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CIMA C1Fundamentals Of Management Accounting

Overheads & Absorption Costing

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CIMA C1Fundamentals of Management Accounting

Class Slides Ian Wilson

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1 Consider !hat overheads are" ho! the#are allocated to product unit costs & themethods emplo#ed

$

Calculate Overhead Absorption% repare cost statements for allocation &

apportionment of overheads" includingreciprocal departments

' Calculate direct" variable & full costs ofproducts" services & activities usingoverhead absorption rates

( Appl# information to pricing decisions

Learning Aims (CIMA)

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We have seen that business costs can be" andneed to be )classi*ed+ b# t#pe & behaviour

,irect Materials ,irect -abour ,irect ./penses 0 Prime Cost roduction Overheads OA23

0 Total Production (Absorbed Cost) 4on5roduction Overheads 0 Total Cost

Context & Link to Session1

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Costs )behave+ in a variet# of !a#s67he classi*cations are6 8ariable Costs

Semi58ariable Costs Step Costs Fi/ed Costs Once costs t#pes & behaviour is 9no!n"

!hat happens ne/t: Wh# did !e collect this information:


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Ke !m"#asis in $ areas o% use6

1 Stoc9 8aluations" !hat is the value;cost ofinventor#:

$ lanning" future forecasts% Control" actual against planned

performance

' ,ecision Ma9ing" the )right+ outcome in

terms of cost;pro*tfor the business


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,irect Costs are )eas#+ to deal !ith" the#relate to )cost units+

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7he method Accountants used to chargeindirect costs to cost unit is called)A+

CIMA denition o% an 'er#ead6 An overhead is )expenditure on labour,materials, or services that cannot beeconomically identifed with a specifc

saleable cost unit+

Context & Link to Session

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Absorption Costing is a method of sharingOverheads Indirect Costs;./penses3bet!een a number of di?erent Finishedroducts on a )+Fair++ basis

=ou !ill have to consider the %A+s6

1 Allocation

$ Apportionment & re5apportionment3

% Absorption' oint % leads to Over;@nderAbsorption

'er#ead Costing & Absor"tion

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It ma# be useful to s9etch out ho! costs areallocated" apportioned and *nall# absorbedinto a single product cost per unit

7his is a useful summar# I al!a#s use togive #ou a )map+ to follo! & remember

Ma9e sure #ou note this do!n6

Absor"tion Cost *iagram

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A Compan# !ill have a 7otal roductionOverhead spend in mind" sa# (BB

If it has $ ,epartments" Cutting & Finishing"ho! much does it charge to each of these,epartments:

,ividing up Overheads is a critical processas the# !ill drive Absorption rates as !e

have alread# seen We follo! a % stage process6

Allocation &A""ortionment

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1 Allocation

$ Apportionment

% 2e5Apportionment

.=ou must be able to tac9le all %6


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Allocation6 Means6 Charging cost centres !ith Overheads that

are incurred solely in that centre

eg6 a salar# of a supervisor in a particularcost centre


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A""ortionment+ Means+ Some costs relate to a business as a !hole

)+Splitting++ shared Overheads bet!een costcentres using some form of )+fair++ basis

eg6 using Door area for rent & rates 6 using number of emplo#ees for canteen

costs 6 using value of assets for ,epreciation

charges


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,e-A""ortionment Means+ 2e5splitting Overheads from )service+ cost

centres to )production+ cost centres eg6 moving service costs for sa# Canteen &

Maintenance centres to production costcentres based on bene*t & use of those

service centres


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./ercise 1 page %E We can complete this e/ercise to practice

the theor#" *rst lets get our details right

Indirect Wages & Materials have alread#been A--OCA7.,to the various cost centres Machining 5 roduction Assembl# 5 roduction

Finishing 5 roduction Maintenance Service -ets calculate an ans!er6


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4ot all departments are 2O,@C7IO4based

Some departments provide )Services+ toproduction departments

7hese departments are called S.28IC.departments

Secondar# apportionment is therefore

apportioning service centre costs toproduction cost centres

Secondar A""ortionment

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What happens !hen service centres provideservices for each other:

7his is )service+ to )service+

7here are $ !a#s to deal !ith this issue61 .limination

$ 2epeated ,istribution

../amples $ & % provides the ans!er

,eci"rocal Sericing

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aving allocated;apportioned our overheadsto a Cost centre" !e need to add them to" orabsorb" these costs in to the Cost of Sales

roduction Overheads are added to the)rime Cost+ seen earlier in the course

7he OA2Overhead Absorption 2ate3 can beseen as a )charge out rate+ for Overheads

Authors also call this )

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7here are % common !a#s to achieve this6

1 A 2ate per @nit identical units3

$ A 2ate per -abour our human time

intensive3% A 2ate per Machine our machine time

intensive3

All of the above are set at a pre5determined

rate" using

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2ates of Overhead A8.to be available atthe S7A27of the production period

