Absorption Costing

Al Wadi International School
ABSORPTION COSTING (NOTES)
Absorption costing is also known as full or total costing. The key principle of absorption
costing is that all overheads are absorbed in cost units. In other words, all overheads are
included when calculating the cost of producing particular items. The main difficulty in
absorption costing is deciding how to divide the cost of overheads between these cost units.
There are four main stages in the absorption costing process.
The first stage is the allocation of those overhead costs that are directly incurred by
particular cost centres.
The second stage is to apportion i.e., divide, all shared overheads between the
production and service cost centres.
The third stage is to apportion (or reapportion) all service cost centre overheads to
the production cost centres.
The final stage is to absorb the allocated and apportioned overheads into the costs
of production of cost units.
Cost Centres and Cost Units
In order to carry out absorption costing, the production costs and overheads of running a
business must be collected and recorded. A cost centre is a particular area or point of a
business for which costs are collected. Depending on the type of business, a cost centre might
be:
A geographical location, such as a factory, a sales region or a shop;
A functional department, such as production or distribution;
An item of equipment or machinery, such as a vehicle or photocopier;
A person, such as a sales representative or maintenance worker.
In the case of manufacturing businesses, there are two main types of cost centres;
Production cost centres, for example production departments such as machining or

assembly.
Service cost centres, for example service departments such as administration and
distribution. Sometimes these are sub-divided into smaller cost centres such as stores
or canteen, or into items of expense that are shared between departments such as
heat and light or rent and rates.
When costs have been collected and recorded in cost centres, the process of absorption costing
involves calculating the cost of each unit of production or cost unit. This might be a single
finished product, such as a chair, a batch of finished products, such as a thousand loaves of
bread, or a sub-assembly, such as an aircraft wing.
Absorption Costing 1
Cost allocation
When cost accountants calculate the total cost of operating a cost centre, they must include
both the direct and indirect costs of production. Direct costs are, by definition, associated with
particular products or cost units and can therefore be charged to the relevant cost centre. For
example, the wages paid to assembly line workers can be allocated directly to the production
department. Indirect costs or overheads that are wholly associated with a particular cost centre
can also be charged directly to that cost centre. The process is known as cost allocation. For
example, the wages of an assembly line supervisor or the depreciation on an assembly line
machine can both be allocated directly to the production department. Examples of cost
allocation also occur in service cost centres. For instance, the paper used in a photocopying
machine might be charged directly to the administration department. The rent payable for a
sales office might be charged directly to the sales department.
Apportionment of Overheads to cost centres
In many cases, it is not possible to allocate overheads directly to cost centres because the costs
are shared between several. For example, the cost of heating, insurance and maintenance
might all be shared between a number of production and service departments. Under these
circumstances, cost apportionment is used to divide the costs between the various cost
centres. A number of methods or bases can be used to apportion overheads. There are no set
guidelines when it comes to selecting bases for apportionment. However, the basis should be
equitable. This means that a fair share of the overheads should be apportioned to the relevant
cost centre. It is important for overheads to be apportioned fairly because businesses will want
to determine as accurately as possible the true cost of operating each cost centre. If overheads
are not apportioned fairly, the business might charge an inappropriate price to its customers.
Another reason is to avoid unfair discrimination between cost centres. Managers responsible for
cost centres might be demotivated if their centres are charged an unrealistic share of
overheads. It would suggest that their centres are more expensive to operate than they really
are.
Example:
Dentons Ltd, a clothing manufacturer. Three overheads incurred by Dentons are $10,000 for
heating, $40,000 in wages for two supervisors and $20,000 for insuring equipment. The
business is divided into four cost centres. The cutting and assembly departments are both
production cost centres and the canteen and maintenance departments are both service
cost centres.
Bases for apportioning overheads

Overheads Possible basis of apportionment
Rent and rates Floor area of cost centres
Heating and lighting Floor area, or volume of space, occupied by cost centres
Personnel costs for e.g (health and welfare) Number of staff employed by each cost centre
Building insurance Floor area, or book value of buildings, in each cost
centre
Machinery and equipment insurance Book value of machinery/equipment in each cost centre
Depreciation (plant, machinery and tools) Book value of assets in each cost centre
Maintenance Book value of assets in each cost centre
Supervisory costs No. of staff, or hours worked by supervisor, in each cost
centre
Staff canteen No. of staff employed in each cost centre
Administration No. of staff employed or direct labour costs in each cost
centre
The four cost centres in Dentons Ltd.
Cutting Assembly Canteen Maintenance Total

