Bookkeeping entries for absorption of production overheads
mge
Registered Posts: 94 Regular contributor ⭐
I have recently been reading about the bookkeeping entries for the absorption of production overheads.
As I understand it, production overheads are transferred to WIP using an OAR based on the PREDICTED overhead costs, and the PREDICTED levels of production.
If the predicted levels are significantly different from the actual levels, this will surely give an inaccurate figure for cost of sales, and therefore gross profit?
I can understand how this system may be necessary for costing purposes. However, for bookkeeping purposes would it not be more accurate to absorb production overheads retrospectively based on the ACTUAL overhead costs incurred and the ACTUAL levels of production?
Any help would be very much appreciated.
As I understand it, production overheads are transferred to WIP using an OAR based on the PREDICTED overhead costs, and the PREDICTED levels of production.
If the predicted levels are significantly different from the actual levels, this will surely give an inaccurate figure for cost of sales, and therefore gross profit?
I can understand how this system may be necessary for costing purposes. However, for bookkeeping purposes would it not be more accurate to absorb production overheads retrospectively based on the ACTUAL overhead costs incurred and the ACTUAL levels of production?
Any help would be very much appreciated.
0
Comments
-
I have recently been reading about the bookkeeping entries for the absorption of production overheads.
As I understand it, production overheads are transferred to WIP using an OAR based on the PREDICTED overhead costs, and the PREDICTED levels of production.
If the predicted levels are significantly different from the actual levels, this will surely give an inaccurate figure for cost of sales, and therefore gross profit?
I can understand how this system may be necessary for costing purposes. However, for bookkeeping purposes would it not be more accurate to absorb production overheads retrospectively based on the ACTUAL overhead costs incurred and the ACTUAL levels of production?
Any help would be very much appreciated.
Realistically in a company you write the raw materials to the WIP account the moment they are issued. If that's at the start of the month, you won't know what the actual costs are. By writing the budgetted costs to the WIP account at that point, it gives an indication of the costs per product, rather than no indication at all.
The point of budgetting costs is to have an expectation/ indication of what the costs will be so you can calculate that in the costs, but you don't know the actual costs till after the period.0 -
Many thanks for your reply Rinske. I'm still trying to get my head around this.
I can understand that raw materials could be transferred to WIP at the moment they are issued. Are you saying that you would transfer production overheads to WIP at the same time? In the examples in the book, production overheads get transferred to WIP at the end of a four week period.0 -
Try and imagine a business where overheads constitute a large proportion of the total costs. I often talk about car repairs in garages.
You take the car in, the mechanic looks at it and quotes £75 per hour plus parts.
You might think wow mechanics get paid £75 per hour until you think that £9.00 is nearer the mark. The remaining £66 is to "recover" overheads and profit. Let us guess £50 per hour to recover overhead.
You don't know the overheads when the year starts so you produce the best budget you can. You pick the best method of recovering them, in the case of car mechanics, labour time.
So every hour a mechanic works on a car £50 is debited to the work in progress control account, and credited to the production overhead account.
Your text book might say it happens at the end of the month, but it doesn't have to.
I don't know where you work, if you work at a garage you might take the hours daily as part of your routine and so you'd enter the transactions a day after the hours are worked. If you are independent and go to the garage once a month/once a week you would put them on the system when you are working for the firm.Sandy
sandy@sandyhood.com
www.sandyhood.com0 -
Many thanks Rinske and SandyHood once again. Your answers have been extremely helpful.
I'm very impressed by this forum - it's great how people are prepared to help others out. Many thanks!0
Categories
- All Categories
- 1.2K Books to buy and sell
- 2.3K General discussion
- 12.5K For AAT students
- 318 NEW! Qualifications 2022
- 161 General Qualifications 2022 discussion
- 11 AAT Level 2 Certificate in Accounting
- 56 AAT Level 3 Diploma in Accounting
- 87 AAT Level 4 Diploma in Professional Accounting
- 8.8K For accounting professionals
- 23 coronavirus (Covid-19)
- 272 VAT
- 92 Software
- 273 Tax
- 135 Bookkeeping
- 7.2K General accounting discussion
- 200 AAT member discussion
- 3.8K For everyone
- 38 AAT news and announcements
- 345 Feedback for AAT
- 2.8K Chat and off-topic discussion
- 582 Job postings
- 16 Who can benefit from AAT?
- 36 Where can AAT take me?
- 42 Getting started with AAT
- 26 Finding an AAT training provider
- 48 Distance learning and other ways to study AAT
- 25 Apprenticeships
- 66 AAT membership