7he business CA44O7!ait until the end ofthe accounting period to see !hat theAC7@A-production overhead costs !ere

7he .7*gures for Overheads are used

OA20

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We !ill !or9 out ./ercises ' & ( Ma9e sure #ou practice this at home It is vitalfor A-- CIMA Management

Accounting papers #ou ta9eG 4ote6 OA2 2ates can be6

1

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7r# ./ercise E age '17his is a t#pical )e/am st#le+ Juestion=ou are given ' ans!ersG

Which is correct:

!/AM 0'CS

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7he OA2is based on estimates 7hisestimate is Juanti*ed in the ).7+

Overhead Costs & Output Activit# -evels areestimated;

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In Sim"le Terms6

Over Absorbed6

Absorbed Overhead KActual Overhead

@nder Absorbed6 Absorbed Overhead LActual Overhead

'er & under Absor"tion

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A possible la#out for #our calculation6 I call this the %

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Aurricula -td age '$

We can practice over;under absorption

calculations for this problem

7r# & use the la#out I suggested for thisJuestion 2emember the )% bo/ approach+

!xercise 2

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We have seen that Costs can be used for61 8aluing Stoc9

$ lanning

% ,ecision ma9ing' Control.What else !ill product;service costs be used

for:

Costs

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As a Management Accountant" #ou !ill beas9ed to )price+ products based on their costvalue 7his means setting the Sales rice

=ou !ill have to consider6

1 Mar95uppro*t e/pressed as a of cost3

$ Marginpro*t e/pressed as a of price3

7r# the e/ample ./ercise (" page ($ of #ournotes

Pricing

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Marginal Costing

3#at is Marginal Costing:7his ta9es place !here Overhead Costs are

!ritten o? in full to the period in !hich the#occur

roduction Overheads under this methodare 4O7 added to rime Cost as is the case!ith Absorption Costing

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,irect Materials ,irect -abour 8ariable Costs ,irect ./penses

0 rime Cost roduction Overheads 5 Fi/ed Costs via OA2

0 7otal roduction Absorbed Cost3

4on5production Overheads 0 7otal Cost

Absor"tion Costingtem"late

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,irect Materials ,irect -abour 8ariable Costs ,irect ./penses

0 rime Cost roduction Overheads Fi/ed Costs 4on5production Overheads 5 Fi/ed Costs 0 7otal Cost

Marginal Costing tem"late

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Sales -ess roduction Costs 0 >ross ro*t

>ross ro*t -ess ./penses 4on5roduction3 0 4et ro*t

Absor"tion Costingtem"late

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Sales -ess 8ariable Costs rime3 0 Contribution

Contribution -ess Fi/ed Costs6 Fi/ed roduction Costs Fi/ed 4on5roduction Costs 0 4et ro*t

Marginal Costing tem"late

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Write do!n the data I have" !e can practiceMarginal A4, Absorption Costing techniJues6

Sales rice6 $B ,irect Materials E ,irect -abour % 8ariable overheads ' All above are .2 @4I7

Fi/ed Overheads $B"BBB

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Actual roduction & sales !as $B"BBB @nitsin a particular month6

Calculate6

1 Contribution per @nit

$ 7otal Contribution for the month

% 7otal ro*t for the Month A-- usingMA2>I4A- COS7I4>

' ro*t for the month using AbsorptionCosting

Marginal Costing !xam"le1

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In this e/ercise" the ro*ts achieved !erethe sameunder Marginal & Absorptionmethods

Wh#:

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7he reconciliation can be made simpler b#!or9ing to a method6

4ote67his is an e/am favourite topic -earn the ne/t slide !ell6 AC 0 Absorption Costing ro*t MC 0 Marginal Costing ro*t

A business can have opening& closingstoc9s Stoc9 levels MA=di?er We can then tac9le a second Juestion6

Marginal Costing

b i & i l

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If Op Stoc9 K Close Stoc9

If Op Stoc9 0 Close Stoc9

If Op Stoc9 L Close Stoc9

Absor"tion & MarginalCosting+

MC ro*t K AC ro*t

MC ro*t 0 AC ro*t

MC ro*t L AC ro*t

7hese are .= 2ules6 remember them

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Sales rice 1B ,irect Materials % ,irect -abour $

8ariable overheads 1 Fi/ed Overheads 1B"BBB per month

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Fi/ed overhead & Stoc9 .?ect 2e5!or9 ./ercise $ Ma9e the follo!ing adustment6

Actual roduction 0 E"BBB @nits Actual Sales 0 '"NBB units Calculate the Absorption & Marginal ro*t

Statements

7hen" 2econcilethe di?erence in pro*ts6

!xercise 4

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cima c1 unit 3 2012(1)

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