Floor area 25m2 200m2 100m2 75m2 400m2
Staff employed 15 30 2 3 50
Book value of equipment $50,000 $135,000 $10,000 $5,000 $200,000
Heating:
The heating cost of $10,000 can be apportioned according to the production of total floor space
that each cost centre occupies. The amount to be apportioned to each cost centre is calculated
using the formula:
Floor space occupied by Cost centre

Cost to be apportioned= ------------------------------------------------- x Total Heating Cost
Total Floor space
25m 2
So: Cutting = $10, 000 $625
400m 2
200m 2
Assembly = $10, 000 $5, 000
400m 2
100m 2
Canteen = $10, 000 $2,500
400m 2
75m 2
Maintenance = $10, 000 $1,875
400m 2
Supervision:
The supervisory costs of $40,000 can be apportioned according to the proportion of total staff
employed in each cost centre. The amount to be apportioned to each centre is calculated using
the formula:
No. of staff employed by Cost centre

Cost to be apportioned= ------------------------------------------------- x Total Supervision Cost
Total number of staff
15
So: Cutting = $40, 000 $12, 000
50
30
Assembly = $40, 000 $24, 000
50
2
Canteen = $40, 000 $1, 600
50
3
Maintenance = $40, 000 $2, 400
50
Insurance:
The insurance cost of $20,000 can be apportioned according to the proportion of the total book
value of equipment used in each cost centre. The amount to be apportioned to each centre is
calculated using the formula:
Book value of equipment in cost centre

Cost of apportioned = ----------------------------------------------------- x Total insurance cost
Total book value
50, 000
So: Cutting = $20, 000 $5, 000
200, 000
135, 000
Assembly = $20, 000 $13,500
200, 000
10, 000
Canteen = $20, 000 $1, 000
200, 000
5, 000
Maintenance = $20, 000 $500
200, 000
Sometimes more than one basis of apportionment could be used in a particular cost centre. For
example, heating costs could be apportioned according to floor area or to the volume of space
occupied by each cost centre. It is, to some extent, a subjective judgement which basis is
chosen. However, the decision should be consistent and appropriate, and it should always be
made clear which basis is chosen.
Share of overheads apportioned to cost centres
Basis Cutting Assembly Canteen Maintenance Total

$ $ $ $ $
Floor area 625 5,000 2,500 1,875
Heating 10,000
Supervisory No. Of 12,000 24,000 1,600 2,400 40,000
employee
s
Insurance Book 20,000
value 5,000 13,500 1,000 500
Total 17,625 42,500 5,100 4775 70,000
Apportionment of Service cost centre overheads
In order to calculate the full cost of producing each cost unit, it is necessary to apportion the
service cost centre overheads to the production cost centres. This process is sometimes called
reapportionment or secondary apportionment. So, for example, the costs involved in
operating service departments, such as stores, planning, canteen and maintenance, must be
shared between the production departments. The reason for this is that it is only the production
cost centres that are directly associated with the manufacture of the cost units. A number of
different apportionment bases can be used when apportioning service cost centre overheads.
Bases for apportioning service centre cost overheads
Service cost centre Possible basis of apportionment

Canteen Number of staff or meals served in each cost centre
Maintenance Hours of maintenance work carried out for each cost centre
Planning Number of hours worked in each cost centre
Stores Number of times that materials are requisitioned by each cost centre
Consider again the example of Dentons Ltd. Example below shows how the companys
overheads are allocated and apportioned to four cost centres. The first line shows that some
costs are allocated directly to the cost centres. These costs include, for example, overheads
such as depreciation on equipment that is used in each cost centre. They also include some
direct costs such as direct labour. The second line shows the apportioned costs.
Share of overheads allocated and apportioned to cost centres.

