SlideShare a Scribd company logo
1 of 25
Chapter 8     Study Text Chapter 8




Overheads and absorption costing
Overheads

•    Overheads/indirect costs are those costs that cannot be traced directly
     and in full to the products or services or department of the business.
•    Overhead= indirect(material+labour+expenses)
•    Overheads are categorised commonly ase
1.   Production overhead
2.   Administration overhead
3.   Selling overhead
4.   Distribution overhead




Slide 2
Absorption costing
• Absorption costing is a method of sharing overheads between
   a number of different products or services on a fair basis.
• Absorption costing procedure
1. Allocation
2. Apportionment
3. absorption




Slide 3
Allocation
1) Allocation
• collection of costs by type
• allocation of as many costs as possible
   directly to cost centers




Slide 4
Overheads
                Total production costs



Direct costs                             Indirect costs
                                         (overheads)             Allocate &
                                                                 apportion
                                         COST CENTRES

                            Production 1        Production 2 Service
          Allocate




                         COST UNITS

    Slide 5
Apportionment
Two stages
1. Overheads that cannot be allocated to specific cost
   centres are spread between cost centres on a fair
   basis.
2. Re-apportionment of service cost center overheads
   to production cost centers
Methods of re-apportionment
a) Direct method
b) Step-down method
Overheads Basis of apportionment
Overhead                 Basis

Rent and rates           Floor space occupied

Depreciation             Cost/NBV of equipment

Staff welfare            Number of employees

Heat, light              Volume of space occupied

Insurance of equipment   Value of equipment

Insurance of building    Floor space occupied

Stores costs             Number of issues

Building repairs &       Floor space occupied
maintenance

Slide 7
Re-apportionment
Direct method of re-apportionment:
• It involves apportioning the costs of each service Cost centre
   to production cost centres only .Text example-page 143
Step-down method of re-apportionment:
• This method recognises the inter-service cost Centre work.
   Each service cost centre’s costs are Not only apportioned to
   production departments but to some ( but not all) of the
   Other Service cost centres that makes use of the Service
   provided
Reapportionment
          To reapportion service cost centre overheads to production cost centres
          there are 2 methods




                Direct                           Step down
                Method                           method




            Inter-service                      Some inter-service
            department                         department work
            work is ignored                     is recognised

Slide 9
Overheads
                Total production costs



Direct costs                             Indirect costs
                                         (overheads)             Allocate &
                                                                 apportion
                                         COST CENTRES

                            Production 1        Production 2 Service
          Allocate
                            Production 1        Production 2    Reapportion



                         COST UNITS

    Slide 10
Basis of re-apportionment
Service cost centre    Possible basis of apportionment


Stores                 Number or cost value of material
                       requisition



Maintenance            Hours of maintenance work done for each
                       cost centre



Production planning    Direct labour hours worked in each
                       production cost centre
Absorption
 Absorption involves;
• Identifing the absorption base
• Establishing an absorption rate for each
  production cost center.
• Absorption of overheads in to cost units.
Absorption costing method
                Total production costs



Direct costs                             Indirect costs
                                         (overheads)                   1.Allocate &
                                                                       apportion
                                         COST CENTRES

                            Production 1        Production 2 Service
          Allocate
                            Production 1        Production 2          2.Reapportion

                                                          3. Absorb
                         COST UNIT

    Slide 13
Possible bases of absorption
The most common absorption bases are as follows;
• A rate per machine hour
• A rate per direct labour hour
• A percentage of direct labour cost
• A percentage of direct material cost
• A percentage of total direct cost
• A rate per unit
• A percentage of factory overhead
• A percentage of sales value of factory cost
Choosing basis of absorption
Basis                 Use when


Unit                  Units are identical


Labour hour           Labour intensive


Machine hour          Machine intensive


% of direct labour    Question asks for it
Absorption rate

                                   Production overhead
                                      _______________
OAR (overhead absorption rate) =
                                       Activity level




Slide 16
Absorption into production




 Overhead                                Pre-determined
 Absorbed      =   Actual activity   x   OAR




Slide 17
Absorption costing -cost card

                   A cost card shows us the cost to make one unit




                                              $/unit
           Direct materials                     X
           Direct labour                        X
           Prime cost                           X
           Overheads                            X
           Full Product cost                    X




