Management Accounting – Week 2

Job-order costing and cost

assignment with absorption costing
systems
Lecture outline

• Full costing systems

• Absorption costing
• Allocation, apportionment, re-apportionment
• Direct method and step-down method
• Advantages and Disadvantages of Absorption
costing
Analysis of total cost

Total
Costs

Cost Cost
behaviour traceability Cost
classification

Variable Fixed Direct Indirect

costs costs costs costs

Variable Full Costing

costing costing method
Cost traceability:
Product costs in manufacturing

Direct costs:
• Direct materials
Prime cost
• Direct labour
• Other direct costs of production*
Manufacturing overhead: Conversion cost
• Indirect materials
• Indirect labour
• Other indirect costs**
= Total product cost

* E.g. Metered power cost

** E.g. Heat, light, power, Plant rent, plant insurance, property
taxes on plants, equipment and building depreciation,
supervisor’s salaries.
Full costing systems

Direct costs
Cost tracing
Cost object

Indirect costs
?
(overheads)
Cost
Apportionment/
Re-apportionment
 Full costing systems
When all fixed and variable costs, including manufacturing costs, are used
to compute the total cost per unit. Examples are as follows:

focus examples
Specific orders: Construction, aircraft,
Job (order) costing readily identified (unique) special-purpose machinery,
units ships e.g.
Group of identical or similar Manufacture of furniture,
units. The only difference is IPhone 11 Pro Max, Airbus
that a number of items are orders of 40 A330neo and
batch costing being costed together, 30 A350s by Emirates.
instead of a single item or
service.
Continuous operations: Chemicals, oil, textiles,
process costing Large numbers/ quantities plastics, flour, food
of nearly identical products processing, mining, cement

https://www.airbus.com/newsroom/press-releases/en/2019/02/airbus-and-emirates-reach-agreement-on-a380-fleet--sign-
new-widebody-orders.html
Job Order Costing

Industries which manufacture products or render

services against specific orders use this method.

There are other names too: e.g. specific order

costing/production order costing/ job lot costing
Job-costing

 In a job-costing system, the cost unit is an individual

order or a batch of a distinct product or service,
called a ‘job’.
Cost units:

 Used in organisations which produces specialised or

made-to-order products.
Job (order) costing:
The cost apportionment base

Different bases for overhead apportionment:

– 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.

Under Job order costing - Overhead is applied to jobs using a predetermined rate.
So today’s lecture we will use that rate to calculate the “full cost”.
Cost per unit – Batch costing

 Batch Costing (formula not in the syllabus)

 Cost per unit – Process costing

Think of some low quality oranges that are received by Innocent or for
Britvic’s J2O production. They may not be good enough to use in production
but can still be sold at a low price and that is the scrap value of normal loss.

The unit cost is a broad, average figure.

 JOB COSTING

© Farooq Mahmood
 Cost card

£ Indirect costs or
Direct Materials 23 overheads do not
Direct Labour 50 belong to any specific
Direct Expenses 17 product. They have
Direct/Prime Costs 90 to be shared amongst
Indirect Materials 0 a range of products
Indirect Labour 17
But how do we
Indirect Expenses 2
decide how much
Manufacturing cost 109
overhead to charge
or absorb to each
product?
 Absorption costing

The following stages are generally used to estimate the

amount of overheads, (such as rent), that is 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
 Overhead re-apportionment
between departments

Some of the methods to re-apportion the costs of

service departments to product(ion) departments:

Direct method
Most commonly used methods of re apportionment

Step-down method

Reciprocal method *
* Reciprocal method will not be examined on the course.
Only mentioned here for completion.
STEP DOWN versus DIRECT METHOD

Step down method:

Reapportions service-department costs to
BOTH operating departments AND support
departments (based on the mutual services
provided between the service departments)

Direct method:
Reapportions support costs only to the main
operating/production departments.
Allocating, apportioning and Re-
apportioning costs
• 1st Some department specific costs will be allocated to
specific departments where they are certain to belong.
• Apportioning - Overheads will be charged to all cost
centres/ departments.
• Re-apportioning – Service department costs are charged
to production departments
Reapportionment of overheads

The canteen does not work on any products because

it is not a production department. It must recharge
its overheads to the production departments on a
reasonable basis
The departments then must charge their overheads
to the products they work on (i.e. the production
output).

