MODULE 3 - L.1

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Questions and Answers

What is classified as a direct cost?

Buildings insurance

Wages of supervisors

Cleaning materials

Cost of raw materials used in production (correct)

Which of the following costs is likely to be classified as an indirect cost?

Rent for the factory premises (correct)

Cost of materials used in manufacturing

Direct labour costs for production

Salaries of assembly line workers

Which of the following represents total product/service costs?

Cost of materials plus indirect costs only

Cost of overheads excluding direct costs

Only the cost of raw materials

Cost of materials, labour, and other expenses (correct)

What distinguishes direct labour costs from other types of costs?

They are directly linked to the time spent on production work Signup and view all the answers

Which statement is true about indirect costs?

They are often grouped as overhead expenses. Signup and view all the answers

In which category would cleaning materials typically fall?

Indirect costs Signup and view all the answers

Which of the following is not a component of total product/service costs?

Marketing expenses Signup and view all the answers

What are direct material costs?

Costs of materials specifically used in making a product Signup and view all the answers

What are production costs defined as in the context of manufacturing?

Costs incurred from the supply of raw materials to finished goods. Signup and view all the answers

Which type of cost would likely be categorized as a financing cost?

Loan interest payments. Signup and view all the answers

Which of the following is not considered a component of overhead?

Direct labour. Signup and view all the answers

What are marketing costs related to?

Creating demand for products. Signup and view all the answers

What aspect of absorption costing is emphasized?

Dividing overheads fairly among products. Signup and view all the answers

Which of the following is classified as a research cost?

Expenses incurred in searching for new products. Signup and view all the answers

Which of these is an example of a production overhead cost?

Factory rent costs. Signup and view all the answers

Which is true regarding marginal costing?

It only considers variable production costs. Signup and view all the answers

Which of the following describes the term 'full factory cost'?

Prime costs plus production overheads. Signup and view all the answers

What is the main purpose of categorizing expenses in a costing system?

To allocate costs to different functional areas. Signup and view all the answers

In the context of costing, what is the significance of direct expenses?

They directly contribute to the production of goods. Signup and view all the answers

Which cost is typically not associated with distribution costs?

Marketing costs to promote products. Signup and view all the answers

Which of the following best describes direct materials in production?

Materials specially purchased for a specific job or process. Signup and view all the answers

What component is NOT included in total cost calculation?

Advertising costs Signup and view all the answers

Which of the following is classified as indirect labour?

Salaries of supervisors overseeing the production line. Signup and view all the answers

Which type of expense corresponds to the costs incurred specifically for production but excluding direct costs?

Indirect materials Signup and view all the answers

What is included in the definition of production overhead?

Indirect materials, wages and expenses incurred in production. Signup and view all the answers

Which of the following best defines administrative overhead?

Indirect costs of running the business, including salaries and office expenses. Signup and view all the answers

What constitutes marketing overhead?

Costs involved in product promotion and customer retention. Signup and view all the answers

Which situation describes direct expenses?

Equipment hire specifically for a particular job. Signup and view all the answers

What impact does an increase in machinery usage have on direct labour costs?

Direct labour costs decrease as reliance on machinery increases. Signup and view all the answers

Which of the following directly reduces the direct labour cost proportion in total product cost?

Increase in skilled labor costs. Signup and view all the answers

Distribution overhead includes which of the following expenses?

Cost of packing materials for shipping. Signup and view all the answers

In a traditional costing system, costs are primarily classified based on what criterion?

The function each cost serves within the company. Signup and view all the answers

What is the primary purpose of absorption costing in inventory valuations?

To charge each unit of output with a portion of overhead costs. Signup and view all the answers

Which of the following aspects does absorption costing NOT assist in?

Determining labor efficiency Signup and view all the answers

What key cost factors are included in the valuation of inventories under IAS 2?

All production overheads incurred. Signup and view all the answers

During which stage of absorption costing are costs allocated directly to a product unit?

Allocation Signup and view all the answers

How does a company typically calculate selling prices using absorption costing?

By calculating full production costs and adding a profit margin. Signup and view all the answers

Which of the following describes apportionment in costing?