Slide 18
Predetermined overhead
            absorption rates
• Calculated using budget figures
Steps in calculating and using POHAR
1. Estimate the overhead
2. Estimate the activity level for the period. This could
   be total hours, units or direct cost or what ever
   measure upon which the OHAR are to be based.
3. Divide the estimated overhead by the budgeted
   activity level.This produces the POAR
4. Absorb or recover overheads in to cost units
Why use predetermined rates instead
     of actual absorption rates
• It enable overheads to be absorbed through out the
  accounting period.
• The actual overheads and actual activity level are not
  known until the end of an accounting period, the
  actual absorption rates can not be calculated until
  then. In effect then the total cost of the product
  cannot be determined until the end of the period as
  well. This is too late for management planning and
  control purpose like product pricing,production
  scheduling,product cost estimation and routine
  accounting functions like invoicing
Effect of using predetermined
                  absorption rates

     At the end of the year actual overheads will be known




              Overhead
              absorbed          ≠              Actual
                                               overhead



      Difference = under or over absorption


Slide 21
Non-production overheads
• For internal purposes and organisations which base
  selling price of their product on estimates of total
  costs or even actual costs. A total cost per unit of
  output may be required. therefore it may be
  appropriate to allocate non-production overheads to
  units of output.
• Overhead absorption rate= estimated non-
  production oH/ estimated production costs
Non-production overheads
Administration overheads include:
• Executive salaries and wages/salaries of all
  staff in administration departments
• Office rent and rates
• Lighting and heating
• Cleaning
Selling costs are incurred in order to obtain sales
Distribution costs include warehouse cost and
delivery costs
Bases for absorption
Types of overhead          Possible absorption base

Selling and marketing      Sales value

Research and development   Consumer cost (= production cost minus
                           cost of direct materials) or added value( =
                           sales value of product minus cost of
                           bought in materials and services)




Distribution               Sales value

Administration             Full production cost
Non-production costs in practice
In practice;
1.An absorption costing system may be
  restricted to production costs only.
2.The non-production overheads are simply
  treated as a period charge against profit.
3.The actual overhead costs are included in the
  cost of sales.

More Related Content

What's hot

Standard costs and variance analysis
Standard costs and variance analysisStandard costs and variance analysis
Standard costs and variance analysisSumit Malhotra
 
A presentation on process costing
A presentation on process costingA presentation on process costing
A presentation on process costingPRIYANKAVP4
 
Accounts from incomplete records
Accounts from incomplete records Accounts from incomplete records
Accounts from incomplete records Ankit Sand
 
Activity Based Costing
Activity Based CostingActivity Based Costing
Activity Based CostingVikas Gupta
 
Methods and techniques of Costing
Methods and techniques of CostingMethods and techniques of Costing
Methods and techniques of CostingAshwin Showi
 
Absorption Costing and Marginal Costing ppt
Absorption Costing and Marginal Costing pptAbsorption Costing and Marginal Costing ppt
Absorption Costing and Marginal Costing pptVaseemParry
 
Advantages and limitations of cost accounting
Advantages and limitations of cost accountingAdvantages and limitations of cost accounting
Advantages and limitations of cost accountingUday Teke
 
Objectives of cost accounting
Objectives of cost accountingObjectives of cost accounting
Objectives of cost accountingUday Teke
 
Job costing power point show
Job costing power point showJob costing power point show
Job costing power point showMaliha Jahan
 
Management accounting TYPES OF BUDGET
Management accounting TYPES OF BUDGETManagement accounting TYPES OF BUDGET
Management accounting TYPES OF BUDGETayushigupta300
 
Classification Of Cost
Classification Of CostClassification Of Cost
Classification Of CostDr. Rana Singh
 

What's hot (20)

Standard costs and variance analysis
Standard costs and variance analysisStandard costs and variance analysis
Standard costs and variance analysis
 
Elements of cost
Elements of costElements of cost
Elements of cost
 
Responsibility Accounting
Responsibility AccountingResponsibility Accounting
Responsibility Accounting
 
Relevant+cost
Relevant+costRelevant+cost
Relevant+cost
 
A presentation on process costing
A presentation on process costingA presentation on process costing
A presentation on process costing
 
Job costing
Job costingJob costing
Job costing
 
Accounts from incomplete records
Accounts from incomplete records Accounts from incomplete records
Accounts from incomplete records
 
