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Please look at this question from the latest examiners report:
Example 2
A company makes product M and to meet demand of 2,000 units, it has budgeted to
use the following resources per unit of product X:Material A 1.2 kg at $10 per kg
Material B 1.3kg at $9 per kg
Labour 2.5 hours at $15 per hourVariable overheads are allocated at a rate of $5 per kg of material B used.
Fixed overheads are $80,000 and are absorbed based on the quantity of material A
used.
What is the standard full cost per unit of product X (to two decimal places)?
$ ____________? The correct answer is $107.70
The requirement asks for the standard full cost; therefore, all variable and fixed costs
must be included. The direct costs of materials A and B and labour are
straightforward to calculate from the information provided in the question. Variable
overheads are based on the quantity of material B, so can be calculated as (1.3kg x
$5) = $6.50. So, the total variable cost per unit is:
$
Material A 1.2 kg x $10 12.00
Material B 1.3 kg x $9 11.70
Labour 2.5 hours x $15 37.50
Variable overheads 1.3 kg x $5 6.50
Total variable cost 67.70Fixed overheads are given at a total level so fixed overhead per unit must be
calculated, ($80,000/2,000) = $40 per unit.
The standard full cost per unit of product M is therefore $67.70 + $40.00 = $107.70.My question is: Why are the fixed overheads not absorbed on the material A used as the question states but are instead absorbed per unit. The answer states because “fixed overheads are given a total level”. Please could you explain this?
Kindest regards, and thank you in advance.
KedeshBecause
Fixed overheads are given at a total level so fixed overhead per unit must be
calculated, ($80,000/2,000) = $40 per unit.The overhead costs are absorbed on a per unit basis because it allows for a more accurate allocation of costs.
Thank you for your response.
I agree that fixed costs provide a better allocation of costs when absorbed on a per unit basis. However, when would you absorb over heads based on the quantity of Material A like the question said.. when there are is a step up in fixed costs?
What do you do with absorption of overheads…….?
Overheads can be absorbed into the cost of production on either a unit, machine hour or labour hour basis, depending on which is most appropriate.
Why are you asking about a stepped up fixed costs?
Good morning,
Thank you, I got you! I was getting confused by the wording of the question but you reminded me absorption is based on whichever is most appropriate. I keep finding myself getting tripped up by the silliest of mistakes when practicing for this exam! I cant begin to explain how frustrating it is to get the more complex issues correct, but keep getting the more minor issues incorrect.
Apologies for the silly question.Thank you again.
Sorry, while i have you here may I ask one more question?
The traditional way of dealing with limiting factors is to use limiting factor analysis whereby you work out the limiting factor and attach contribution per limiting resource per product produced.A modern approach to deal with this type of situation is throughput accounting whereby we find the bottleneck and attach a throughput per bottleneck resource per product produced.
Unless explicitly told in the question, is there a way to know which approach I should be using in the question? Am I to look out for specific words like ‘bottleneck’ or ‘limiting resource’ within the question?
So, if the question explicitly mentions terms like “throughput accounting” or “limiting factor analysis,” it is a clear indication of which approach to use. However, if the question does not specify, you can look for certain clues within the question to determine the appropriate approach.
For throughput accounting, you can look for phrases like “maximising profit,” “optimal production plan,” or “bottleneck activity.” These indicate a focus on maximising throughput and identifying the bottleneck resource.
On the other hand, for limiting factor analysis, you can look for phrases like “scarcity of resources,” “maximising contribution,” or “rank products.” These indicate a focus on optimising the utilisation of limited resources.
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