cost of canteen department; let y 7 total cost of maintenance department ,) .) x 7 +2"--- 8 - -/y y 7 +3"--- 8 - .-x a) b) c) d) x - - -/y -- .-x 8 y x - - -/y -x 8 / y 5 3/y y 7 2--7 3--7 2--7 5/--7 /1--7 ,-6-6

9olve simultaneously: Multiply b) by /

Add 9olve 9ubstitute in ,): x 7 2--- 8 - -/ x ,-6-6 7 2/1/ Pressing + ,-"--/"--,/"--5".06 /"223 ./",/0

Allocated Apportioned Canteen: (/-:1-:.-) Maintenance: (//:5-:/)

Assembly + .-"--0"--.0"--."/0, 5".21 1."255

Canteen + /"--1"--2"--(2"/1/) /1/ -

Maintenance + 0"--1"--3"--,"6-6 (,-"6-6) -

%here is a lot of sub:ectivity (guesswor$;) involved in these first two processes< Absorption =ow that the overhead costs have all ended up in production cost centres" they can be >absorbed? into the costs of the units of production %his process involves calculating an absorption rate" and the basis for this rate will be chosen from the following: a rate per direct labour hour - used when the process is labour intensive a rate per machine hour - used when the process is machine intensive a rate per unit of production - used when all items of production are identical 'r more unusually: a rate per + of direct material cost a rate per + of direct labour cost a rate per + of prime cost Illustration @ela (td estimate that the factory costs for the coming year will be as follows (#t is expected that .--"--- units of its single product will be manufactured ) *irect material *irect labour Aactory overheads + 5-"--0-"--,--"--1-"--,1-"---

%he budget is based on ,--"--- direct labour hours and /-"--- machine hours Absorption rates *irect labour hour: Machine hour: !nit of production: *irect material cost: *irect labour cost: )rime cost: +1-"---&,--"--+1-"---&/-"--+1-"---&.--"--+1-"---&+5-"--+1-"---&+0-"--+1-"---&+,--"--7 1-p per direct labour hour 7 0-p per machine hour 7 ,/p per unit 7 6/p per + or 6/4 7 /-p per + or /-4 7 1-p per + or 1-4

Note: The final three are often quoted as %ages. %he organisation will chose the absorption rate base most appropriate to the cost centre being considered; and a typical cost statement can be drawn up:

Illustration !sing the data for @ela above" the unit cost statement for one unit will be as follows" assuming that the rate per labour hour is used: *irect material (5-"---&.--"---) *irect labour (0-"---&.--"---) )B#MC C'9% 'verhead cost (each ta$es ,&. hour to ma$e) %'%A( AAC%'BD C'9% + - .- 1- /- ,/ - 0/

#t is important to note that the 'AB ('verhead Absorption rate) to be used will be calculated at the start of the year" based on budgeted figures and expected output levels #f cost are different from estimate" or if activity level differs from budget" this will result in over or under absorption of overheads %he three important figures are: ,) .) 1) 'riginal budgeted overhead - which determines 'AB Actual overhead spent 'verhead absorbed - 'AB x actual activity level

%he difference between .) and 1) gives the overhead over or under absorbed and this will be ta$en to the profit and loss account for the period: .) E 1) 1) E .) !nder absorbed; debit )F( 'ver absorbed; credit )F(

Marginal costing Marginal costing does not reGuire any of the allocation" apportionment" reapportionment and absorption process to ta$e place 'nly the variable costs of production are allocated directly to the product - the overheads are charged as a total to the profit and loss account for the period %his is best illustrated using figures< Illustration Holly (td is a manufacturing company who ma$e a single product" the IeachIomb %hey budget to ma$e ,-"--- IeachIombs in the first six months of .--6 %he budgeted costs and selling prices are as follows: 9elling price Materials *irect labour cost per unit 'ther variable costs of production Aixed production costs Aixed selling costs Actual figures turn out to be: 'pening stoc$ )roduction 9ales !sing this data we will produce: , . 1 5 A marginal costing standard cost card An absorption costing standards cost card A marginal costing profit and loss account An absorption costing profit and loss account ,"--- units ,,"--- units 3"--- units +.- per unit +1 per unit +1 per unit +. per unit +5-"--+.-"---

A marginal costing standard cost card Material cost (abour cost 'ther variable costs of production 9elling price Marginal cost Contribution per unit 1 1 . 2 .2 ,.

An absorption costing standards cost card Material cost 1 (abour cost 1 'ther variable costs of production . Aixed production overhead 5 ,. 9elling price )roduction cost 9elling cost )rofit per unit .,. . 0

A marginal costing profit and loss account 9ales (+.- x 3"---) 'pening stoc$ (,"--- x 2) )roduction costs (,,"--- x 2) Closing stoc$ (1"--- x 2) Contribution Aixed production costs Aixed selling costs )rofit + ,2-"--2"--22"--30"--(.5"---)

(6."---) ,-2"--(5-"---) (.-"---) 52"--+ ,2-"---

An absorption costing profit and loss account 9ales (+.- x 3"---) 'pening stoc$ (,"--- x ,.) )roduction costs (,,"--- x ,.) Closing stoc$ (1"--- x ,.) Contribution 'ver absorbed production costs Aixed selling costs )rofit ,."--,1."--,55"--(10"---)

(,-2"---) 6."--5"--(.-"---) /0"---

!ample " #n its first period of trading a small manufacturing company has the following financial results: )roduction: Aixed costs of production: Jariable cost of production: 9ales: ,-"--- units of output +5-"--+/ per unit produced 2"--- units at a price of +,. per unit

#n the second period" the following results are obtained: 'pening stoc$: )roduction: Aixed costs of production: Jariable cost of production: 9ales: Re#uired )repare operating statements for the two periods" using a) Absorption costing b) Marginal costing Cxplain the differences between the two results ."--- units ,-"--- units of output +5-"--+/ per unit produced ,."--- units at +,. each

!ample $ *elete as appropriate to ma$e the following table ma$e sense: )roduction exceeds sales 9toc$ levels rise/fall/constant )rofit figure using absorption costing is more than/less than/ equal to that under marginal costing )rofit figure using absorption costing is more than/less than/ equal to that under marginal costing )rofit figure using absorption costing is more than/less than/ equal to that under marginal costing

9ales exceed production

9toc$ levels rise/fall/constant

9ales eGual production

9toc$ levels rise/fall/constant