Distributing indirect costs fairly among cost centres. Signup and view all the answers

In which situation is the cost plus pricing method particularly useful?

When dealing with unique contracts or jobs. Signup and view all the answers

What will happen to profitability during a period if inventory valuations change due to absorption costing?

Profitability may increase or decrease based on cost of goods sold calculations. Signup and view all the answers

Which of the following best describes the term 'allocation' in accounting?

Assigning entire costs directly to a specific department or product. Signup and view all the answers

How are indirect costs typically treated in absorption costing?

They are allocated based on a predetermined rate. Signup and view all the answers

What does the allocation of overhead costs involve in the context of absorption costing?

Directly charging costs to specific products or departments. Signup and view all the answers

What is one challenge of establishing product profitability in absorption costing?

It can be difficult to assign overhead costs fairly to multiple products. Signup and view all the answers

The cost of goods sold under absorption costing is calculated by which of the following formulas?

$Cost of goods produced + Opening inventories - Closing inventories$ Signup and view all the answers

Why might a company choose absorption costing over variable costing?

To comply with accounting standards like IAS 2. Signup and view all the answers

What is the primary purpose of overhead apportionment?

To share general overhead costs between various departments. Signup and view all the answers

Which of the following is NOT a basis for apportioning overhead costs?

Total sales revenue generated by each department. Signup and view all the answers

If a service department uses the step-down method for cost apportionment, what is a critical initial step?

Determine the method of apportionment for service departments. Signup and view all the answers

What factor would you use for apportioning machine insurance costs?

Book value of machinery in each department. Signup and view all the answers

In the context of overhead apportionment, what does the term 'indirect costs' refer to?

Costs incurred that cannot be traced directly to a product or service. Signup and view all the answers

Which service department might use the number of material requisitions for cost apportionment?

Stores department. Signup and view all the answers

What is the purpose of apportioning overheads in a service department?

To accurately allocate costs to production departments. Signup and view all the answers

What type of overhead apportionment method involves sharing costs directly among all departments without considering service department expenses?

Direct method. Signup and view all the answers

If total contribution exceeds fixed costs, what financial outcome occurs?

Profit Signup and view all the answers

What does marginal costing distinguish necessary for calculation?

Variable costs, fixed costs, and contribution Signup and view all the answers

For what specific overhead cost is the book value of equipment typically used as the basis of apportionment?

Depreciation of equipment. Signup and view all the answers

Which statement best describes absorption costing?

It absorbs fixed costs into unit production costs. Signup and view all the answers

Which of these bases of absorption would be most appropriate in a machine-intensive environment?

A machine hour rate. Signup and view all the answers

Using the overhead apportionment example, what overhead cost is apportioned according to the number of employees?

Cafeteria costs. Signup and view all the answers

For which scenario is it advisable to consider changing the absorption base used?

When the working conditions change significantly. Signup and view all the answers

What is the potential result of incorrect overhead apportionment on product costing?

Underestimated costs leading to unrelated profits. Signup and view all the answers

What total overhead does the maintenance department contribute towards other departments in this example?

$34,840. Signup and view all the answers

According to marginal costing principles, how is closing inventory valued?

At marginal production cost Signup and view all the answers

Which of the following would typically be an overhead cost allocated using floor area?

Rent and rates. Signup and view all the answers

How is overhead absorbed into the product cost calculated?

By using a predetermined overhead absorption rate based on budgeted activity levels. Signup and view all the answers

What is the focus of Stage 2 in the overhead apportionment process?

Apportioning service department costs to production departments. Signup and view all the answers

What were the total fixed costs for the month in Mill Stream's accounting for April 20X1?

$45,000 Signup and view all the answers

Why is absorption costing criticized?

It involves arbitrary methods in choosing absorption bases. Signup and view all the answers

What is a key advantage of contribution information over profit information?

It helps determine profit or losses easily with sales fluctuations. Signup and view all the answers

What is the importance of choosing a fair basis of apportionment?

It ensures equitable distribution of costs. Signup and view all the answers

What is the first step in the calculation of overhead absorption rates?

Estimate the overhead likely to be incurred. Signup and view all the answers

What was the production for the Mill in April 20X1?

