Questions and Answers
What is classified as a direct cost?
Which of the following costs is likely to be classified as an indirect cost?
Which of the following represents total product/service costs?
What distinguishes direct labour costs from other types of costs?
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Which statement is true about indirect costs?
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In which category would cleaning materials typically fall?
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Which of the following is not a component of total product/service costs?
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What are direct material costs?
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What are production costs defined as in the context of manufacturing?
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Which type of cost would likely be categorized as a financing cost?
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Which of the following is not considered a component of overhead?
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What are marketing costs related to?
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What aspect of absorption costing is emphasized?
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Which of the following is classified as a research cost?
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Which of these is an example of a production overhead cost?
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Which is true regarding marginal costing?
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Which of the following describes the term 'full factory cost'?
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What is the main purpose of categorizing expenses in a costing system?
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In the context of costing, what is the significance of direct expenses?
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Which cost is typically not associated with distribution costs?
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Which of the following best describes direct materials in production?
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What component is NOT included in total cost calculation?
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Which of the following is classified as indirect labour?
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Which type of expense corresponds to the costs incurred specifically for production but excluding direct costs?
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What is included in the definition of production overhead?
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Which of the following best defines administrative overhead?
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What constitutes marketing overhead?
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Which situation describes direct expenses?
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What impact does an increase in machinery usage have on direct labour costs?
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Which of the following directly reduces the direct labour cost proportion in total product cost?
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Distribution overhead includes which of the following expenses?
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In a traditional costing system, costs are primarily classified based on what criterion?
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What is the primary purpose of absorption costing in inventory valuations?
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Which of the following aspects does absorption costing NOT assist in?
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What key cost factors are included in the valuation of inventories under IAS 2?
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During which stage of absorption costing are costs allocated directly to a product unit?
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How does a company typically calculate selling prices using absorption costing?
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Which of the following describes apportionment in costing?
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In which situation is the cost plus pricing method particularly useful?
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What will happen to profitability during a period if inventory valuations change due to absorption costing?
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Which of the following best describes the term 'allocation' in accounting?
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How are indirect costs typically treated in absorption costing?
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What does the allocation of overhead costs involve in the context of absorption costing?
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What is one challenge of establishing product profitability in absorption costing?
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The cost of goods sold under absorption costing is calculated by which of the following formulas?
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Why might a company choose absorption costing over variable costing?
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What is the primary purpose of overhead apportionment?
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Which of the following is NOT a basis for apportioning overhead costs?
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If a service department uses the step-down method for cost apportionment, what is a critical initial step?
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What factor would you use for apportioning machine insurance costs?
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In the context of overhead apportionment, what does the term 'indirect costs' refer to?
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Which service department might use the number of material requisitions for cost apportionment?
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What is the purpose of apportioning overheads in a service department?
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What type of overhead apportionment method involves sharing costs directly among all departments without considering service department expenses?
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If total contribution exceeds fixed costs, what financial outcome occurs?
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What does marginal costing distinguish necessary for calculation?
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For what specific overhead cost is the book value of equipment typically used as the basis of apportionment?
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Which statement best describes absorption costing?
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Which of these bases of absorption would be most appropriate in a machine-intensive environment?
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Using the overhead apportionment example, what overhead cost is apportioned according to the number of employees?
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For which scenario is it advisable to consider changing the absorption base used?
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What is the potential result of incorrect overhead apportionment on product costing?
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What total overhead does the maintenance department contribute towards other departments in this example?
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According to marginal costing principles, how is closing inventory valued?
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Which of the following would typically be an overhead cost allocated using floor area?
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How is overhead absorbed into the product cost calculated?
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What is the focus of Stage 2 in the overhead apportionment process?
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What were the total fixed costs for the month in Mill Stream's accounting for April 20X1?
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Why is absorption costing criticized?
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What is a key advantage of contribution information over profit information?
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What is the importance of choosing a fair basis of apportionment?
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What is the first step in the calculation of overhead absorption rates?
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What was the production for the Mill in April 20X1?
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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?
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How much direct materials cost per unit for the Mill product?
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Which of the following accurately defines overhead absorption?
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What would be the profit for the Mill after considering both fixed and variable costs?
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In absorption costing, what happens to the fixed costs concerning inventories?
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When should a rate per unit of product be effective in overhead absorption?
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Which of the following is NOT a common base used for overhead absorption?
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What is the total variable production cost per unit for the Stream product?
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What informs the calculation of the overhead absorption rate per unit?
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What contributes to the total overheads for the stores department?
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If total contribution equals fixed costs, what is the financial result?
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Which production department has a higher absorbed overhead cost according to the provided figures?
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What is the absorption rate for Department A when calculated as a percentage of direct materials cost?
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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?
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What is the unit absorption rate for Department B based on the units of output?
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What is one disadvantage of using a single factory overhead absorption rate?
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If a machine hour basis is used, what would be the overhead cost for a product requiring 23 machine hours in Department A?
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Which basis of absorption would lead to higher costs for products primarily produced in a higher overhead department?
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What is the absorption rate per direct labour hour for Department A?
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If Job Y takes 2 hours in Department B, what would be the total factory overhead for Job Y using separate departmental rates?
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What would be the factory cost of Job X if using a single factory overhead absorption rate?
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What is the total budgeted overhead for Department A in Stoakley Ltd.?
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For Department B, what is the absorption rate based on budgeted overheads and direct labour hours?
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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?
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What does the term 'contribution' refer to in marginal costing?
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Which costs are included in the marginal production cost per unit?
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How are fixed costs treated in marginal costing?
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Which of the following statements is true regarding the calculation of profit using marginal costing?
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What happens to profit when selling an extra item under marginal costing principles?
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What is typically true about the valuation of closing inventories in marginal costing?
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Which of the following contributes to the variable cost of sales in marginal costing?
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How does absorption costing differ from marginal costing regarding inventory valuation?
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Which factor is not a part of the marginal costing principles?
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When considering direct labor costs in marginal costing, when might they be excluded?
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What values of inventory are typically higher in absorption costing compared to marginal costing?
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Which cost behavior is characteristic of fixed costs within the relevant range in marginal costing?
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What is the primary focus when calculating profit using total contribution?
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Which scenario describes how profit per unit changes with varying sales volumes in marginal costing?
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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.