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Hello tutor,
There is a statement about predetermined absorption rate
“Using a predetermined absorption rate avoids fluctuations in unit costs caused by abnormally high or low overhead expenditure or activity levels”But I remember in ACCA FA (F3), in chapter Inventory – cost of conversion: production overhead, they said that:
“- Low production/ idle plan will not result in a higher fixed overhead allocation to each unit.
– Unallocated overheads must be recognised as an expense in the period in which they incurred.
– When production is abnormally high, the fixed production overhead allocated to each unit will be reduced, so avoiding inventories being stated at more than cost. …”So from those above lines, we can see obviously that the low or abnormally high overhead expenditures will not affect the cost of inventory. But why in the statement before about predetermined absorption rate, the unit costs can be affected by those fluctuations in OH expenditure?
I think I am a bit confused at the moment, can you please enlight me?
Thank you!
You really should watch my free lectures because I explain exactly this in my lectures. You cannot expect me to explain what you have read in some book when you are not bothering to watch my lectures.
If we were to use the actual absorption rates then because the production and total costs are likely to change each month, the unit cost for valuing the inventory would also be changing each month which would be ridiculous (given that these are management accounts and not financial accounts). By using and absorption rate based on the budgeted production and costs for the year (i.e. a pre-determined rate) we would value the inventory at the same amount each month.
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