Absorption Costing exam PDF

Preview

Summary

Exam questions and answers for the Absorption Costing of a company. All answers are correct...

Description

Chapter 6: End of Chapter Exercises Section A Questions Question 6.1 ‘Absorption costing’ is also referred to as ‘Total Costing’ because… A

It includes the total variable costs of a product or service

B

It includes the total variable costs of a product or service plus a fair share of all company overheads

C

It includes all of the direct costs of a product or service plus a fair share of production overheads

D

It comprises of the total costs of the business

The correct answer is C.

Question 6.2 The mantra of Activity Based Costing is… A

“If activities are reduced, products will be cheaper”

B

“Products cause costs, and activities consume products”

C

“Base your costs on your activities”

D

“Activities cause costs, and products consume activities”

The correct answer is D.

Question 6.3 Which of the following comments regarding absorption costing is untrue? A

Absorption costing complies with financial reporting standards

B

Absorption costing results in lower corresponding costs than marginal costing

C D

Absorption costing is also known as ‘total costing’ Absorption costing ensures that production fixed costs are accounted for in the cost of a product

Statement B is untrue Absorption costing will result in higher corresponding costs than marginal costing as it also contains a fair share of production fixed costs.

Question 6.4 The cost of equipment insurance should be apportioned between the various production departments of a manufacturing company according to: A

The value of equipment in each department

B

The number of different products each produces

C

The number of staff each employs

D

Their respective floor space

The correct answer is A.

The Language of Business Question 6.5 A factory has total floor space of 30,000 metres 2. The machining department occupies 4,500 metres 2. If the rent & rates for the whole factory totals £125,000 per annum, how much of this should be apportioned to the machining department? A

£16,500

B

£18,750

C

£21,250

D

£24,900

The correct answer is B Rent & Rates for Machining Dept. = (4,500 / 30,000) x £125,000 = £18,750

Question 6.6 As part of the budgeting process the assembly department of a factory has been assigned a total production fixed cost of £66,000 and is also budgeted to have 40,000 labour hours in the coming year. What should the corresponding overhead absorption rate (OAR) be? A

£0.61 per labour hour

B

£1.61 per labour hour

C

£1.61 per labour hour

D

£1.65 per labour hour

The correct answer is D. OAR = Budgeted Overhead / Budgeted Activity = £66,000 / £40,000 = £1.65 per labour hour

Question 6.7 A firm of Solicitors quotes for legal work based on the estimated time a qualified solicitor will take to complete the task, plus absorbed office fixed costs at a rate of £15.00 per solicitor-hour. Qualified solicitors are paid £25 per hour and a 150% mark-up is added to the calculated total cost. How much will a customer be quoted for a legal task estimated to take 10 hours? A

£400

B

£600

C

£1,000

D

£1,400

The correct answer is C Direct costs = 10 hrs x £25 ph = £250 Absorbed Overheads = 10 hrs x £15 ph =£150 Total cost = £250 + £150 = £400 plus 150% mark-up of £600 Quoted Price = £1,000

The Language of Business

Question 6.8 A company has previously used a marginal costing system but is now considering changing to an absorption costing system. Under the old marginal costing system a certain product had total direct costs of £15.00 per unit. However under the alternative absorption costing system it also absorbs fixed production costs at the rate of £2.00 per unit. If, in a certain month, the production of this product exceeded the sales of the product by 200 units what would be the reported difference in net profit between the two costing systems? A B

No reported difference in profit Marginal costing would report £400 higher profit than absorption costing

C

Absorption costing would report £400 higher profit than marginal costing

D

Marginal costing would report £3,400 higher profit than absorption costing

The correct answer is C The £15 direct costs will be included in both costing methods and can therefore be ignored. The absorption costing method will absorb 200 x £2 = £400 of fixed production overheads into the value of the unsold 200 items (rather than charging it immediately to the P&L which would happen under marginal costing). Thus with absorption costing the closing inventory will be £400 higher, and the P&L expenses £400 lower, which will result in £400 more reported profit

Question 6.9 The ‘under-absorption’ of overheads might occur as a result of which of the following: i.

Actual overheads being higher than budgeted

ii.

Actual overheads being lower than budgeted

iii.

Actual activity being higher than budgeted

iv.

Actual activity being lower than budgeted

Choose the answer which shows the correct statements from those provided: A

i & ii

B

ii & iii

C

iii & iv

D

i & iv

The correct answer is D

The Language of Business

Question 6.10 Which of the following are benefits of Activity Based Costing (ABC) compared to Traditional Absorption Costing? i.

ABC is cheaper to implement

ii.

ABC is easier for the workforce to understand

iii.

ABC ultimately provides more accurate costing

iv.