(production) (production) (service) (service)
8,500 10,500 4,400 6,600 30,000
Allocated costs
Apportioned costs 17,625 42,500 5,100 4,775 70,000
Total 26,125 53,000 9,500 11,375 100,000
The costs associated with the two service cost centres are reapportioned in the following
ways:
Canteen:
According to the number meals served to staff employed in each cost centre;
Maintenance:
According to the number of hours that maintenance staff work in each cost centre.
Example below shows that 30% (i.e. 3750 meals 12500 meals) of the costs associated with
the canteen are apportioned to the cutting department and 60% (i.e. 7,500 meals 12,500
meals) are apportioned to the assembly department. Note also that 10% (1,250 meals
12,500 meals) of the canteen costs are apportioned to the other service department,
maintenance. This is because the maintenance workers also make use of the canteen. The
costs associated with the maintenance department are split equally between the cutting and
assembly departments. This is because, in this example, they both use half the total number of
maintenance hours.
Service cost centre apportionment

3,750 7,500 - 1,250 12,500
Canteen: No. of meals
(as a % of total) 30% 60% - 10% 100%
Maintenance: No. of hours 3,000 3,000 - - 6,000
(as a % of total) 50% 50% - - 100%
Example below shows how the total overhead costs are charged to the two production
departments.
The first step is to reapportion the overheads associated with the canteen. Using the
information from example, 30% of the costs are charged to the cutting department, i.e.
$2,850 (30% x $9,500), 60% are charged to the assembly department, i.e. $5,700 (60%
x $9500) and 10% are charged to the maintenance department i.e. $950 (10% x
$9,500).
The next stage is to reapportion the maintenance overheads to the production

departments. In this example these include some of the apportioned canteen overheads.
The maintenance costs are split equally with $6,162.50 (50% x [$11,375 + $950]) being
charged to each production department.
Total overheads apportioned

$ $ $ $ $
26,125 53,000 9,500 11,375 100,000
Total overheads
Canteen overheads apportioned 2,850 5,700 9,500 950
Sub-total 28,975 58,700 - 12,325 100,000
Maintenance overheads apportioned 6,162.50 6,162.50 12,325
Total overheads apportioned 35,137.50 64,862.50 - - 100,000
Overheads absorption
When all overheads have been charged to production cost centres, they can then be absorbed
into cost units. This ensures that all costs are taken into account when calculating the cost of
producing the goods that are to be sold. The rate at which overheads are charged to cost units
is called the overhead absorption rate (OAR) or recovery rate. Several different methods of
calculation are used. Three are explained below. Note that the overheads are not absorbed on
the basis of actual overheads incurred but on the basis of estimated or budgeted figures. This
is because actual overheads will not be known precisely until the end of the financial year.
Machine hour overheads absorption rate:
This method is most suitable when production is capital intensive, i.e. where there is a
high investment in fixed assets, such as machinery, relative to labour. Under these
circumstances, most of the overheads are related to the cost of using the machinery. They
include, for example depreciation, power, insurance, maintenance and repairs. It is
appropriate to recover these overheads according to the amount of time that machinery is
used on each cost unit. The machine hour OAR is given by:
Total cost centre overheads

OAR = ---------------------------------------- = rate per machine hour
Number of machine hours
Suppose, for example, that in a machining department, the total annual overheads are
estimated to be $250,000. The budgeted annual total of machine hours in this cost centre
is 10,000. Therefore, the machine hour OAR is:
$250,000
OAR = --------------- = $25 per machine hour
10,000
Consequently, if a particular cost unit takes 6 hours to produce in the machining

department, $150 (6 x $25) overheads will be charged to the production of that single unit.
Direct labour hour overheads absorption rate:
This method is most suitable when production is labour intensive, ie. When direct labour
costs are high relative to capital costs. Under these circumstances, it is appropriate to
recover overheads according to the number of hours it takes employees to produce each
cost unit. The direct labour hour OAR is given by:

OAR = -------------------------------------- = rate per direct labour hour
Total direct labour hours
Suppose, for example, that in a packaging department the total annual overheads are
estimated to be $60,000. The budgeted annual total of direct labour hours in the
department is 20,000. Therefore, the direct labour hour OAR is:
$60,000
OAR = ----------- = $3 per direct labour hour
20,000
Consequently, if it takes half an hour to pack a cost unit, $1.50 (0.5 x $3) overheads will be
charged to each unit.
Cost unit overheads absorption rate:
This method is appropriate when cost units are identical. For example, it would be suitable
in a brewery where the only output is a single type of bottled beer. However, the method is
unsuitable if a cost centre produces a wide range of different products that each take a
different length of time to produce. The cost unit OAR is given by:

