- This topic has 3 replies, 2 voices, and was last updated 14 years ago by
.
- Posts
Here is a question set by BPP on the i-pass CD.
LG uses a standard absorption costing system. The following information has been extracted from its budget for last period.
Fixed Production overhead cost – $240,000
Production (units) – 48,000Last period, the fixed overhead production cost was over absorbed by $14,000 and the fixed production overhead expenditure variance was $3000 favourable.
The actual number of units was?
Their answer is 50,200 units. They got this answer by deducting $3000 (which I understand), but then they added on $14,000 (which I don’t understand). Then they divided that result by the o/h absorption rate per unit ($5) to reach 50,200 units.
What confuses me, is that I would have thought that they should have deducted the $14,000, not added it on. If they are right, could someone please explain the logic of this to me please?
Thanks.
- Topics: 0
- Replies: 111
- ☆☆
Don’t think it mathematically.
Frame the problem in the costing flow and ask yourself what will lead to an over absorption. The first reason must be the $3000 favourable actual spending that you have understood. The second reason is the actual production volume is bigger than the planned volume (48000 units) so that a bigger volume x $5 was debited to the WIP account during the year. The question asks you what is the actual production volume so that BPP is correct to add the bigger volume to the planned one.
Hi sosologos, thanks for explaining it to me.
I’m still a little confused though! In my mind, I had the idea that over absorption meant that actual production was less than budgeted production. Assuming that to be the case (but please correct me if that’s wrong), if we start with budgeted production (48,000 units), why wouldn’t actual production be 14,000 fewer units if it had been over absorbed?
Sorry if I’m being really stupid, I’m just having difficulty getting my brain around this!
- Topics: 0
- Replies: 111
- ☆☆
The question of BPP is assumed to be a normal costing system. The overhead is absorbed into the product through a pre-determined rate, which is calculated by BUDGETED overhead/BUDGETED volume (i.e. $240,000/48,000 in your case and the pre-determined rate becomes $5 per unit). The $5 pre-determined rate will multiply with the ACTUAL volume (i.e. 50200 units in your case) for absorption into the products throughout the year in order to maintain the perpetual inventory system. The constant pre-determined rate will make the FIXED overhead appear to be VARIABLE; thus, a BIGGER ACTUAL volume will ultimately lead to an over-absorption of FIXED overhead into the products.
You think in the opposite way because, I suppose, you regard a bigger ACTUAL volume will share out a fixed overhead more efficiently. However, we always use the BUDGETED volume, NOT ACTUAL VOLUME, to calculate the pre-determined rate in a normal costing system.
- You must be logged in to reply to this topic.