Activity Based Costing
Activity Based CostingActivity Based Costing
Activity Based Costing
 
Methods and techniques of Costing
Methods and techniques of CostingMethods and techniques of Costing
Methods and techniques of Costing
 
Absorption Costing and Marginal Costing ppt
Absorption Costing and Marginal Costing pptAbsorption Costing and Marginal Costing ppt
Absorption Costing and Marginal Costing ppt
 
ABC costing
ABC costing ABC costing
ABC costing
 
Advantages and limitations of cost accounting
Advantages and limitations of cost accountingAdvantages and limitations of cost accounting
Advantages and limitations of cost accounting
 
Classification of cost
Classification of costClassification of cost
Classification of cost
 
Objectives of cost accounting
Objectives of cost accountingObjectives of cost accounting
Objectives of cost accounting
 
Cost concepts
Cost conceptsCost concepts
Cost concepts
 
Job costing power point show
Job costing power point showJob costing power point show
Job costing power point show
 
Management accounting TYPES OF BUDGET
Management accounting TYPES OF BUDGETManagement accounting TYPES OF BUDGET
Management accounting TYPES OF BUDGET
 
Classification Of Cost
Classification Of CostClassification Of Cost
Classification Of Cost
 
Cost accounting
Cost accountingCost accounting
Cost accounting
 
Activity based costing
Activity based costingActivity based costing
Activity based costing
 

Viewers also liked

Absorption and marginal costing
Absorption and marginal costingAbsorption and marginal costing
Absorption and marginal costingTrisha Dookhony
 
Absorption and marginal costing
Absorption and marginal costingAbsorption and marginal costing
Absorption and marginal costingKhalid Aziz
 
Marginal Costing vs Absorption Costing - ACCA - F5
Marginal Costing vs Absorption Costing - ACCA - F5Marginal Costing vs Absorption Costing - ACCA - F5
Marginal Costing vs Absorption Costing - ACCA - F5Jessy Chong
 
Absorption and marginal costing
Absorption and marginal costing Absorption and marginal costing
Absorption and marginal costing Ravindra Sharma
 
Marginal and absorption costing
Marginal and absorption costingMarginal and absorption costing
Marginal and absorption costingNandini Chowdary
 
Absorption costing vs. marginal costing
Absorption costing vs. marginal costingAbsorption costing vs. marginal costing
Absorption costing vs. marginal costingshivpratap121
 

Viewers also liked (10)

Absorption and marginal costing
Absorption and marginal costingAbsorption and marginal costing
Absorption and marginal costing
 
Absorption and marginal costing
Absorption and marginal costingAbsorption and marginal costing
Absorption and marginal costing
 
Overhead
OverheadOverhead
Overhead
 
Absorption costing
Absorption costingAbsorption costing
Absorption costing
 
Absorption vs marginal costing
Absorption vs marginal costingAbsorption vs marginal costing
Absorption vs marginal costing
 
Marginal Costing vs Absorption Costing - ACCA - F5
Marginal Costing vs Absorption Costing - ACCA - F5Marginal Costing vs Absorption Costing - ACCA - F5
Marginal Costing vs Absorption Costing - ACCA - F5
 
Absorption and marginal costing
Absorption and marginal costing Absorption and marginal costing
Absorption and marginal costing
 
Marginal and absorption costing
Marginal and absorption costingMarginal and absorption costing
Marginal and absorption costing
 
Absorption costing vs. marginal costing
Absorption costing vs. marginal costingAbsorption costing vs. marginal costing
Absorption costing vs. marginal costing
 
Marginal Costing
Marginal CostingMarginal Costing
Marginal Costing
 

Similar to Absorption costing

Accy121 finalexaminstrmanualchs9 11_13_16_appendix
Accy121 finalexaminstrmanualchs9 11_13_16_appendixAccy121 finalexaminstrmanualchs9 11_13_16_appendix
Accy121 finalexaminstrmanualchs9 11_13_16_appendixUmair Sarwer
 
ACCOUNTING FOR OH.pptx
ACCOUNTING FOR OH.pptxACCOUNTING FOR OH.pptx
ACCOUNTING FOR OH.pptxDaveN31
 
Job order costing -jnu
Job order costing -jnuJob order costing -jnu
Job order costing -jnuavrobd
 
