AC114: Chapter 2 - Calculating unit costs

What are the 4 stages used to assign overhead (indirect costs) to cost units?

Allocation → Apportionment → Reapportionment→Absorption

What is allocation of overhead (indirect costs)?

Putting direct costs into their correct departments

What is apportionment of overhead (indirect costs)?

Share out costs used by multiple departments fairly (bigger departments take on bigger costs)

What is re-apportionment of overhead (indirect costs)?

Move costs from service departments to production

What is absorption of overhead (indirect costs)?

Distribute overhead (indirect costs) across all units

What is an overhead absorption rate (OAR) and why is it used?

Used to assign a portion of overhead costs to each unit of product.

How do you calculate an overhead absorption rate (OAR)?

OAR = Overhead (indirect costs) ÷ Activity level

How do you calculate a predetermined OAR?

Predetermined OAR = Budgeted overhead (indirect costs) ÷ Budgeted activity level

Why do we use a predetermined OAR instead of actual overhead?

So we can assign overhead to products during the period and avoid big changes from month to month.

What is an absorption base and why should it match the cost driver?

It’s the activity used to spread overheads, and it should reflect what actually causes the costs.

How do you calculate over- or under-absorption of overhead (indirect costs)?

(Actual activity × OAR) − Actual overhead (indirect costs)

Under-absorbed overhead (indirect costs)

Less overhead (indirect costs) charged than actually incurred

Over-absorbed overhead (indirect costs)

More overhead (indirect costs) charged than actually incurred

How is under-absorbed overhead (indirect costs) treated in the income statement?

Debited (increases costs, reduces profit)

How is over-absorbed overhead (indirect costs) treated in the income statement?

Credited (reduces costs, increases profit)

What is marginal costing and how are costs treated?

Method where only variable costs are included in the cost of a product, and fixed costs are treated as period expenses.

What is absorption costing and how are costs treated?

A method where all production costs, including fixed overheads, are included in the unit cost.

Why do profits differ between marginal and absorption costing?

Because fixed overhead (indirect costs) are treated differently in inventory

When will absorption costing show higher profit than marginal costing?

When inventory levels increase (more fixed overhead (indirect costs) deferred)

When should job, batch, contract, and process costing be used?

Job = unique jobs; Batch = identical items in groups; Contract = long-term projects; Process = continuous production

Give one example where each costing method is appropriate

Job = plumbing; Batch = shoes; Contract = construction; Process = oil refining