15,000 units Signup and view all the answers

If a production department has 4,000 units produced and an overhead absorption rate of $34,840, what is the overhead cost for that department?

$17,420. Signup and view all the answers

How much direct materials cost per unit for the Mill product?

$8 Signup and view all the answers

Which of the following accurately defines overhead absorption?

Adding overhead costs to product costs through a predetermined rate. Signup and view all the answers

What would be the profit for the Mill after considering both fixed and variable costs?

$45,000 Signup and view all the answers

In absorption costing, what happens to the fixed costs concerning inventories?

They are absorbed into the cost of sales. Signup and view all the answers

When should a rate per unit of product be effective in overhead absorption?

When all units produced are identical. Signup and view all the answers

Which of the following is NOT a common base used for overhead absorption?

Rate based solely on company profits. Signup and view all the answers

What is the total variable production cost per unit for the Stream product?

$17 Signup and view all the answers

What informs the calculation of the overhead absorption rate per unit?

Budgeted fixed overheads divided by budgeted units. Signup and view all the answers

What contributes to the total overheads for the stores department?

General and allocated overheads. Signup and view all the answers

If total contribution equals fixed costs, what is the financial result?

Breakeven with zero profit or loss Signup and view all the answers

Which production department has a higher absorbed overhead cost according to the provided figures?

Department A with $16,608. Signup and view all the answers

What is the absorption rate for Department A when calculated as a percentage of direct materials cost?

112.5% Signup and view all the answers

How much overhead cost would be applied to a product with a direct labour cost of $85 in Department A using the percentage of direct labour cost basis?

$76.50 Signup and view all the answers

What is the unit absorption rate for Department B based on the units of output?

$6.40 per unit Signup and view all the answers

What is one disadvantage of using a single factory overhead absorption rate?

It can lead to inequitable charge distribution Signup and view all the answers

If a machine hour basis is used, what would be the overhead cost for a product requiring 23 machine hours in Department A?

$82.80 Signup and view all the answers

Which basis of absorption would lead to higher costs for products primarily produced in a higher overhead department?

Separate departmental absorption rates Signup and view all the answers

What is the absorption rate per direct labour hour for Department A?

$2.00 Signup and view all the answers

If Job Y takes 2 hours in Department B, what would be the total factory overhead for Job Y using separate departmental rates?

$10.00 Signup and view all the answers

What would be the factory cost of Job X if using a single factory overhead absorption rate?

$169.90 Signup and view all the answers

What is the total budgeted overhead for Department A in Stoakley Ltd.?

$360,000 Signup and view all the answers

For Department B, what is the absorption rate based on budgeted overheads and direct labour hours?

$5.00 Signup and view all the answers

What would be the overhead cost of a product with a prime cost of $165 using the percentage of prime cost basis in Department A?

$82.50 Signup and view all the answers

What does the term 'contribution' refer to in marginal costing?

Difference between sales price and variable cost of sales. Signup and view all the answers

Which costs are included in the marginal production cost per unit?

Direct materials, variable production overheads, and direct labour. Signup and view all the answers

How are fixed costs treated in marginal costing?

Charged in full to the profit and loss statement in the period incurred. Signup and view all the answers

Which of the following statements is true regarding the calculation of profit using marginal costing?

Profit is derived by deducting fixed costs from total contribution. Signup and view all the answers

What happens to profit when selling an extra item under marginal costing principles?

Increases by the contribution earned from that item. Signup and view all the answers

What is typically true about the valuation of closing inventories in marginal costing?

Valued at only variable production costs. Signup and view all the answers

Which of the following contributes to the variable cost of sales in marginal costing?

Variable production costs and variable marketing costs. Signup and view all the answers

How does absorption costing differ from marginal costing regarding inventory valuation?

Absorption costing includes fixed production costs in inventory valuation. Signup and view all the answers

Which factor is not a part of the marginal costing principles?

Contribution per unit is variable with sales volume. Signup and view all the answers

When considering direct labor costs in marginal costing, when might they be excluded?

When the workforce number is fixed with employees on a salary. Signup and view all the answers

What values of inventory are typically higher in absorption costing compared to marginal costing?

