Question 3.

30
4 COST ASSIGNMENT
(a) Calculation of department overhead rates
Department Department Department
P Q R
() () ()
Repairs and maintenance 42 000
a
10 000 10 000
Depreciation 17 000
a
14 000 9 000
Consumable supplies 4 500
b
2 700 1 800
Wage related costs 48 250
a
26 250 12 500
Indirect labour 45 000
a
27 000 18 000
Canteen/rest/smoke room 15 000
c
9 000 6 000
Business rates and insurance 13 000
d
10 400 2 600

a

184 750
a
99 350 55 900
Direct labour hours 50 000
a
30 000 20 000
Overhead absorption rate 3.70
a
3.31 3.00
Notes:
The calculations for Department P are:
a
Depreciation = 170 000/400 000 40 000.
b
Consumable supplies = 50 000/100 000 9000.
c
Canteen = 25/50 30 000.
d
Business rates insurance = 5000/10 000 26 000.
(b) Job 976: Sample quotation
() ()
Direct materials 800.00
Direct labour P (30 7.72
a
) 231.60
Q (10 7.00
b
) 70.00
R (5 5.00
c
) 25.00 326.60

Overhead absorbed P (30 3.70) 111.00

Q (10 3.31) 33.10
R (5 3.00) 15.00 159.10

Production cost 1285.70
Selling, distribution and administration costs (20% 1285.70) 257.14

Total cost 1542.84

Profit margin (20% of selling price) 385.71

Selling price (1542.84 100/800) 1928.55

Notes:
a
386 000/50 000.
b
210 000/30 000.
c
100 000/20 000.
Cost assignment
Solutions to Chapter 3 questions
(c) ()
Direct materials 800.00
Direct labour 326.60

Prime cost 1126.60

Overhead applied (125%) 1408.25

Total cost 2534.85

The auditors system results in a higher cost for this quotation. However, other
jobs will be overcosted with the previous system. The auditors system will result
in the reporting of more accurate job costs with some job costs being higher, and
others being lower, than the present system. For a more detailed answer see the
section on plant-wide (blanket) overhead rates in Chapter 3.
(a) Calculation of overhead absorption rates
Machining Assembly Finishing Stores Maintenance
(000) (000) (000) (000) (000)
Allocated costs 600.00 250.00 150.00 100.00 80.00
Stores apportionment 40.00 (40%) 30.00 (30%) 20.00 (20%) (100.00) 10.00 (10%)
Maintenance
apportionment 49.50 (55%) 18.00 (20%) 18.00 (20%) 4.50 (5%) (90.00)
Stores apportionment
a
2.00 (4/9) 1.50 (3/9) 1.00 (2/9) ( 4.50)
Total 691.50 299.50 189.00
Machine hours 50 000
Labour hours 30 000 20 000
Overhead absorption rates
b
13.83 9.98 9.45
Notes
a
Costs have become too small at this stage to justify apportioning 10% of the
costs to the maintenance department. Therefore stores costs are apportioned in
the ratio 40: 30: 20.
b
Machine hours are the predominant activity in the machine department
whereas labour hours are the predominant activity in the assembly and finish-
ing departments. Therefore machine hours are used as the allocation base in
the machining department and direct labour hours are used for the assembly
and finishing departments.
(b) Quotation for Job XX 34
() ()
Direct material 2400.00
Direct labour 1500.00
Overhead cost:
Machining (45 machine hours at 13.83) 622.35
Assembly (15 labour hours at 9.98) 149.70
Finishing (12 labour hours at 9.45 113.40 885.45

Total cost 4785.45

Selling price (Profit margin = 20% of selling price

selling price = 4785.45/0.8) 5981.81
(c) Overhead control account
() ()
Overhead incurred 300 000 WIP control (30 700 hrs at 9.98) 306 386
Balance over-recovery transferred
to costing profit and loss
account 6 386

306 386 306 386

Question 3.31
COST ASSIGNMENT 5
(d) For the answer to this question see An illustration of the two-stage process for
an ABC system in Chapter 3. In particular, the answer should stress that cost
centres will consist of activity cost centres rather than departmental centres.
Separate cost driver rates would also be established for the service departments
and the costs would be allocated to cost objects via cost driver rates rather than
being reallocated to production departments and assigned within the produc-
tion department rates. The answer should also stress that instead of using just
two volume-based cost drivers (e.g. direct labour and machine hours) a variety
of cost drivers would be used, including non-volume-based drivers such as
number of set-ups and number of material issues. The answer could also stress
that within the machining department a separate set-up activity centre might
be established with costs being assigned using the number of set-ups as the
cost driver. The current system includes the set-up costs within the machine
hour overhead rate.
(a)
Department A Department B
Allocated costs 217 860 374 450
Apportioned costs 45 150 58 820
Total departmental overheads 263 010 433 270
Overhead absorption rate 19.16 (263 010/13 730) 26.89 (433 270/16 110)
(b)
Department Department Department
A B C
() () ()
Allocated costs 219 917 387 181 103 254)
Apportionment of 70% of Department C costs
a
32 267 40 011 ( 72 278)
Apportionment of 30% of Department C costs
b
11 555 19 421 ( 30 976)

