Business, Accounting and Financial Studies (Elective Part) Excellence Publication Ltd
2(b) Cost Accounting Question bank Chapter 3 Absorption Costing
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1. What are the differences between absorption costing and marginal costing? (4 marks) For internal reporting, in which areas can the information form absorption costing be used by management? (3 marks)
Absorption costing is a method of inventory costing that includes all direct costs and all indirect costs as inventoriable costs. In other words, when inventory value is calculated, part of fixed costs should also be included. Both fixed and variable factory overheads are included as manufacturing costs. (2 marks)
In contrast, under marginal costing, only variable manufacturing cost is included as inventoriable cost. Fixed manufacturing cost is not included in the calculation of unsold inventory. (2 marks)
Information from absorption costing can be used by management in the following ways:
(1) Analysis of profitability: Management normally requires profit information at intervals. This profit information is particularly useful in evaluating the performance of managers. (1 mark)
(2) Setting of prices: Under the absorption costing approach, fixed manufacturing cost is also considered in arriving at the inventoriable cost. This allows managers to set a more reasonable price to achieve breakeven. (1 mark)
(3) Control over costs: Absorption costing reminds managers of the importance of fixed manufacturing overhead. It ensures fixed manufacturing overhead is not neglected when cost control is needed. (1 mark)
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2. List FOUR arguments in favour of absorption costing and FOUR arguments against it. (8 marks)
Arguments in favour of absorption costing:
(1) The use of absorption costing ensures that fixed costs will be covered. Then the importance of fixed costs will not be understated.
(2) When sales are stable, managers can still influence the reported profit by adjusting the output level.
(3) Where inventory building is a necessary part of operations, e.g. seasonal sales, it is necessary and desirable to include fixed costs in inventory valuation. Absorption costing appears to provide the more logical profit calculation.
(4) Many companies mark up prices on costs. Absorption costing automatically includes fixed costs. It is less likely that firms will set prices lower than the total costs.
(5) According to accrual concept, costs and revenues must be matched in the period when the revenue arises, not when the costs are paid and incurred. Thus, accounting standards recommend the use of absorption costing for financial accounts.
(6) Managers are likely to use the same rules and procedures for both internal and external profit measurement and inventory valuation, so that they will focus on the same measures as those used by financial markets.
(7) Overhead allocation is the only practical way of obtaining job costs for setting prices and analysing profits. Moreover, analysis of under-absorbed or over-absorbed overheads is useful to identify inefficient utilisation of resources.
(1mark each, max 4 marks)
Arguments against using absorption costing:
(1) Profits may be distorted if inventory levels are likely to fluctuate significantly.
(2) Comparison between products can also be misleading because the allocation of fixed overheads could be arbitrary and inaccurate. Significant adjustments may arise.
(3) Internal profit statements may be used as a basis for measuring managerial performance. When absorption costing is used, managers may deliberately alter their inventory levels to influence profit.
(4) If these surplus inventories cannot be sold out before year-end, the profit calculation for the current period will be misleading. This is because fixed overheads will deferred to the next accounting period.
(5) If the production process involves more than one product or one department, the apportionment of fixed costs into the cost units may not be fair enough to reflect their share of overheads.