Unit 9 cost measurement
Unit 9 cost measurementUnit 9 cost measurement
Unit 9 cost measurementRyk Ramos
 
UNIT 2 PROCESS COSTING.pptx
UNIT 2 PROCESS COSTING.pptxUNIT 2 PROCESS COSTING.pptx
UNIT 2 PROCESS COSTING.pptxENOCK13
 
Ac315 chapter4lecturenotes
Ac315 chapter4lecturenotesAc315 chapter4lecturenotes
Ac315 chapter4lecturenotesknappr3
 
Marginal-Costing_7dmZZc0.pdf
Marginal-Costing_7dmZZc0.pdfMarginal-Costing_7dmZZc0.pdf
Marginal-Costing_7dmZZc0.pdfMonishAswani1
 
Overhead Costs (1).docx
Overhead Costs (1).docxOverhead Costs (1).docx
Overhead Costs (1).docxJyotirupSamal
 

Similar to Absorption costing (20)

Accy121 finalexaminstrmanualchs9 11_13_16_appendix
Accy121 finalexaminstrmanualchs9 11_13_16_appendixAccy121 finalexaminstrmanualchs9 11_13_16_appendix
Accy121 finalexaminstrmanualchs9 11_13_16_appendix
 
ACCOUNTING FOR OH.pptx
ACCOUNTING FOR OH.pptxACCOUNTING FOR OH.pptx
ACCOUNTING FOR OH.pptx
 
Overhead cost
Overhead costOverhead cost
Overhead cost
 
Job order costing -jnu
Job order costing -jnuJob order costing -jnu
Job order costing -jnu
 
Job and batch costing
Job and batch costingJob and batch costing
Job and batch costing
 
Costing introduction
Costing introductionCosting introduction
Costing introduction
 
Overheads
OverheadsOverheads
Overheads
 
Activity-Based Costing System
Activity-Based Costing SystemActivity-Based Costing System
Activity-Based Costing System
 
Absorption costing
Absorption costingAbsorption costing
Absorption costing
 
Unit 9 cost measurement
Unit 9 cost measurementUnit 9 cost measurement
Unit 9 cost measurement
 
Bf icab chapter 3, Management Information, ICAB
Bf icab chapter 3, Management Information, ICABBf icab chapter 3, Management Information, ICAB
Bf icab chapter 3, Management Information, ICAB
 
UNIT 2 PROCESS COSTING.pptx
UNIT 2 PROCESS COSTING.pptxUNIT 2 PROCESS COSTING.pptx
UNIT 2 PROCESS COSTING.pptx
 
Costs
CostsCosts
Costs
 
ACC 116 OVERHEAD
ACC 116 OVERHEADACC 116 OVERHEAD
ACC 116 OVERHEAD
 
ma_ch03_slides.ppt
ma_ch03_slides.pptma_ch03_slides.ppt
ma_ch03_slides.ppt
 
Cost allocation
Cost allocationCost allocation
Cost allocation
 
Ac315 chapter4lecturenotes
Ac315 chapter4lecturenotesAc315 chapter4lecturenotes
Ac315 chapter4lecturenotes
 
Marginal-Costing_7dmZZc0.pdf
Marginal-Costing_7dmZZc0.pdfMarginal-Costing_7dmZZc0.pdf
Marginal-Costing_7dmZZc0.pdf
 
Overhead Costs (1).docx
Overhead Costs (1).docxOverhead Costs (1).docx
Overhead Costs (1).docx
 
BBA 3rd Sem Cost Accounting: Unit-4 - Overheads Theory
BBA 3rd Sem Cost Accounting: Unit-4 - Overheads TheoryBBA 3rd Sem Cost Accounting: Unit-4 - Overheads Theory
BBA 3rd Sem Cost Accounting: Unit-4 - Overheads Theory
 

Recently uploaded

WSMM Technology February.March Newsletter_vF.pdf
WSMM Technology February.March Newsletter_vF.pdfWSMM Technology February.March Newsletter_vF.pdf
WSMM Technology February.March Newsletter_vF.pdfJamesConcepcion7
 
NAB Show Exhibitor List 2024 - Exhibitors Data
NAB Show Exhibitor List 2024 - Exhibitors DataNAB Show Exhibitor List 2024 - Exhibitors Data
NAB Show Exhibitor List 2024 - Exhibitors DataExhibitors Data
 