OAR = ---------------------------------------- = rate per unit
Total cost units
Suppose, for example, that a small brewery which produces just one type of bottled beer
incurs estimated $10,000 annual overheads. The budgeted annual total number bottles
produced are 40,000. Therefore, the cost unit OAR is:
$10,000
OAR= ---------- = $ 0.25 per unit
40,000
The overhead to be charged to each bottle produced is $0.25.
Calculating unit costs using absorption costing
Example:
Wright Ltd, a manufacturer of sailing boat kits. The company manufactures some parts of the
boats and buys in a variety of other components that are used to make up the rest of the kits.
The business is divided into four cost centres.
Body shop produces the fibre glass parts that are needed to construct the boat shell.
Sub-assembly - assembles the boughtin components.
Packing and dispatch packs and dispatches the kits to customers.
Quality control oversees quality control in the three production cost centres. This is a
service cost centre.
A machine hour OAR is used in the body shop to charge overheads and a direct labour hour
OAR is used in the other two production departments. Details of overheads and additional
information are shown below:
Overheads and additional information for Wright Ltd
Body Sub- Packaging & Quality Total

Shop assembly dispatch control
Floor space 8,000 m2 4,000m2 2,000 m2 2,000 m2 16,000 m2
Book value of assets $600,000 $200,000 $200,000 - $1,000000
Number of employees 10 40 20 10 80
Quality control hours 2,000 8,000
Overheads $
Rent 1,600,000
Heat and light 400,000
Depreciation 200,000
Administration 800,000
Total 3,000,000
Annual budgeted machine hours in the body shop: 50,000

Annual budgeted direct labour hours in the sub-assembly dept: 40,000
Annual budgeted direct labour hours in the packing and dispatch dept: 20,000
$
Cost of direct materials per boat: 500
Cost of direct labour per boat: 2,500
Time taken to produce one boat kit in each department:
Body shop: 10 hours

Sub-assembly: 15 hours
Packing and dispatch 8 hours
In order to calculate the cost to Wright Ltd of producing one boat, the following steps are taken.
Step One
The first step is to apportion the $3m overheads to the four cost centres.
The rent of $1,600,000 is apportioned according to the floor space used by each centre.
For example, $800,000 ($1,600,000 x 8,000 16,000) is charged to the body shop.
Heat and light costs of $400,000 are also apportioned according to floor space. For
example, $200,000 ($400,000 x 8,000 16,000) is charged to the body shop.
Depreciation of $200,000 is apportioned according to the book value of assets employed

by each centre. For example, $120,000 (200,000 x 600,000 1,000,000) is charged to the
body shop. Note that depreciation is not charged to the quality control cost centre. This is
because the department does not use any machinery or equipment.
The administration costs of $800,000 are apportioned according to the number of staff
employed in each cost centre. For example, $100,000 ($800,000 x 10 80) is charged to
the body shop.
The apportioned overheads for Wright Ltd.
Body shop Sub- Packing & Quality Total

$ assembly ($) dispatch ($) control ($) $
Rent 800,000 400,000 200,000 200,000 1,600,000
Heat and light 200,000 100,000 50,000 50,000 400,000
Depreciation 120,000 40,000 40,000 0 200,000
Administration 100,000 400,000 200,000 100,000 800,000
Total 1,220,000 940,000 490,000 350,000 3,000,000
Step Two
The next step is to apportion (or reapportion) the overheads of the service department
to the production departments. This is done according to the number of hours that the
quality control department is estimated to spend working for them. So, for example,
$50,000 ($350,000 x 2,000 14,000) is apportioned to the body shop. The amended
analysis of overheads is shown below:
Service cost centre overheads apportioned to production cost centres
Body shop Sub- Packing & Quality Total
$ assembly ($) dispatch ($) control ($) $
Total overheads 1,220,000 940,000 490,000 350,000 3,000,000
Quality control
reapportioned 50,000 200,000 100,000 (350,000) _______
Total 1,270,000 1,140,000 590,000 - 3,000,000
Step Three
When all the overheads have been apportioned to production cost centres, the next
step is to calculate the overhead absorption rates.
The body shop uses the machine hours OAR and the annual budgeted number of
machine hours is 50,000. Therefore the OAR of this department is:
$1,270,000
---------------- = $25.40 per machine hour
50,000
The sub-assembly department uses the direct labour OAR and the annual budgeted
number of direct labour hours is 40,000. Therefore the OAR of this department is:
$1,140,000
-------------------- = $28.50 per direct labour hour
40,0000
The packing and dispatch department also uses the direct labour OAR and the annual
budgeted number of direct labour hours is 20,000. Therefore the OAR of this
department is:
$590,000
------------- = $29.50 per direct labour hour
20,000
Step four
The fourth step is to calculate the overheads that are to be charged to each cost unit,
i.e. boat. In order to do this, it is necessary to multiply the relevant OAR by the length
of time it takes to process a single cost unit in each department. This is given below:
OAR Number of hours Cost per unit