(1mark each, max 4 marks)
Sd (bafs_sq_2b0303)
3. (a) In which classifications can cost be classified by cost behaviour? (1 marks)
(b) What are product costs and period costs? (2 marks)
(c) Classify each cost as product costs or period costs under absorption costing:
(i) Fixed manufacturing overheads
(ii) Variable manufacturing overheads
(iii) Fixed operating overheads
(iv)Variable operating overheads
(v) Direct manufacturing costs (5 marks)
(a) Costs can be classified into two categories by their cost behaviour: variable cost and fixed cost. (1 mark)
(b) Product costs are also called inventoriable costs; they are incurred to manufacture products and included in the inventory valuation. (1 mark)
Period costs are also called operating overheads or expenses; they are associated with time periods, rather than with the manufacturing of products, i.e. they are non-manufacturing costs by nature. (1 mark)
(c) (i) Product costs (1 mark)
(ii) Product costs (1 mark)
(iii) Period costs (1 mark)
(iv) Period costs (1 mark)
(v) Product costs (1 mark)
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4. A company sells a product for $30 and incurs $8.0 of variable costs in its manufacture. The fixed production costs are $1 800 per year and are absorbed on the basis of the normal production volume of 250 units per year. Selling overheads $6.0 per unit sold and office overheads are fixed at $480.00 per year. The results for the 20X1, 20X2 and 20X3, when no expenditure variances arose, were as follows:
20X1 / 20X2 / 20X3Units / Units / Units
Opening Inventory / 200 / 300 / 300
Production / 250 / 200 / 200
450 / 500 / 500
Closing Inventory / (300) / (300) / 0
Sales / 150 / 200 / 500
Required:
Show the profit statements of the three years under absorption costing principles in columnar form. (8 marks)
20X1 / 20X2 / 20X3Sales $30
Opening inventory
Production
Variable ($8)
Fixed product cost ($7.2)
Closing inventory ($15.2)
Gross profit
Over-/ under-absorbed
Selling overhead（$6）
Office overhead
Net profit (Loss) / $
4 500
3 040
2 000
1 800
(4 560)
2 280
2 220
0
(900)
(480)
840 / $
6 000
4 560
1 600
1 440
(4 560)
3 040
2 960
(360)
(1 200)
(480)
920 / $
15 000
4 560
1 600
1 440
(0)
7 600
7 400
(360)
(3 000)
(480)
3 560 / (0.5)
(0.5)
(1)
(1)
(0.5)
(0.5)
(1)
(1)
(0.5)
(0.5)
(1)
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5. Lambo Company is a motor bike manufacturer. It incurs $600 of variable costs in manufacturing per unit of bike. The fixed production costs are $135 000 per year and are absorbed on the basis of the normal production volume of 250 units per year. Selling overheads $450 per unit sold and office overheads are fixed at $36 000 per year. The company sells motor bikes for $2 250. The results for the last two years, when no expenditure variances arose, were as follows:
Year 1 / Year 2Units / Units
Opening Inventory / 0 / 200
Production / 950 / 250
950 / 450
Closing Inventory / (200) / (300)
Sales / 750 / 150
Required:
Show the profit statements of the two years under absorption costing principles in columnar form. (8 marks)
20X1 / 20X2Sales ($2 250)
Opening inventory
Production
Variable ($600)
Fixed product cost ($540)
Closing inventory ($1 140)
Gross profit
Over-/ under-absorbed
Selling overhead（$450）
Office overhead
Net profit (Loss) / $
1 687 500
0
570 000
513 000
(228 000)
855 000
832 500
378 000
(337 500)
(36 000)
837 000 / $
337 500
228 000
150 000
135 000
(342 000)
171 000
166 500
0
(67 500)
(36 000)
63 000 / (0.5)
(0.5)
(1)
(1)
(0.5)
(0.5)
(1)
(1)
(0.5)
(0.5)
(1)
6. sd (bafs_sq_2b0306)
A company has two production centres (A and B) and two products (X and Y). The production of the two products involves the contribution of both centres. Information about the centres and products is as follows:
Centre A / Centre BBudgeted overhead / $780 000 / $500 000
Labour hours for 1 unit of X / 200 / 100
Labour hours for 1 unit of Y / 90 / 80
Product X / Product Y
Budgeted production units / 1 800 / 900
You are required to calculate:
(a) The overhead absorption rate per labour hour for each production centre. (4 marks)
(b) The total amount of overhead to be included in the unit cost of each of the two products. (4 marks)
（a）Overhead absorption rate for centre A
= $780 000 ÷ [（200 × 1 800） +（90 × 900）]
= $780 000 ÷ 441 000
= $1.77 per labour hour (2 marks)
Overhead absorption rate for centre B
= $500 000 ÷ [（100 × 1 800）+（80 × 900）]
= $500 000 ÷ 252 000
= $1.98 per labour hour (2 marks)
（b）Overhead as per unit of product X