The McKinsey 7S Framework: A Holistic Approach to Harmonizing All Parts of th...
The McKinsey 7S Framework: A Holistic Approach to Harmonizing All Parts of th...The McKinsey 7S Framework: A Holistic Approach to Harmonizing All Parts of th...
The McKinsey 7S Framework: A Holistic Approach to Harmonizing All Parts of th...Operational Excellence Consulting
 
Psychic Reading | Spiritual Guidance – Astro Ganesh Ji
Psychic Reading | Spiritual Guidance – Astro Ganesh JiPsychic Reading | Spiritual Guidance – Astro Ganesh Ji
Psychic Reading | Spiritual Guidance – Astro Ganesh Jiastral oracle
 
Memorándum de Entendimiento (MoU) entre Codelco y SQM
Memorándum de Entendimiento (MoU) entre Codelco y SQMMemorándum de Entendimiento (MoU) entre Codelco y SQM
Memorándum de Entendimiento (MoU) entre Codelco y SQMVoces Mineras
 
trending-flavors-and-ingredients-in-salty-snacks-us-2024_Redacted-V2.pdf
trending-flavors-and-ingredients-in-salty-snacks-us-2024_Redacted-V2.pdftrending-flavors-and-ingredients-in-salty-snacks-us-2024_Redacted-V2.pdf
trending-flavors-and-ingredients-in-salty-snacks-us-2024_Redacted-V2.pdfMintel Group
 
Driving Business Impact for PMs with Jon Harmer
Driving Business Impact for PMs with Jon HarmerDriving Business Impact for PMs with Jon Harmer
Driving Business Impact for PMs with Jon HarmerAggregage
 
Excvation Safety for safety officers reference
Excvation Safety for safety officers referenceExcvation Safety for safety officers reference
Excvation Safety for safety officers referencessuser2c065e
 
Types of Cyberattacks - ASG I.T. Consulting.pdf
Types of Cyberattacks - ASG I.T. Consulting.pdfTypes of Cyberattacks - ASG I.T. Consulting.pdf
Types of Cyberattacks - ASG I.T. Consulting.pdfASGITConsulting
 
Traction part 2 - EOS Model JAX Bridges.
Traction part 2 - EOS Model JAX Bridges.Traction part 2 - EOS Model JAX Bridges.
Traction part 2 - EOS Model JAX Bridges.Anamaria Contreras
 
14680-51-4.pdf Good quality CAS Good quality CAS
14680-51-4.pdf  Good  quality CAS Good  quality CAS14680-51-4.pdf  Good  quality CAS Good  quality CAS
14680-51-4.pdf Good quality CAS Good quality CAScathy664059
 
Effective Strategies for Maximizing Your Profit When Selling Gold Jewelry
Effective Strategies for Maximizing Your Profit When Selling Gold JewelryEffective Strategies for Maximizing Your Profit When Selling Gold Jewelry
Effective Strategies for Maximizing Your Profit When Selling Gold JewelryWhittensFineJewelry1
 
Technical Leaders - Working with the Management Team
Technical Leaders - Working with the Management TeamTechnical Leaders - Working with the Management Team
Technical Leaders - Working with the Management TeamArik Fletcher
 
digital marketing , introduction of digital marketing
digital marketing , introduction of digital marketingdigital marketing , introduction of digital marketing
digital marketing , introduction of digital marketingrajputmeenakshi733
 
Horngren’s Financial & Managerial Accounting, 7th edition by Miller-Nobles so...
Horngren’s Financial & Managerial Accounting, 7th edition by Miller-Nobles so...Horngren’s Financial & Managerial Accounting, 7th edition by Miller-Nobles so...
Horngren’s Financial & Managerial Accounting, 7th edition by Miller-Nobles so...ssuserf63bd7
 
Planetary and Vedic Yagyas Bring Positive Impacts in Life
Planetary and Vedic Yagyas Bring Positive Impacts in LifePlanetary and Vedic Yagyas Bring Positive Impacts in Life
Planetary and Vedic Yagyas Bring Positive Impacts in LifeBhavana Pujan Kendra
 
Welding Electrode Making Machine By Deccan Dynamics
Welding Electrode Making Machine By Deccan DynamicsWelding Electrode Making Machine By Deccan Dynamics
Welding Electrode Making Machine By Deccan DynamicsIndiaMART InterMESH Limited
 
