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I just have 2 quick questions. Firstly regarding closing stock and under/over absorption. If you have produced say 5000 units and absorbed £2.00/unit i.e £10,000 but the actual cost is £11,000.00 we are said to have under absorbed by £1,000.00 and this is written off in the P&L. But if we have 1,000 units of closing stock do we have to adjust the £2.00 per unit absorbed in the closing stock to £2.20 and adjust the under absorbed amount or just leave it and essentially the closing stock is understated ……
Also, in a JIT environment I don’t understand how all costs can be treated as direct costs, how do they know how much of the fixed over will be attributed to a product. My Kaplan book also states that in a JIT environment overhead costs will typically be much higher – is this correct and why?
Thanks for your help
In answer to your first question, we do not adjust anything for the closing inventory. The reason is that the profit statement would normally be done monthly and although some months we may produce more, some months we will produce less, and so we assume that the standard cost remains valid.
(In practice, there may be times when it is decided to change the standard cost, but not in F5).In answer to your second question, JIT does not result in all costs being treated as direct costs at all.
The reason overhead costs are likely to be higher is that operating a JIT system involves a much greater emphasis on quality and it is this that is likely to increase overheads (but at the same time, improving quality is going to reduce other costs associated with poor quality, and will also reduce the costs associated with storing inventory).
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