Production Production Canteen

Dept. A Dept. B

Reapportioning
Absorption costing example
Step Down method:
1. The canteen staff are outside contractors
2. The maintenance department provides 12,000 service hours
to Dept. 1 and 10,000 hours to Dept. 2
3. Dept. 1 is machine intensive and Dept. 2 is labour intensive
4. Budgeted machine hours for Dept.1 is 6,320 and budgeted
labour hours for Dept. 2 is 7,850
5. Department.1 spends 2 machine hours on a unit of product X
and 1.5 hours on a unit of product Y
6. Department.2 spends 3 labour hours on a unit of product X
and 4 hours on a unit of product Y
Dept. 1 Dept. 2 Maint. Canteen Total
Floor space (sq. m) 10,000 12,000 5,000 3,000 30,000
Value of machinery (£) 150,000 120,000 20,000 10,000 300,000
No. of employees 40 30 10 80
Absorption costing example
Calculate overhead absorbed per product X and Y.
The annual expected overhead costs for a company
which has two production centres and two service
centres (Maintenance & Canteen) are as follows:

Dept. 1 Dept. 2 Maint. Canteen Total

£ £ £ £ £
Food & drink 4,000
Rent & Rates 18,000
Heating & Lighting 12,000
Depreciation 30,000
Supervision 24,000
Food & drink

The food and drink should be allocated to the

canteen department:

Dept. 1 Dept. 2 Maint. Canteen Total

£ £ £ £ £
Food & drink 4,000 4,000
Rent & Rates 18,000
Heating & Lighting 12,000
Depreciation 30,000
Supervision 24,000
 Rent & rates

The rent & rates should be apportioned to all the

departments, but how?
The more floor space, each department occupies, the
more rent it should be charged

Basis Dept. 1 Dept. 2 Maint. Canteen Total

£ £ £ £ £
Food & drink 4,000 4,000
Rent & Rates 18,000
Heating & Lighting 12,000
Depreciation 30,000
Supervision 24,000
 Rent & rates

Calculate the proportion of space occupied by

Dept.1
Then multiply by the total cost of rent and rates

Basis Dept. 1 Dept. 2 Maint. Canteen Total

£ £ £ £ £
Food & drink 4,000 4,000
Rent & Rates 18,000
Heating & Lighting 12,000
Depreciation 30,000
Supervision 24,000
 Rent & rates

Rent & rates charged to Dept. 1 =

Basis Dept. 1 Dept. 2 Maint. Canteen Total

£ £ £ £ £
Food & drink 4,000 4,000
Rent & Rates floor space 18,000
Heating & Lighting 12,000
Depreciation 30,000
Supervision 24,000
 Rent & rates
Now Calculate the proportion of space occupied
for each department. Then multiply by the total
cost of rent and rates
(10,000 sqm/30,000 sqm )x £18,000

Basis Dept. 1 Dept. 2 Maint. Canteen Total

£ £ £ £ £
Food & drink 4,000 4,000
Rent & Rates floor space 6,000 18,000
Heating & Lighting 12,000
Depreciation 30,000
Supervision 24,000
 Heating & lighting

The heating & lighting should also be space

occupied for each department.

Basis Dept. 1 Dept. 2 Maint. Canteen Total

£ £ £ £ £
Food & drink 4,000 4,000
Rent & Rates floor space 6,000 7,200 3,000 1,800 18,000
Heating & Lighting 12,000
Depreciation 30,000
Supervision 24,000
 Heating & lighting
The heating & lighting should also be space
occupied for each department,.

(10,000 sqm/30,000 sqm )x £12,000

Basis Dept. 1 Dept. 2 Maint. Canteen Total

£ £ £ £ £
Food & drink 4,000 4,000
Rent & Rates floor space 6,000 7,200 3,000 1,800 18,000
Heating & Lighting floor space 4,000 12,000
Depreciation 30,000
Supervision 24,000
 Depreciation

Depreciation should be apportioned to all the

departments, but how?

