CHAPTER 3

CALCULATING OF UNIT COST (P2)

1/ INVENTORY VALUATION

There are 2 methods for determining the value of inventory:

(a) Absorption costing: Inventory is valued at full production cost i.e. including both variable and
fixed elements of production cost

(b) Marginal costing: Inventory is valued at variable cost only

Neither method includes non-production costs in the inventory value

2/ STANDARD COST: is the expected or budgeted cost per unit of output. A standard cost is drawn up in
advance of a period and shows the expected usage of resources ad price of resources of each cost unit.

Example: Standard cost card for a unit of product

Direct material 13.5

Direct labour 10

Direct expense 2

Prime cost 25.5

Variable production overhead 0.5

Marginal cost 26.0

Fixed production overhead 15

Absorption cost 41

Non production overheads – admin overhead

(20% of production cost) 8.2

Total cost 49.2

Profit (30% mark up on total cost) 14.76

Sales price 63.96

2/ ABSORPTION COSTING (FULL COSTING):

- Production cost of a cost unit (a product/a service) = full production cost, including:
Direct material
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 Direct labour
Direct expense (if any)
Share of Indirect cost/Overhead

- Share of Overhead per cost unit:

1. Overhead Allocation: charging whole cost items directly to a cost center (production cost
departments, service cost departments, admin/offices)
2. Overhead apportionment: sharing cost items between cost centers

1st stage: apportioning general overhead: → apportioning overhead to cost centers including
production cost centers (production departments) and production service cost centers (canteen, admin
offices, planning, maintenance, stores/warehouse)

2nd stage: reapportioning overhead of service cost centers: → re-apportioning cost of service
cost centers to production cost centers

Note:

(Cost of Equipment = historical cost: nguyên giá

Book value = Carrying value: giá trị ghi sổ/ giá trị sổ sách = giá trị còn lại = NG – hao mòn lũy kế (Cost –
Accumulated Depreciation)

3. Overhead absorption to cost unit:

Predetermined Overhead absorption rate (OAR) = Budgeted overhead cost/ budgeted level of activity

With “level of activity” can be total machine hours, total direct labor hours or total units of productions

Note: OAR can be a percentage of direct material cost or labor cost or prime cost

Overhead absorbed/unit = OAR x actual level of activity/unit

Under/(Over) absorption = Actual Overhead - Overhead absorbed

Example: page 60

Budget Production 1

Production overhead $36,000

Direct material cost 32,000

Direct labour cost 40,000

Machine hours 10,000

Direct labour hour 18,000

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Units of productions 1,000 A and 500 B

Actual A B

Material cost per unit $80

Labor cost per unit 85

Machine hour/unit 23 hrs

Direct labour /unit 36 hrs

➔ OAR? (units of production, direct labor hours, machine hours, direct material cost, direct labor
cost, prime cost)
➔ Absorption cost per unit?

Workings:

a/ overhead absorbed is based on units of production

OAR (units of production) = 36,000/ (1000 + 500) = $24/unit

Absorption cost per unit

Direct material 80

Direct labor 85

Overhead absorbed 24

Total Absorption cost per unit $189

b/ overhead absorbed is based on direct labor hours

OAR = 36000/18000 = $2/hr

Overhead absorbed per unit A = 2 x 36 = $72

Absorption cost per unit A = 80 + 85 + 72 = $237

c/ overhead absorbed is based on direct material cost

OAR = 36000/ 32000 = 1.125 = 112.5%

Overhead absorbed per unit A = 1.125 x 80 = $90

Absorption cost per unit A = 80 + 85 + 90 = $255

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Interactive question 8:

Forming Machining Assembly

OAR 2.5 (per DL Hr) 5.5 (per M.Hr) 2 (per DL Hr)

Overhead Absorbed 2.5 x 5370 =13425 5.5 x 6370 = 35035 2x 5400 = 10800

Actual Overhead 13900 30300 8500

Under/Over Absorbed under 475 over 4735 over 2300

Practices:

Test 9

OAR (per product) = Budgeted overhead cost/ budgeted level of activity

= 4000 / (350 +50) = $10/unit

Budgeted absorption cost/unit:

Paintbrush Easel

Direct material: 4 8
Direct labour: 0.5 9
Direct expense (if any) 0 0
Variable production overhead 0.1 2

Fixed overhead absorbed 10 10

Absorption cost/unit: 14.6 29

Test 9B (Overhead absorbed based on prime cost)

