Absorption Costing
System
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I have copied an email I have sent to a student who contacted me recently asking for help with:
To start I have tried to talk through what is going on, then I've used the Dec 06 paper to use as an example of two expenses that need to be absorbed.
I find students can generally understand absorption if they have some numbers to use.
Before we do that let me try with some household costs.
I get a rent bill, a gas bill, and an electricity bill, and telephone bill for a household of AAT students.
There are 4 people in the house. Alan and Bev share a large room, Chris has a large room to himself and Debbie has a small room.
So we can carve up the bills:
If we know specific details we can ALLOCATE the costs.
Fortunately every telephone call is logged whenever any of the group uses the phone so we find the total number of "units" that have been used and everyone in the house pays their amount. We effectively APPORTION the total telephone bill according to the units each student has consumed.
The gas bill is only for the central heating. As this is just for the living room, everyone agrees to pay one quarter each. So we APPORTION the gas bill according to the number of people.
The electricity bill basically covers the heating of the bedrooms. So we figure out that the big rooms use more than the small rooms and allocate the cost on the basis of floor space. Alan and Bev share a large room so they pay one amount, Chris has a room of the same size, so he pays the same as Alan and Bev, and Debbie has the small room so she pays a lower amount.
The rent bill is apportioned in the same way as the electricity, on the basis of floor space.
This is the basis of apportionment. Finding total expenses (or bills) and dividing them up between department in a way that is as fair as possible.
Let's look at the Dec 06 exam (page 6)
http://www.aat.co.uk/other_files/pep/Dec2006/Dec_2006_ECR_-_questions.pdf
Breckville Dairies Ltd. has the following departments involved in one of the stages of
production: ....
Insurance of machinery is budgeted to cost £33,600 (for all 3 departments)
Should we allocate this on the basis of:-
Should we allocate this on the basis of:-
Indirect labour costs are allocated costs as we are told exactly how much to put into each department
Materials Mixing £35,750
Product Packing £87,450
Maintenance £12,250
apportion reapportion and absorption
To start I have tried to talk through what is going on, then I've used the Dec 06 paper to use as an example of two expenses that need to be absorbed.
I find students can generally understand absorption if they have some numbers to use.
Before we do that let me try with some household costs.
I get a rent bill, a gas bill, and an electricity bill, and telephone bill for a household of AAT students.
There are 4 people in the house. Alan and Bev share a large room, Chris has a large room to himself and Debbie has a small room.
So we can carve up the bills:
If we know specific details we can ALLOCATE the costs.
Fortunately every telephone call is logged whenever any of the group uses the phone so we find the total number of "units" that have been used and everyone in the house pays their amount. We effectively APPORTION the total telephone bill according to the units each student has consumed.
The gas bill is only for the central heating. As this is just for the living room, everyone agrees to pay one quarter each. So we APPORTION the gas bill according to the number of people.
The electricity bill basically covers the heating of the bedrooms. So we figure out that the big rooms use more than the small rooms and allocate the cost on the basis of floor space. Alan and Bev share a large room so they pay one amount, Chris has a room of the same size, so he pays the same as Alan and Bev, and Debbie has the small room so she pays a lower amount.
The rent bill is apportioned in the same way as the electricity, on the basis of floor space.
This is the basis of apportionment. Finding total expenses (or bills) and dividing them up between department in a way that is as fair as possible.
Let's look at the Dec 06 exam (page 6)
http://www.aat.co.uk/other_files/pep/Dec2006/Dec_2006_ECR_-_questions.pdf
Breckville Dairies Ltd. has the following departments involved in one of the stages of
production: ....
Insurance of machinery is budgeted to cost £33,600 (for all 3 departments)
Should we allocate this on the basis of:-
-
Net book value of fixed assets(£000), or
-
Square metres occupied or
-
Number of employees
Should we allocate this on the basis of:-
-
Net book value of fixed assets(£000), or
-
Square metres occupied or
-
Number of employees
Indirect labour costs are allocated costs as we are told exactly how much to put into each department
Materials Mixing £35,750
Product Packing £87,450
Maintenance £12,250
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Comments
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Reapportionment
Did you work out the amounts to charge each department for the 2 apportioned costs?
If you have, then you can add up the columns
and have a total for:-
material mixing
-
product packing
-
maintenance
Products pass though the material mixing and product packing departments, but don't pass though Maintenance. So if we need an overhead value to use in working out the cost of our products we need all the overheads to be divied up between the departments which actually produce the products.
This means we need to re-apportion the total maintenance cost between the other two deprtments.
We do it in the same way as insurance and rent, using a basis. This question states:The total maintenance overheads are then reapportioned to the two production
departments. 60% of the Maintenance department’s time is spent maintaining equipment in
the Materials mixing department.
Have a go, then add up the Materials Mixing column and the Product Packing column. And cross check that these two added together equal the £260,250 total fixed overhead.
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Re:Absorption Costing
When I did it I got:-£260,250 £118,172 £142,0780 -
Absorption
On page 11 of the exam, the examiner tests absorption-
Can you identify when to use machine hours and when to use labour hours?
The Materials Mixing department is highly automated, and operates with expensive
machinery. The Product Packing department, on the other hand, is highly labour intensive.
Here is a clue:
One dept absorbs using machine hours
The other uses labour hours
The absorption (or recovery) rate is the total overhead divided by the basis
I thought Material Mixing would use machine hours
so:
Total overhead (£118,172) divided by total machine hours (3,940 hours) would give me the rate per machine hour.
I make this £29.993 but the question statesNote: You should round your answers to whole pounds.
So round off to £30.00 per machine hour.
Can you calculate the absorption rate for the product packing dept?0 -
Re:Absorption Costing
thank for your help sandy, will have a good read.
regards
becky0