Basis Dept. 1 Dept. 2 Maint. Canteen Total

£ £ £ £ £
Food & drink 4,000 4,000
Rent & Rates floor space 6,000 7,200 3,000 1,800 18,000
Heating & Lighting floor space 4,000 4,800 2,000 1,200 12,000
Depreciation 30,000
Supervision 24,000
 Depreciation
Depreciation should be apportioned to all the
departments, but how?
Machinery cost!
(£150,000/£300,000 )x £30,000

Basis Dept. 1 Dept. 2 Maint. Canteen Total

£ £ £ £ £
Food & drink 4,000 4,000
Rent & Rates floor space 6,000 7,200 3,000 1,800 18,000
Heating & Lighting floor space 4,000 4,800 2,000 1,200 12,000
Depreciation £machinery 15,000 30,000
Supervision 24,000
 Depreciation

Basis Dept. 1 Dept. 2 Maint. Canteen Total

£ £ £ £ £
Food & drink 4,000 4,000
Rent & Rates floor space 6,000 7,200 3,000 1,800 18,000
Heating & Lighting floor space 4,000 4,800 2,000 1,200 12,000
Depreciation £machinery 15,000 12,000 2,000 1,000 30,000
Supervision 24,000
 Supervision

Supervision should be apportioned to all the

departments, but how?

Basis Dept. 1 Dept. 2 Maint. Canteen Total

£ £ £ £ £
Food & drink 4,000 4,000
Rent & Rates floor space 6,000 7,200 3,000 1,800 18,000
Heating & Lighting floor space 4,000 4,800 2,000 1,200 12,000
Depreciation £machinery 15,000 12,000 2,000 1,000 30,000
Supervision 24,000
 Supervision
It can logically be apportioned based on the
number of employees

(40/80)x £24,000

Basis Dept. 1 Dept. 2 Maint. Canteen Total

£ £ £ £ £
Food & drink 4,000 4,000
Rent & Rates floor space 6,000 7,200 3,000 1,800 18,000
Heating & Lighting floor space 4,000 4,800 2,000 1,200 12,000
Depreciation £machinery 15,000 12,000 2,000 1,000 30,000
Supervision employees 12,000 24,000
 Supervision

Basis Dept. 1 Dept. 2 Maint. Canteen Total

£ £ £ £ £
Food & drink 4,000 4,000
Rent & Rates floor space 6,000 7,200 3,000 1,800 18,000
Heating & Lighting floor space 4,000 4,800 2,000 1,200 12,000
Depreciation £machinery 15,000 12,000 2,000 1,000 30,000
Supervision employees 12,000 9,000 3,000 0 24,000
 Absorption costing example
All overheads have now been allocated or
apportioned to the cost centres (departments)
The next stage would be for the service centres to
charge (reapportion) the overheads to the main
production centres
Basis Dept. 1 Dept. 2 Maint. Canteen Total
£ £ £ £ £
Food & drink 4,000 4,000
Rent & Rates floor space 6,000 7,200 3,000 1,800 18,000
Heating & Lighting floor space 4,000 4,800 2,000 1,200 12,000
Depreciation £machinery 15,000 12,000 2,000 1,000 30,000
Supervision employees 12,000 9,000 3,000 0 24,000
37,000 33,000 10,000 8,000 88,000
 Absorption costing example
The service departments do not work on any of the
products so cannot charge or absorb the overhead
costs
The service departments’ overheads will be
reapportioned on the basis of the amount of work
done for the other departments

Basis Dept. 1 Dept. 2 Maint. Canteen Total

£ £ £ £ £
Food & drink 4,000 4,000
Rent & Rates floor space 6,000 7,200 3,000 1,800 18,000
Heating & Lighting floor space 4,000 4,800 2,000 1,200 12,000
Depreciation £machinery 15,000 12,000 2,000 1,000 30,000
Supervision employees 12,000 9,000 3,000 0 24,000
37,000 33,000 10,000 8,000 88,000