Inventory values. Signup and view all the answers

Which cost behavior is characteristic of fixed costs within the relevant range in marginal costing?

They remain constant regardless of sales volume. Signup and view all the answers

What is the primary focus when calculating profit using total contribution?

Understanding the balance between contribution and fixed costs. Signup and view all the answers

Which scenario describes how profit per unit changes with varying sales volumes in marginal costing?

Profit per unit increases and decreases variably. Signup and view all the answers

Study Notes

Cost Classification

Costs can be categorized as direct or indirect.
Classification by function includes production/manufacturing, administration, and marketing/distribution costs.

Total Product/Service Costs

Total cost of a product/service includes:
- Cost of materials
- Labour costs (wages and salaries)
- Other expenses (e.g. rent, utilities, depreciation)

Direct Costs vs. Indirect Costs

Direct Costs: Traceable fully to a product/service/department.
Indirect Costs/Overheads: Costs incurred during production that cannot be fully traced.
Direct material costs: Materials used directly in making a product.
Direct labour costs: Labour costs specifically for the production of a product.
Indirect costs examples: Supervisors' wages and cleaning materials.

Analysis of Total Cost

Materials: Direct + Indirect materials
Labour: Direct + Indirect labour
Expenses: Direct + Indirect expenses
Total Cost: Direct costs + Overhead

Direct Material Costs

All materials consumed in the manufacturing process are classified as direct materials.
Examples include specialized components and primary packaging materials.

Direct Labour Costs

Include wages for both normal and overtime hours specifically for product work.
Examples include wages for direct production workers and supervisors directly involved in production.

Direct Expenses

Expenses incurred specifically for a product, such as equipment hire and maintenance.

Overheads

Overheads are costs incurred in production, including indirect materials, labor, and expenses, categorized into:
- Production overhead
- Administration overhead
- Marketing and distribution overhead

Functional Costs

Production Costs: Incurred in the manufacturing process.
Administration Costs: Related to managing the organization.
Marketing Costs: Associated with product demand creation.
Distribution Costs: Cover activities from production completion to delivery.

Absorption Costing

Allocates a portion of overhead to product cost based on production volume.
Aims to provide a fair distribution of overhead across products.
Helps with inventory valuation, pricing decisions, and assessing product profitability.

Practical Reasons for Absorption Costing

Inventory Valuation: The closing inventory figure impacts profitability.
Pricing Decisions: Establishing a selling price based on full production costs.
Assessing Profitability: Necessary for multi-product companies to evaluate individual product profitability.

International Accounting Standard 2 (IAS 2)

Recommends absorption costing for financial accounting.
Closing inventory should include production overheads incurred in normal business operations.

Overhead Allocation

Allocation involves charging direct costs to cost centres, such as production, administrative, or service departments.
Costs are charged direct to departments based on their attributable nature.

Overhead Apportionment

Procedure to fairly spread indirect costs between several cost centres.
Indirect costs should be allocated to relevant departments using rational and fair methods.### Overhead Costs Overview
Key overhead costs include gas and electricity, building repair costs, machinery depreciation, rent, cafeteria expenses, and machinery insurance.
Total recorded overhead costs amount to $80,120, covering various departments.

Departmental Details

Departments A and B have distinct floor areas and machinery values.
Department A: 6,000 m², machinery book value of $48,000, 50 employees.
Department B: 4,000 m², machinery book value of $20,000, 20 employees.
Maintenance: 3,000 m²; Stores: 2,000 m².

Service Department Usage

Service departments (Maintenance, Stores) provide services defined by hours worked and requisitions made.
Maintenance recorded 10,000 hours; total stores requisitions amounted to 4,000.

Overhead Apportionment Stages

First stage: Identify overhead costs as either production or non-production (administrative or marketing).
Apportion costs like rent, electricity, and repairs across relevant departments based on fair criteria.

Bases of Apportionment

Rent and related costs should apportion based on floor area occupied.
Equipment costs are allocated by machinery book value.
Cafeteria and personnel costs proportioned by the number of employees or labor hours worked.

Example Workings

Gas and electricity costs apportioned to departments based on floor area:
- Department A receives 7,680;DepartmentBreceives7,680; Department B receives 7,680;DepartmentBreceives3,840, with others similarly calculated.