= $1.77 × 200 + $1.98 × 100
= $354 + $198
= $552 (2 marks)
Overhead as per unit of product Y
= $1.77 × 90 + $1.98 × 80
= $159.3 + $158.4
= $317.7 (2 marks)
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China Stationary Manufacturing Company has two production centres: Western Centre and Northern Centre, and two products: rubbers and pens. The production of the two products involves the contribution of both centres. Information about the centres and products is as follows:
Western Centre / Northern CentreBudgeted overhead / $100 000 / $200 000
Machine hours for 1 unit of rubber / 10 / 15
Machine hours for 1 unit of pen / 20 / 25
Rubbers / Pens
Budgeted production units / 8 900 / 6 400
You are required to calculate:
(a) The overhead absorption rate per machine hour for each production centre. (4 marks)
(b) The total amount of overhead to be included in the unit cost of each of the two products. (4 marks)
（a）Overhead absorption rate for Western Centre
= $100 000 ÷ [（10 × 8 900）+（20 × 6 400）]
= $100 000 ÷ 217 000
= $0.46 per machine hour (2 marks)
Overhead absorption rate for Northern Centre
= $200 000 ÷ [（15 × 8 900）+（25 × 6 400）]
= $200 000 ÷ 293 500
= $0.68 per machine hour (2 marks)
（b）Overhead as per unit of rubber
= $0.46 × 10 + $0.68 × 15
= $4.6 + $10.2
= $14.8 (2 marks)
Overhead as per unit of pen
= $0.46 × 20 + $0.68 × 25
= $9.2 + $17
= $26.2 (2 marks)
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8. BAFS Limited manufactures and sells footballs. The selling price is $24 each. Each football has the following unit cost:
$Direct labour per unit / 2.0
Direct material per unit / 4.0
Fixed production overheads per unit / 6.0
Variable production overheads per unit / 4.0
Fixed administration overheads are incurred at the rate of $4 000 per annum.
The company obtained the following production and sales data of footballs in 20X1:
Total units of production 1 000
Total units of sales 900
The following information is also relevant:
(i) The fixed production costs of $6 per unit have been calculated on the basis of a budgeted production volume of 900 units.
(ii) There was no opening inventory for 20X1.
(iii) There were no differences between actual and budgeted costs.
(iv) Any adjustments of over or under-absorption are to be treated as period costs
Required:
Prepare a net income summary for 20X1 using absorption costing. (7 marks)
BAFS Manufacturing Company
Income statement for the year ended 31 December 20X1
Cost of goods manufacturedDirect materials ($4)
Direct labour ($2)
Variable overheads ($4)
Fixed overheads absorbed ($6)
Sales ($24 each)
Less: Cost of goods sold
Opening inventory
Cost of goods manufactured
Goods available for sale
Less: Closing inventory
Gross profit
Add: Over-absorbed overheads
Less: Non-production overheads
Net profit / $
4 000
2 000
4 000
6 000
16 000
21 600
0
16 000
16 000
1 600
14 400
7 200
600
4 000
3 800
(0.5 mark for each bold figure; total: 7 marks)
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9. Now Limited manufactures and sells cups. The selling price is $18 each. Each cup has the following unit cost:
$Direct labour per unit / 1.5
Direct material per unit / 3.0
Fixed production overheads per unit / 4.5
Variable production overheads per unit / 3.0
Fixed administration overheads are incurred at the rate of $3 000 per annum.
The company obtained the following production and sales data of cups for 20X3:
Total units of production 900
Total units of sales 950
The following information is also relevant:
(i) The fixed production costs of $4.5 per unit have been calculated on the basis of a budgeted production volume of 900 units.
(ii) There was 100 units of opening inventory for 20X3.
(iii) There were no differences between actual and budgeted costs.
(iv) Any adjustments of over or under-absorption are to be treated as period costs
Required:
Prepare a net income summary for 20X3 using absorption costing. (7 marks)
Now Manufacturing Company
Income statement for the year ended 31 December 20X3
Cost of goods manufacturedDirect materials ($3)
Direct labour ($1.5)
Variable overheads ($3)
Fixed overheads absorbed ($4.5)
Sales ($18 each)
Less: Cost of goods sold
Opening inventory
Cost of goods manufactured
Goods available for sale
Less: Closing inventory
Gross profit
Add: Over-absorbed overheads
Less: Non-production overheads
Net profit / $
2 700
1 350
2 700
4 050
10 800
17 100
1 200
10 800
12 000
600
11 400
5 700
0
3 000
2 700
(0.5 mark for each bold figure; total: 7 marks)