$
Body shop 25.40 x 10 = 254.00
Sub-assembly 28.50 x 15 = 427.50
Packing & dispatch 29.50 x 8 = 236.00
Total Overhead p/u 917.50
Step five
The final step is to calculate the total cost of each boat or cost unit by adding the total
overheads charged per cost unit to the labour cost and the direct materials cost. The
total cost is $3,917.50 as shown below.

$
Direct material per cost unit 500.00
Direct labour per cost unit 2,500.00
Overheads per cost unit 917.50
Total cost per unit 3,917.50
Under and Over Absorption
The overhead absorption rate (OAR) is based on budget estimates of overheads costs and the
expected level of activity in the business. These estimates will be inaccurate if either the actual
overhead costs or activity level are higher or lower than budgeted estimates. If this happens, the
OAR will also be inaccurate.
Example 1:
Budgeted Overheads $200000

Budgeted Production in units 10000
Actual Overheads $205000

Actual Production in units 9500
STEP 1: Calculation of Overhead Absorption Rate
OAR = Budgeted Overheads

Budgeted Units
OAR = $200000 = $20 per unit.

10000
STEP 2: Calculation of Overheads Absorbed on Actual Production
Overheads Absorbed = Actual production X OAR
Overheads Absorbed = 9500 X $20 = $190000.
STEP 3: Calculation of Overheads Over / Under Absorbed
Over / (Under) Absorbed Overheads = Overheads Absorbed Actual Overheads
Over / (Under) Absorbed Overheads = $190000 - $205000 = ($15000) Under Absorbed.
Example 2:
Budgeted Overheads $231000

Budgeted Production in units 11000
Actual Overheads $220000
Actual Production in units 12000
STEP 1:Calculation of Overhead Absorption Rate
OAR = Budgeted Overheads

Budgeted Units
OAR = $231000 = $21 per unit.

11000
STEP 2: Calculation of Overheads Absorbed on Actual Production
Overheads Absorbed = Actual production X OAR
Overheads Absorbed = 12000 X $21 = $252000.
STEP 3: Calculation of Overheads Over / Under Absorbed
Over / (Under) Absorbed Overheads = Overheads Absorbed Actual Overheads
Over / (Under) Absorbed Overheads = $252000 - $220000 = $32000 Over Absorbed.
Points to Remember:
Under Absorption occurs when Actual Overheads is more than the Budgeted
Overheads or when Actual output (units) is less than the Budgeted output (units).
Over Absorption occurs when Actual Overheads is less than the Budgeted
Overheads or when Actual output (units) is more than the budgeted output (units).
Advantages and disadvantages of absorption costing
Advantages:
Absorption costing is a widely used method of costing because it ensures that costs are fully
recovered. This means that businesses will cover their costs as long as the actual costs and
level of activity are similar to the budgeted figures.
A second advantage of absorption costing is that it conforms to the accounting standard

SSAP9 states that absorption costing should be used valuing stocks in the final accounts. This
is because absorption costing includes a share of fixed costs. It therefore recognises these fixed
costs in the same period as revenues, and so conforms to the matching principle.
Disadvantages:
The main disadvantage of absorption costing is that it is based on budgeted figures, which
might be inaccurate. This is because the figures are generally based on historical data that
might not reflect future costs or activity levels. As a result, businesses might under or over
absorb their overheads, and therefore set prices that are too low or too high.
A second disadvantage is that it can be complex, time consuming and expensive to gather
detailed information from different cost centres. This is particularly the case in small to medium
size companies that do not employ specialist cost accountants.
ABSORPTION COSTING (WORKSHEET)
1. Darnick Holdalls Ltd manufactures three types of high quality hand-made cases, Small,
Medium and Large. These are manufactured in two departments, the cutting department and
the stitching department. There are also two service departments, maintenance and
canteen. The estimated data for the year ending 31 Department data for the year ending
31 December 2004 is as follows.
Small Medium Large