The detailed analysis required in the implementation of ABC might reveal areas of potential cost saving Select the most appropriate statements from those provided: A

i & ii

B

ii & iii

C

iii & iv

D

i & iii

The correct answer is C

The Language of Business Section B Questions Question 6.11 – Traditional Absorption Costing (AAA) Botanical Ltd manufacture a large range of different gardening tools and use a ‘cost-plus’ system to set their selling prices. The company is keen to ensure that the set prices cover all the costs of the business and not just the direct costs which relate to individual products, and has therefore decided to implement an absorption costing system for the company’s product range. The factory consists of three production areas: 1. Machining Where certain components are actually manufactured ‘in house’. This department is heavily dependent on machines. 2. Assembly Where both components manufactured in-house, and bought in components are assembled into finished products. The work in this department largely comprises of manual labour. 3. Finishing In the finishing department the finished goods have any required safety labels fixed and are packaged complete with a set of instructions where required. Despite the diversity of the product range it has been noted that each product requires approximately the same time in the finishing department. Use traditional absorption costing techniques and the supplied information to calculate a ‘total cost’ for two of the company’s products: a garden fork, and an electric strimmer. This will require three distinct stages: 1. Since this is a multi-department company the first stage is to apportion (or simply allocate) each of the total budgeted factory overheads across (or into) the appropriate production departments. 2. The second stage is to calculate an Overhead Absorption Rates (OAR) for each Department. 3. The final stage is to calculate a total cost for each products, using both the details of the ‘direct costs’ the product incurs, plus a fair share of the ‘indirect costs’ (using the calculated OARs). A simple 50% mark-up is then added to calculate the selling price for each product.

The Language of Business Budgeted Factory Overheads Factory Rent

£100,000

Heat & Light

£20,000

Canteen Costs

£10,000

Plant & Machine Depreciation

£30,000

Machine Maintenance

£20,000

Factory Cleaning

£10,000

Machining Dept. Supervisors Assembly Dept. Supervisor

£40,000 £18,000

Finishing Dept. Supervisor

£15,000

Factory Manager

£40,000 (mainly deals with ‘people’ issues)

TOTAL FACTORY OVERHEADS

£303,000

Floor Space Machining Department

2,500 metres2

Assembly Department

3,500 metres2

Finishing Department TOTAL FLOOR SPACE

4,000 metres2 10,000 metres2

Number of Employees Machining Department

10

Assembly Department

60

Finishing Department TOTAL EMPLOYEES

30 100

Value of Machinery in each Department Machining Department

£180,000

Assembly Department

£12,000

Finishing Department

£8,000

TOTAL MACHINERY

£200,000

The Language of Business Stage One Either apportion or allocate each of the factory’s overheads in order to calculate the total overhead which must be absorbed by each of the three production departments.

Overhead

Total

Sharing Basis?

Machining Dept.

Assembly Dept.

Finishing Dept.

Add to check

Factory Rent

£100,00 0

Apportion: Floor Area

£25,000

£35,000

£40,000

Y

Heat & Light

£20,000

Apportion: Floor Area

£5,000

£7,000

£8,000

Y

Canteen Costs

£10,000

Apportion: No. of employees

£1,000

£6,000

£3,000

Y

Plant & Machinery Depreciation

£30,000

Apportion: Value of machinery

£27,000

£1,800

£1,200

Y

Machinery Maintenance

£20,000

Apportion: Value of machinery

£18,000

£1,200

£800

Y

Factory Cleaning

£10,000

Apportion: Floor Area

£2,500

£3,500

£4,000

Y

Machine Dept. Supervisors

£40,000

Allocate to appropriate Dept.

£40,000

-

-

Y

Assembly Dept. Supervisor

£18,000

Allocate to appropriate Dept.

-

£18,000

-

Y

Finishing Dept. Supervisor

£15,000

Allocate to appropriate Dept.

-

-

£15,000

Y

Factory Manager

£40,000

Apportion: No. of employees

£4,000

£24,000

£12,000

Y

TOTAL FACTORY OVERHEADS

£303,00 0

£122,500

£96,500

£84,000

Y

Stage Two

The Language of Business Now calculate an appropriate Overhead Absorption Rate (OAR) which will be used to determine how overhead should be absorbed by different products as they pass through the various production departments. The budgeted Level of activity for each department in the coming year is as follows: Budgeted Level of Activity for coming year Machining Department

10,000 machine hours

Assembly Department

125,000 staff hours

Finishing Department

Output of 500,000 products

Transfer the total overhead for each department from the last table, and then calculate the three OARs. Remember to quote the appropriate units for each OAR! Machining Dept.

Assembly Department

Finishing Dept.