OAR = Budgeted overhead cost/ budgeted level of activity

= 4000 / (350 x 4.5 + 50 x 17) = 4000/2425 = 1.65

Budgeted absorption cost/unit:

Paintbrush Easel

Direct material: 4 8
Direct labour: 0.5 9
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 Direct expense (if any) 0 0
Variable production overhead 0.1 2

Fixed overhead absorbed 4.5 x 1.65 = 7.425 17 x 1.65 = 28.05

Absorption cost/unit: 12.025 47.05

Test 10

OAR = 7800/ (16 x 1000 + 3.5 x 1000) = 0.4

B. Absorption cost per product:

Trainer Sweat bands

Prime cost 16 3.5

Variable production overhead 1 0.5

Fixed overhead absorbed 0.4 x 16 = 6.4 0.4 x 3.5 = 1.4

Absorption cost/unit: 23.4 5.4

(Non-production overhead costs are not included in inventory valuation)

Test 11

OAR = 530/ (50 x 20 + 20 x 30) = 0.33

Overhead absorbed (per Brooch) = 0.33 x 20= $6.6

Overhead absorbed (per Handbag) = 0.33 x 30= $9.9

Absorption cost per Brooch = 20 + 15 + 6.6 = $41.6

Absorption cost per Handbag = 30 + 7.2 + 9.9 = $47.1

Test 12

OAR = 500/ (1x 150 + 0.5 x 150) = $2.22/hr

Budgeted Absorption cost per product:

Wedding Thank you

Direct labor 6 2.5

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 Direct material 3 2

Fixed overhead absorbed 2.22 x 1 =2.22 2.22 x 0.5 =1.11

Absorption cost/unit: $11.22 $5.61

Test 15

a/ departmental OAR

OAR (Assembly) = 31370/ 3175 = $9.88/ hr

OAR (Finishing) = 35150/ 3800= $9.25/ hr

Overhead absorbed (Assembly) = 9.88 x 15/60 = $2.47/unit

Overhead absorbed (Finishing) = 9.25 x 30/60 = $4.625/unit

Total Overhead absorbed per unit: 2.47+ 4.625 = $7.095

b/ Company-wide OAR (blanket OAR/Single OAR)

OAR = (31370 + 35150) / (3175 + 3800) = $9.54/hr

Overhead absorbed per unit = 9.54 x 45/60 = $7.155

Test 18

OAR = $4/unit

Overhead absorbed = 4 x 61000 = $244,000

Actual Overhead = 242,400

Over absorption = 242400 - 244000 = ($1600)

3/ ACTIVITY BASED COSTING (ABC)

➔ A development of traditional absorption costing

Calculate product cost using ABC

(1) Identify a business major activities.

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 (2) Identify the cost drivers: the volume related or transactions related to activity.

(3) Collect the costs associated with each activity into a cost pool

(4) Calculate activity absorption rate and absorb overheads into cost unit.

Test 22 (example)

a/ Absorption costing

OAR = 2150/ (40000+ 25000) = $0.033/ unit

Overhead absorbed per newspaper:

➔ Crystal Courier = $0.033

➔ Palace Bugle = $0.033

b/ ABC

Step 1: Major Activity: production run set up ( → production run set up cost)

Step 2: Cost driver: number of production runs: 3

Step 3: collect activity cost: $2150/ week (for 3 production runs)

Step 4: Activity absorption rate (per production run) = 2150/ 3 = $716.67/ production run

Crystal Palace

Overhead absorbed 716.67 1433.33

Units of production 40.000 25.000

Overhead absorbed/unit 0.0179 0.0573

➔ Overhead absorbed per newspaper:

+ Crystal Courier = 716.67 /40000 = $0.0179
+ Palace Bugle = (716.67 x 2)/25000 = $0.057

4/ COSTING METHODS

- Job costing (short duration)

➔ Job cost includes: prime cost + absorbed overhead

- Contract costing (long duration)

Contract cost includes: prime cost + allocated & absorbed overhead

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 - Batch costing:

Batch cost = prime cost + absorbed overhead

Unit cost = Batch cost/ Number of units (of one batch)

- Process costing
Total process cost: prime cost + absorbed overhead
Unit cost = Total process cost / units of productions
- Life cycle costing
Cost includes cost from research, development, and …to withdrawal from the market.
- Target costing
Target Price – Target profit = Target cost

5/ JUST IN TIME (JIT)

- Zero inventory is held.

- Pull system (customer demand → production)
- High Quality
- Closed relationship with customers (customer does not have to wait)
- Speed
- Reliability
- Efficient production planning
- Reliable sales forecasting