Estimated production (units) 10000 9000 4400
Machine hours required per unit 3 4 5
$ $ $
Unit Selling price 125 140 155
Unit Prime costs
Direct materials 30 35 40
Direct labour Cutting department 17 18 20
Direct labour Stitching department 5 6 7
Estimated overheads for the year ending 31 December 2004:
Cutting Stitching Maintenance Canteen Total

Space costs $90000
Depreciation of Equipment $200000
Allocated overheads $44200 $47600 $15000 $18000 $124800
$414800
Additional information
Floor area (sq metres) 5000 6000 2000 2000
Number of employees 12 9 4 5
Cost of equipment $700000 $850000 $250000 $200000
Required:
(a) Prepare an Overhead Analysis Sheet for the year ending 31 December 2004 detailing
overheads for the cutting and stitching departments. Canteen costs are shared among all
the other departments on the basis of number of employees. Maintenance costs are
shared between the production departments on the basis of 70% to stitching and 30% to
cutting.
(b) Calculate the Overhead Recovery Rate of;
(i) The Cutting department, based on direct wages;

(ii) The Stitching department, based on machine hours. (Show all workings).
(c) Give reasons for the two different methods used in (b).
(d) Calculate the Total unit cost of one medium case.
2. (a) Explain the following terms:
(i) Cost Centre.

(ii) Cost Unit.
(b) Julie and Cleary Ltd manufacture toy soldiers. The company has three production
departments Moulding, Sanding and Painting and two service departments
Canteen and Maintenance. Estimated Indirect overheads for the year ended 30 April
2002 are as follows:
Overhead Costs Basis of Apportionment or Allocation

Administration $104000 Number of employees
Electricity $70000 Kilowatt hours used
Depreciation 10% Cost of Fixed Asset
Indirect Wages $360000 Allocated
Rent $80500 Floor area (square metres)
Relevant information on the five departments is as follows:
Moulding Sanding Painting Canteen Maintenance

No of employees 40 50 40 38 40
Power (Kw hours) 1400 1600 150 160 190
Cost of Fixed Asset $162000 $175000 $40000 $43000 $80000
Floor area (sq m) 625 475 500 300 400
Indirect wages $6000 $11250 $6375 $18750 $36190
Direct Labour hours 8000 7800 7500
Direct Machine hours 7750 5625 1250
Canteen costs are shared among all the other departments on the basis of number of
employees. Maintenance costs are shared among the three production departments on
the basis of floor area.
Required:
(i) Prepare an Overhead Analysis Sheet for the year ending 30 April 2002 detailing the total
overheads for Moulding, Sanding and painting.
(ii) Moulding and Sanding Department overhead rates are calculated on a Direct Machine
hour basis. Painting Department overhead rate is calculated on a Direct labour basis.
3. Box and Cox Ltd three production departments Moulding, Assembly and Finishing
and two service departments Personnel and Maintenance. The following figures are
required to calculate Overhead Recovery Rates:
Moulding Assembly Finishing Personnel Maintenance

Number of employees 200 250 200 190 200
Floor area (sq metres) 2500 1900 2000 1200 1600
Direct labour hours 32000 31200 30000 - -
Direct machine hours 31000 22500 5000 - -
Power (kw hours) 6000 6550 600 650 750
Indirect wages ($) 24000 45000 25500 75000 144750
Cost of machinery ($) 650000 700000 520000 170000 320000
Personnel costs are split amongst all the other departments on the basis of number of
employees. Maintenance costs are split amongst the three production departments on the
basis of floor area. Indirect overheads are apportioned as follows:
Overhead Cost Basis of apportionment

Rent and Rates $55200 Floor area
Depreciation 15% Cost of machinery
Power $43650 Kilowatt hours
Indirect wages $314250 as shown
Moulding and Assembly department overhead rates are applied on a machine hour basis.
Finishing department rates are applied on a direct labour hour basis.
Required:
(a) Calculate Overhead Recovery Rates for each of the three production departments.
The following costs apply to Job No. KRF304:
Direct Direct Labour Rate per Direct Direct Machine