OAR Basis

Per Machine Hour

Per Labour Hour

Per Item

Total Budgeted Overheads

£122,500

£96,500

£84,000

Budgeted Activity

10,000 machine hours

125,000 staff hours

500,000 items

Overhead Absorption Rate (OAR)

£12.25 per machine hour

£0.772 per staff hour

£0.168 per item

The Language of Business Stage Three Now using the additional data below and the calculated OARs, calculate the selling price for a garden fork and for an electric strimmer. The hourly rates for the three departments are as follows:

Machining Department

£10 per hour



Assembly Department

£8 per hour



Finishing Department

£6 per hour Garden Fork

Electric Strimmer

Direct Labour

0.1 hours x £10 per hour =£1.00

0.1 hours x £10 per hour =£1.00

Direct Materials

£1.00

£5.00

Overheads Absorbed

0.2 mc hr x £12.25 per mc hour =£2.45

0.25 mc hr x £12.25 per mc hour =£3.06

Direct Labour

0.1 hour x £8 per hour = £0.80

0.5 hour x £8 per hour = £4.00

Direct Materials

£0.75

£10.00

Overheads Absorbed

0.1 hour x £0.772 per staff hour = £0.08

0.5 hour x £0.772 per staff hour = £0.39

Direct Labour

0.1. hour x £6 per hour = £0.60

0.1. hour x £6 per hour = £0.60

Direct Materials

£0.50

£1.00

Overheads Absorbed

£0.17

£0.17

TOTAL COST

£7.35

£25.22

50% Mark Up

£3.67

£12.61

SELLING PRICE

£11.02

£37.83

Machining Dept.

Assembly Dept.

Finishing Dept.

The Language of Business Garden Fork Machining Department Direct Labour

6 minutes (=0.1 hour)

Direct Materials

£1

Machine Time

12 minutes (=0.2 hours)

Assembly Department Direct Labour

6 minutes (=0.1 hour)

Direct Materials

£0.75

Assembly Time

6 minutes (=0.1 hours)

Finishing Department Direct Labour

6 minutes (= 0.1 hours)

Direct Materials

£0.50

Electric Strimmer Machining Department Direct Labour 6 minutes (=0.1 hour) Direct Materials £5 Machine Time 15 minutes (=0.25 hours) Assembly Department Direct Labour 30 minutes (=0.5 hour) Direct Materials £10.00 Assembly Time 30 minutes (=0.5 hours) Finishing Department Direct Labour 6 minutes (= 0.1 hours) Direct Materials £1.00

The Language of Business Question 6.12 Collegiate Ltd uses Activity Based Costing (ABC) to calculate the total cost of the products it manufactures. The company has identified four separate activities as shown in the table below. Calculate the cost driver rates for each area of activity (fully labelling the appropriate units for each cost driver rate). Activity

Cost Driver

Annual Overhead

Level of Activity

Machining

Machine Hours

£18,000

6,000 hours

Assembly

Labour Hours

£30,000

20,000 hours

Quality Control

Inspections

£15,000

250 inspections

Machine Set Up

£12,500

25 Set Ups

Engineering

Cost Driver Rate £3 per machine hour £1.50 per labour hour £60 per inspection £500 per machine set up

Support The direct costs for product X are as follows: 

Direct materials

£30



Direct Labour in Machining Department: 1 hour @ £12 per hour

£12

(Machine time in Machining Department = 1 hour) 

Direct Labour in Assembly Department: 3 hours @ £10 per hour



Direct Expenses

£30 £5

Over the course of a full year 2,000 product X’s are manufactured and this involves 3 full reconfigurations of the production line (i.e. Machine Set Ups) and 7 Quality Inspections Using Activity Based Costing calculate the full cost of one single product X and the selling price (including VAT) if a 70% gross profit margin is required.

The Language of Business

OVERHEAD ABSORPTION FOR PRODUCT X

ACTIVITY

Cost Driver Rate

Level of Activity for Product X

Machining Overhead

£3 per machine hour

2,000 Machine Hours

Assembly Overhead

£1.50 per labour hour

6,000 Assembly Hours

Quality Control Overhead

£60 per inspection

Engineering Support Overhead

£500 per machine set

7 Quality Inspections

Absorbed Overhead for Product X £6,000 £9,000 £420 £1,500

3 Set Ups

£16,920

Absorbed Overheads for 2,000 units of production

£8.46

Absorbed Overheads for 1 unit of production

COST CARD – PRODUCT X Direct Materials

£30

Direct Labour - Machining

£12

Direct Labour – Assembly

£30

Direct Expenses

£5

Absorbed Overhead

£8.46

Total Cost (inc. Overheads)

£85.46

Selling Price (exc. VAT)

£284.87 (=£85.46/30 x 100)

Selling Price (inc. VAT)

£341.84 (=£284.87 x 1.2)

The Language of Business Question 6.13 Summarise the benefits & drawbacks of both absorption costing methods

Traditional Absorption Costing Benefits 

Easier to understand and implement than ABC



Usually suitable and quite satisfactory for traditional manufacturing which has relatively high prime costs and relatively low overheads to absorb.

Drawbacks 

Can result in somewhat random assigning of overheads to products based on arbitrary choice of overhead absorption rates.



Less accurate costing of products could result in products being set a selling price which is either too low and therefore not covering the costs the product is causing (and thus potentially lossmaking) or too high (and thus potentially making the product uncompetitive).

Activity Based Costing Benefits 

More accurate costing can potentially lead to more competitive pricing.



More suited to modern businesses which have less reliance on ‘labour hours’ and ‘machine hours’ (i.e. prime costs) and instead have higher levels of overhead. (e.g. ABC is highly used in Financial & Commercial sectors)

...