Service Department Cost Apportionment

Allocate service department costs (Maintenance and Stores) to production departments using methods like direct, step-down, or reciprocal methods.
Maintenance costs are distributed based on maintenance hours worked; Stores costs on material requisitions.

Overhead Absorption Process

Overhead absorption integrates allocated and apportioned overheads into total unit costs.
Absorption rates may use various bases, such as labor hours, machine hours, or material costs.

Absorption Rate Calculation

To determine the absorption rate:
- Estimate total overhead, budgeted activity level (e.g., labor hours).
- Divide estimated overhead by budgeted activity levels to get the overhead absorption rate.

Marginal Costing vs. Absorption Costing

Marginal costing focuses on variable costs per unit, while absorption costing allocates fixed costs into the cost of units produced.
Marginal costing treats fixed production costs as period costs; they are fully accounted for in the income statement within the incurred period.
Inventory values calculated using absorption costing differ, being higher than those using marginal costing.

Contribution Concept

Contribution is calculated by subtracting marginal or variable costs from sales price, essential for covering fixed overheads and achieving profit.

Profit Calculation Methods

In marginal costing, selling an additional unit increases revenue by the selling price minus variable costs, directly affecting profit.
In absorption costing, profits are impacted by how fixed costs are absorbed and reflected in inventory, influencing financial reports across periods.### Profit Measurement and Costing Principles
A single item drop in sales results in profit decline equivalent to the contribution from that item.
Profit can be analyzed through total contribution, separating fixed costs from variable costs.
Fixed costs are time-related and do not vary with sales volume, making absorption costing potentially misleading.
Marginal costing method values closing inventory at variable production costs: direct materials, labor, and variable overheads.

Worked Example: Rain Until September Co.

Product: Splash; Variable production cost: 6;Salesprice:6; Sales price: 6;Salesprice:10.
Production: 20,000 units in September 20X0 with fixed costs: $45,000.
Sales scenarios studied: 10,000, 15,000, and 20,000 units.
Contribution calculated by deducting variable costs from total sales.

Profit Calculations

Profit for 10,000 Splashes: (10×10,000)−variablecosts−fixedcostsresultedin10 × 10,000) - variable costs - fixed costs resulted in 10×10,000)−variablecosts−fixedcostsresultedin5,000 loss.
Profit for 15,000 Splashes: $15,000 profit.
Profit for 20,000 Splashes: $35,000 profit.
Contribution per unit remains constant throughout sales levels; total contribution increases with volume.

Key Insights from the Example

Profit per unit varies depending on sales volume due to average fixed costs.
Contribution allows easy profit prediction based on sales changes.
Expected profit can be calculated using total contribution minus fixed costs.

Mill Stream Case Study

Products: Mill and Stream with distinct sales and cost structures.
Data for April 20X1 includes production, sales, and costs for both products.
Marginal costing principles guide profit evaluation for the month.

Advantages of Contribution Reporting

Simplifies determination of profit based on changes in sales volume.
Enables quick calculations of profit/loss by comparing total contribution against fixed overhead.

Marginal vs. Absorption Costing

Marginal costing treats fixed costs as period costs and values inventory at marginal production costs.
Absorption costing incorporates fixed costs into unit costs, affecting closing inventory values.

Comparison Case Study: Big Possum Ltd

Produces a single product, Bark, with clear details on costs and sales.
Fixed production overhead budgeted at $1.6 million annually; overhead absorption calculated based on production units.
Sales data and production quantities influence profit estimation through both costing methods.

Profit/Loss Statement Preparation

Under marginal costing, inventory is valued at variable costs; dollar values reflect production and sales.
Absorption costing includes under/over absorption adjustments, providing a different profit picture.

Additional Questions and Scenarios

Budgeted profits calculated under marginal costing from given production and cost figures.
Understanding the implications of switching from marginal to absorption costing impacts profit evaluation.

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Description

This quiz covers the foundational concepts of cost classification, including the distinction between direct and indirect costs. It also explores how costs can be categorized by function such as production, administration, and marketing. Understanding these classifications is essential for effective financial management.