Materials Hours Labour Hour Hours
Moulding department $315 40 $5.00 50
Assembly department $52 8 $4.00 12
Finishing department $20 2 $4.00 3
Required:
(b) Calculate the Total cost of job KRF304.
4. A manufacturing Company has three production departments: A, B and C. It also has a
service department; Stores.
Budgeted Overhead expenditure for the six months Ended 31 December 2008:
$
Rent 80000
Electricity 52000
Insurance of premises 4800
Insurance of machinery 18750
Canteen costs 76000
Depreciation of machinery is calculated at 17.5% per annum on cost.
The companys budget for the six months ending 31 December 2008 is based on the following
information:
Production Departments Stores

A B C
Area in metres2 5000 7000 3000 1000
Machinery at costs $60000 $500000 $150000
No. of workers 70 85 25
No. of Stores requisitions 600 750 150 10
Required:
(a) Complete the following table to show the apportionment of the overheads to
departments A, B and C, and the basis on which each apportionment is calculated.
(b) Calculate the Overhead Absorption Rate (OAR) for each department based on
budgeted man-hours if all workers work a 35-hour week for 24 weeks in the period
covered by the budget.
(c) Calculate the Total Overhead incurred in making one unit of this product.
The time taken in each department for the manufacture of one unit of a particular
product is:
Dept. A 2 hours; Dept. B 3 hours; Dept. C 1 hours.
5. Horden Products Ltd. Manufactures goods, which could involve any or all of three-production
department. These departments are simply are simply entitled A, B and C. A direct wages
cost percentage absorption rate for the recovery of production overheads is applied to
individual job costs.
Details from the companys budget for the year ended 31 March 2008 are as follows:
Dept. A ($) Dept. B ($) Dept. C ($)

Indirect materials 23,000 35,000 57,000
Indirect wages 21,000 34,000 55,000
Direct wages 140,000 200,000 125,000
Direct labour hours 25,000 50,000 60,000
Machine hours 100,000 40,000 10,000
The following information is also available for the production departments.
Dept. A ($) Dept. B ($) Dept. C ($)

Area (square meters) 30,000 20,000 10,000
Cost of machinery 220,000 160,000 20,000
Horse power of machinery 55 30 15
Other budgeted figures are:
$
Power 120,000
Rent, rates, light, heat 90,000
Insurance (machinery) 20,000
Depreciation 80,000
Machinery is depreciated on the basis of 20% on cost. Job No.347 passed through all
three departments and incurred the following actual direct costs and times.
Direct Material Direct Wages Direct Labour Machine

$ $ Hours Hours
Dept. A 152 88 35 60
Dept. B 85 192 90 30
Dept. C 52 105 45 10
A sum amounting to 30% of the production cost is added to every job enable a selling price to
be quoted.
Required:
(a) A statement to show the total production overheads per department and calculate
the absorption rate which the company has adopted.
(b) Calculate the selling price to be quoted for Job No. 347.
(c) Using the available data, calculate absorption rates when based on:
(i) Direct labour hour rate;
(ii) Machine hour rate.
6. The Harlton Manufacturing Company uses job costing. The company has four production
departments and three service departments. Indirect labour and other indirect costs for a
typical month have been allotted as shown:
Production Department Service Department

Grinding Blending Firing Polishing Personnel Administration Maintenance
Indirect
Labour $ 4600 $ 3300 $ 5400 $ 2900 $ 700 $ 1800 $ 800
Other
indirect
Costs $ 1400 $ 1200 $ 2800 $ 1600 $ 500 $ 300 $ 1200
The service Departments costs are allotted as follows:
Grinding Blending Firing Polishing Administration Maintenance

Personnel (%) 15 25 30 20 5 5
Administration (%) 10 30 40 15 - 5
Maintenance (%) 15 35 45 5 - -
In the Grinding and Firing departments, job costing uses an overhead rate per machine
hour; in Blending and Polishing an overhead rate per direct labour is used. Machine hours
worked are 611 Hours in Grinding and 520 Hours in Firing. Direct labours hours worked are
1,034 in Blending and 431 in Polishing.
Required:
(a) Calculate the Overhead recovery rates for each of the production departments.
(b) Use your answers to calculate the cost of job number 84 which incurs the following costs:
Grinding Direct materials cost $ 120

Department Direct labour hours at $ 2.40 per hour 14 Hrs
Machine hours 30 Hrs
Then passed on to Direct materials cost $ 97
Blending where; Direct labour hours at $ 2.60 per hour 18 Hrs
7. The factory of Stamford Limited is organised into four cost centres. The company
manufactures different types of industrial values. At present, Stamford Limited uses a single
production overhead absorption rate calculated by dividing total budgeted production overheads
by total budgeted direct wages. Given below are the budgeted costs and other data for the year
ended 31 December 2008.
Direct Production Direct Machine hours