Environmental Impact Of Rotary Screw Compressors
Environmental Impact Of Rotary Screw CompressorsEnvironmental Impact Of Rotary Screw Compressors
Environmental Impact Of Rotary Screw Compressorselgieurope
 
Fordham -How effective decision-making is within the IT department - Analysis...
Fordham -How effective decision-making is within the IT department - Analysis...Fordham -How effective decision-making is within the IT department - Analysis...
Fordham -How effective decision-making is within the IT department - Analysis...Peter Ward
 

Recently uploaded (20)

WSMM Technology February.March Newsletter_vF.pdf
WSMM Technology February.March Newsletter_vF.pdfWSMM Technology February.March Newsletter_vF.pdf
WSMM Technology February.March Newsletter_vF.pdf
 
NAB Show Exhibitor List 2024 - Exhibitors Data
NAB Show Exhibitor List 2024 - Exhibitors DataNAB Show Exhibitor List 2024 - Exhibitors Data
NAB Show Exhibitor List 2024 - Exhibitors Data
 
The McKinsey 7S Framework: A Holistic Approach to Harmonizing All Parts of th...
The McKinsey 7S Framework: A Holistic Approach to Harmonizing All Parts of th...The McKinsey 7S Framework: A Holistic Approach to Harmonizing All Parts of th...
The McKinsey 7S Framework: A Holistic Approach to Harmonizing All Parts of th...
 
Psychic Reading | Spiritual Guidance – Astro Ganesh Ji
Psychic Reading | Spiritual Guidance – Astro Ganesh JiPsychic Reading | Spiritual Guidance – Astro Ganesh Ji
Psychic Reading | Spiritual Guidance – Astro Ganesh Ji
 
Memorándum de Entendimiento (MoU) entre Codelco y SQM
Memorándum de Entendimiento (MoU) entre Codelco y SQMMemorándum de Entendimiento (MoU) entre Codelco y SQM
Memorándum de Entendimiento (MoU) entre Codelco y SQM
 
trending-flavors-and-ingredients-in-salty-snacks-us-2024_Redacted-V2.pdf
trending-flavors-and-ingredients-in-salty-snacks-us-2024_Redacted-V2.pdftrending-flavors-and-ingredients-in-salty-snacks-us-2024_Redacted-V2.pdf
trending-flavors-and-ingredients-in-salty-snacks-us-2024_Redacted-V2.pdf
 
Driving Business Impact for PMs with Jon Harmer
Driving Business Impact for PMs with Jon HarmerDriving Business Impact for PMs with Jon Harmer
Driving Business Impact for PMs with Jon Harmer
 
The Bizz Quiz-E-Summit-E-Cell-IITPatna.pptx
The Bizz Quiz-E-Summit-E-Cell-IITPatna.pptxThe Bizz Quiz-E-Summit-E-Cell-IITPatna.pptx
The Bizz Quiz-E-Summit-E-Cell-IITPatna.pptx
 
Excvation Safety for safety officers reference
Excvation Safety for safety officers referenceExcvation Safety for safety officers reference
Excvation Safety for safety officers reference
 
Types of Cyberattacks - ASG I.T. Consulting.pdf
Types of Cyberattacks - ASG I.T. Consulting.pdfTypes of Cyberattacks - ASG I.T. Consulting.pdf
Types of Cyberattacks - ASG I.T. Consulting.pdf
 
Traction part 2 - EOS Model JAX Bridges.
Traction part 2 - EOS Model JAX Bridges.Traction part 2 - EOS Model JAX Bridges.
Traction part 2 - EOS Model JAX Bridges.
 