Wages Overheads Labour hours
$000 $000 000 000
Cost centre A 1500 7500 250 600
Cost centre B 6220 6000 500 120
Cost centre C 1830 3675 350 nil
Cost centre D 5100 4800 320 300
Actual costs and actual times relating to Job XY32, which was completed during October 2008
were as follows:
Direct Production Direct Machine hours

Wages Overheads Labour hours
$000 $000 000 000
Cost centre A 1200 350 50 100
Cost centre B 260 680 110 25
Cost centre C 175 180 30 nil
Cost centre D 290 240 35 30
Selling prices are calculated by adding to prime cost, production overheads based on the
predetermined absorption rate, and then adding a mark-up of 40% to the total production cost.
The newly appointed accountant at Stamford has suggested that if separate overhead
absorption rates were calculated for each centre, this would be a more accurate basis for
determined job costs.
Required:
(a) Calculate the present Overhead Absorption rate based on the budgeted figures for the
year ended 31 December 2008.
(b) Using the rate calculated in (a) above, calculate the production overhead allocated to Job
XY32, together with the total production cost and selling price for the job.
(c) Comment on the proposal from the new accountant the calculating overhead production
rates separately for each centre would result in more accurate job Costing.
MULTIPLE CHOICE QUESTIONS

Absorption Costing

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Absorption Costing

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Al Wadi International School

ABSORPTION COSTING (NOTES)

Cost Centres and Cost Units

A functional department, such as production or distribution;

An item of equipment or machinery, such as a vehicle or photocopier;

A person, such as a sales representative or maintenance worker.

Production cost centres, for example production departments such as machining or

Apportionment of Overheads to cost centres

Bases for apportioning overheads

The four cost centres in Dentons Ltd.

Cutting Assembly Canteen Maintenance Total

Floor space occupied by Cost centre

No. of staff employed by Cost centre

Book value of equipment in cost centre

Share of overheads apportioned to cost centres

Basis Cutting Assembly Canteen Maintenance Total

Apportionment of Service cost centre overheads

Bases for apportioning service centre cost overheads

Service cost centre Possible basis of apportionment

Share of overheads allocated and apportioned to cost centres.

Cutting Assembly Canteen Maintenance Total

Service cost centre apportionment

Cutting Assembly Canteen Maintenance Total

The next stage is to reapportion the maintenance overheads to the production

Total overheads apportioned

Cutting Assembly Canteen Maintenance Total

Machine hour overheads absorption rate:

Total cost centre overheads

Consequently, if a particular cost unit takes 6 hours to produce in the machining

Direct labour hour overheads absorption rate:

Total cost centre overheads

Cost unit overheads absorption rate:

Total cost centre overheads

The overhead to be charged to each bottle produced is $0.25.

Calculating unit costs using absorption costing

Sub-assembly - assembles the boughtin components.

Packing and dispatch packs and dispatches the kits to customers.

Overheads and additional information for Wright Ltd

Body Sub- Packaging & Quality Total

Annual budgeted machine hours in the body shop: 50,000

Time taken to produce one boat kit in each department:

Body shop: 10 hours

Depreciation of $200,000 is apportioned according to the book value of assets employed

The apportioned overheads for Wright Ltd.

Body shop Sub- Packing & Quality Total

Service cost centre overheads apportioned to production cost centres

Body shop Sub- Packing & Quality Total

OAR Number of hours Cost per unit

Under and Over Absorption

Budgeted Overheads $200000

Actual Overheads $205000

STEP 1: Calculation of Overhead Absorption Rate

OAR = Budgeted Overheads

OAR = $200000 = $20 per unit.

STEP 2: Calculation of Overheads Absorbed on Actual Production

Overheads Absorbed = Actual production X OAR

Overheads Absorbed = 9500 X $20 = $190000.

STEP 3: Calculation of Overheads Over / Under Absorbed

Over / (Under) Absorbed Overheads = Overheads Absorbed Actual Overheads

Over / (Under) Absorbed Overheads = $190000 - $205000 = ($15000) Under Absorbed.

Budgeted Overheads $231000

STEP 1:Calculation of Overhead Absorption Rate

OAR = Budgeted Overheads

OAR = $231000 = $21 per unit.