14680-51-4.pdf Good quality CAS Good quality CAS
14680-51-4.pdf  Good  quality CAS Good  quality CAS14680-51-4.pdf  Good  quality CAS Good  quality CAS
14680-51-4.pdf Good quality CAS Good quality CAS
 
Effective Strategies for Maximizing Your Profit When Selling Gold Jewelry
Effective Strategies for Maximizing Your Profit When Selling Gold JewelryEffective Strategies for Maximizing Your Profit When Selling Gold Jewelry
Effective Strategies for Maximizing Your Profit When Selling Gold Jewelry
 
Technical Leaders - Working with the Management Team
Technical Leaders - Working with the Management TeamTechnical Leaders - Working with the Management Team
Technical Leaders - Working with the Management Team
 
digital marketing , introduction of digital marketing
digital marketing , introduction of digital marketingdigital marketing , introduction of digital marketing
digital marketing , introduction of digital marketing
 
Horngren’s Financial & Managerial Accounting, 7th edition by Miller-Nobles so...
Horngren’s Financial & Managerial Accounting, 7th edition by Miller-Nobles so...Horngren’s Financial & Managerial Accounting, 7th edition by Miller-Nobles so...
Horngren’s Financial & Managerial Accounting, 7th edition by Miller-Nobles so...
 
Planetary and Vedic Yagyas Bring Positive Impacts in Life
Planetary and Vedic Yagyas Bring Positive Impacts in LifePlanetary and Vedic Yagyas Bring Positive Impacts in Life
Planetary and Vedic Yagyas Bring Positive Impacts in Life
 
Welding Electrode Making Machine By Deccan Dynamics
Welding Electrode Making Machine By Deccan DynamicsWelding Electrode Making Machine By Deccan Dynamics
Welding Electrode Making Machine By Deccan Dynamics
 
Environmental Impact Of Rotary Screw Compressors
Environmental Impact Of Rotary Screw CompressorsEnvironmental Impact Of Rotary Screw Compressors
Environmental Impact Of Rotary Screw Compressors
 
Fordham -How effective decision-making is within the IT department - Analysis...
Fordham -How effective decision-making is within the IT department - Analysis...Fordham -How effective decision-making is within the IT department - Analysis...
Fordham -How effective decision-making is within the IT department - Analysis...
 

Absorption costing

  • 1. Chapter 8 Study Text Chapter 8 Overheads and absorption costing
  • 2. Overheads • Overheads/indirect costs are those costs that cannot be traced directly and in full to the products or services or department of the business. • Overhead= indirect(material+labour+expenses) • Overheads are categorised commonly ase 1. Production overhead 2. Administration overhead 3. Selling overhead 4. Distribution overhead Slide 2
  • 3. Absorption costing • Absorption costing is a method of sharing overheads between a number of different products or services on a fair basis. • Absorption costing procedure 1. Allocation 2. Apportionment 3. absorption Slide 3
  • 4. Allocation 1) Allocation • collection of costs by type • allocation of as many costs as possible directly to cost centers Slide 4
  • 5. Overheads Total production costs Direct costs Indirect costs (overheads) Allocate & apportion COST CENTRES Production 1 Production 2 Service Allocate COST UNITS Slide 5
  • 6. Apportionment Two stages 1. Overheads that cannot be allocated to specific cost centres are spread between cost centres on a fair basis. 2. Re-apportionment of service cost center overheads to production cost centers Methods of re-apportionment a) Direct method b) Step-down method
  • 7. Overheads Basis of apportionment Overhead Basis Rent and rates Floor space occupied Depreciation Cost/NBV of equipment Staff welfare Number of employees Heat, light Volume of space occupied Insurance of equipment Value of equipment Insurance of building Floor space occupied Stores costs Number of issues Building repairs & Floor space occupied maintenance Slide 7
  • 8. Re-apportionment Direct method of re-apportionment: • It involves apportioning the costs of each service Cost centre to production cost centres only .Text example-page 143 Step-down method of re-apportionment: • This method recognises the inter-service cost Centre work. Each service cost centre’s costs are Not only apportioned to production departments but to some ( but not all) of the Other Service cost centres that makes use of the Service provided
  • 9. Reapportionment To reapportion service cost centre overheads to production cost centres there are 2 methods Direct Step down Method method Inter-service Some inter-service department department work work is ignored is recognised Slide 9
  • 10. Overheads Total production costs Direct costs Indirect costs (overheads) Allocate & apportion COST CENTRES Production 1 Production 2 Service Allocate Production 1 Production 2 Reapportion COST UNITS Slide 10
  • 11. Basis of re-apportionment Service cost centre Possible basis of apportionment Stores Number or cost value of material requisition Maintenance Hours of maintenance work done for each cost centre Production planning Direct labour hours worked in each production cost centre
  • 12. Absorption Absorption involves; • Identifing the absorption base • Establishing an absorption rate for each production cost center. • Absorption of overheads in to cost units.
  • 13. Absorption costing method Total production costs Direct costs Indirect costs (overheads) 1.Allocate & apportion COST CENTRES Production 1 Production 2 Service Allocate Production 1 Production 2 2.Reapportion 3. Absorb COST UNIT Slide 13
  • 14. Possible bases of absorption The most common absorption bases are as follows; • A rate per machine hour • A rate per direct labour hour • A percentage of direct labour cost • A percentage of direct material cost • A percentage of total direct cost • A rate per unit • A percentage of factory overhead • A percentage of sales value of factory cost
  • 15. Choosing basis of absorption Basis Use when Unit Units are identical Labour hour Labour intensive Machine hour Machine intensive % of direct labour Question asks for it
  • 16. Absorption rate Production overhead _______________ OAR (overhead absorption rate) = Activity level Slide 16
  • 17. Absorption into production Overhead Pre-determined Absorbed = Actual activity x OAR Slide 17
  • 18. Absorption costing -cost card A cost card shows us the cost to make one unit $/unit Direct materials X Direct labour X Prime cost X Overheads X Full Product cost X Slide 18
  • 19. Predetermined overhead absorption rates • Calculated using budget figures Steps in calculating and using POHAR 1. Estimate the overhead 2. Estimate the activity level for the period. This could be total hours, units or direct cost or what ever measure upon which the OHAR are to be based. 3. Divide the estimated overhead by the budgeted activity level.This produces the POAR 4. Absorb or recover overheads in to cost units
  • 20. Why use predetermined rates instead of actual absorption rates • It enable overheads to be absorbed through out the accounting period. • The actual overheads and actual activity level are not known until the end of an accounting period, the actual absorption rates can not be calculated until then. In effect then the total cost of the product cannot be determined until the end of the period as well. This is too late for management planning and control purpose like product pricing,production scheduling,product cost estimation and routine accounting functions like invoicing
  • 21. Effect of using predetermined absorption rates At the end of the year actual overheads will be known Overhead absorbed ≠ Actual overhead Difference = under or over absorption Slide 21
  • 22. Non-production overheads • For internal purposes and organisations which base selling price of their product on estimates of total costs or even actual costs. A total cost per unit of output may be required. therefore it may be appropriate to allocate non-production overheads to units of output. • Overhead absorption rate= estimated non- production oH/ estimated production costs
  • 23. Non-production overheads Administration overheads include: • Executive salaries and wages/salaries of all staff in administration departments • Office rent and rates • Lighting and heating • Cleaning Selling costs are incurred in order to obtain sales Distribution costs include warehouse cost and delivery costs
  • 24. Bases for absorption Types of overhead Possible absorption base Selling and marketing Sales value Research and development Consumer cost (= production cost minus cost of direct materials) or added value( = sales value of product minus cost of bought in materials and services) Distribution Sales value Administration Full production cost
  • 25. Non-production costs in practice In practice; 1.An absorption costing system may be restricted to production costs only. 2.The non-production overheads are simply treated as a period charge against profit. 3.The actual overhead costs are included in the cost of sales.

Editor's Notes

  1. Explain the concept of inter-service dept work and then chat through the approaches Direct method is most suitable if have only one service dept or +1 but no inter-service work Step method is not used in FIM Reciprocal method most suitable when +1 service depts and there is inter-service work between them – there are two techniques which we will see later Question will either tell you or the scenario will fit in with those referred to above – would expect a reciprocal approach
  2. Now we need to take any costs in the service centres and re-apportion them to the production departments – so that all costs are sitting in production cost centres only –as it is through these centres that the physical units flow
  3. Chat through each stage Direct cost are variable so allocate directly – don’t forget to do this - can often be so obsessed with overheads that forget this bit Then indirect costs – this is all of them at the minute (FC and VC) although later on and in questions will probably only be FC We’ll go through each stage in a bit more detail now
  4. Note – we work out an OAR for each production dept.
  5. Our aim is to be able to compile a cost card so chat through how we do it Prime costs easy to identify as variable Overheads more difficult as not easily attached to each cost unit – at this stage we consider them as a whole I.e fixed and variable We’re going to look at the methodology of identifying the overhead cost per unit but first we must understand the concept of cost centres AC is Required by ssap 9
  6. Discuss why there are differences – actual volume and expenditure may differ from budget