Total departmental overheads 263 739 446 613

Overheads charged to production 261 956
c
455 866
d
Under/(over-recovery) 1 783 ( 9 253)
Notes:
a
Allocated on the basis of actual machine hours
b
Allocated on the basis of actual direct labour hours
c
19.16 13 672 actual machine hours
d
26.89 16 953 actual direct labour hours
(c)
See Appendix 3.1 (Chapter 3) for the answer to this question.
(a) Year 1
(1) Budgeted machine hours 132 500
(2) Budgeted fixed overheads 2 411 500 (132 500 18.20)
(3) Actual machine hours 134 200 (2 442 440/18.20)
(4) Fixed overheads absorbed 2 442 440
(5) Actual fixed overheads incurred 2 317 461
Over-absorption of fixed overheads 124 979 (5 4)
The section on Under- and over-recovery of fixed overheads in Chapter 3 indi-
cates that an under- or over-recovery will arise whenever actual activity or expen-
diture differs from budgeted activity or expenditure. Actual activity was 1700
hours in excess of budget and this will result in an over-recovery of fixed over-
Question 3.32
Question 3.33
6 COST ASSIGNMENT
heads of 30 940. Actual overheads incurred were 94 039 (2 317 461 2 411 500)
less than budget and this is the second factor explaining the over-absorption of
fixed overheads.
Summary ()
Over-recovery due to actual expenditure
being less than budgeted expenditure 94 039
Over-recovery due to actual activity exceeding
budgeted activity 30 940

Total over-recovery of overhead for year 1 124 979

Year 2
(1) Budgeted machine hours (134 200 1.05) 140 910
(2) Budgeted fixed overheads 2 620 926
(3) Fixed overhead rate (2 620 926/140 900 hours) 18.60
(4) Actual fixed overheads incurred 2 695 721
(5) Fixed overheads absorbed (139 260 18.60) 2 590 236
(6) Under-recovery of overhead for year 2 (4 5) 105 485
Analysis of under-recovery of overhead ()
Under-recovery due to actual activity
being less than budgeted activity (139 260 140 910) 18.60 30 690
Under-recovery due to actual expenditure being greater
than budgeted expenditure (2 695 721 2 620 926 74 795

Total under-recovery for the year 105 485

Change in the overhead rate

Change in the rate (18.60 18.20)/18.20 2.198%
This can be analysed as follows:
Increase in budgeted
expenditure (2 620 926 2 411 500)/2 411 500 8.684%
Increase in budgeted
activity (140 910 hours 132 500 hrs)/132 500 6.347%
The increase of 2.198% in the absorption rate is due to an expenditure increase of
8.684% in budgeted expenditure partly offset by an increase in budgeted activity
of 6.347% over the 2 years.
Proof
(1.08684/1.06347) 1 0.02198 (2.198%)
(b) See Plant-wide (blanket) overhead rates and Budgeted overhead rates in
Chapter 3 for the answers to these questions.
(a) (i) and (ii) An activity increase of 150 hours (1650 1500) results in an increase
in total overheads of 675. It is assumed that the increase in total over-
heads is due entirely to the increase in variable overheads arising from an
increase in activity. Therefore the variable overhead rate is 4.50 (675/150
hours) per machine hour. The cost structure is as follows:
1. Activity level (hours) 1 500 1 650 2 000
2. Variable overheads at 4.50 per hour 6 750 7 425 9 000
3. Total overheads 25 650 26 325 27 900
4. Fixed overheads (3 2) 18 900 18 900 18 900
Question 3.34
COST ASSIGNMENT 7
(iii) The fixed overhead rate is 10.50 (15 4.50 variable rate)
normal activity fixed overheads (18 900)/fixed overhead rate (10.50)
1800 machine hours
(iv) Under-absorption 100 machine hours (1800 1700) at 10.50 1050
(b) (i) A machine hour rate is recommended for the machine department
because most of the overheads (e.g. depreciation and maintenance) are
likely to be related to machine hours. For non-machine labour-intensive
departments, such as the finishing department, overheads are likely to be
related to direct labour hours rather than machine hours. Overheads are
therefore charged to jobs performed in the finishing department using the
direct labour hour method of recovery.
Calculation of overhead rates
Machining Finishing
department department
Production overhead 35 280 12 480
Machine hours 11 200
Direct labour hours 7800
Machine hour overhead rate 3.15
Direct labour hour overhead rate 1.60
(ii) Machining Finishing
department department
Direct materials () ()
(189 1.1 2.35/0.9) 542.85
Direct labour
a
25 hours 4 100.00
28 hours 4 112.00
Production overhead
46 machine hours at 3.15 144.90
28 direct labour hours at 1.60 44.80

787.75 156.80

Total cost of job = 944.55 (787.75 + 156.80)
Note
a
Overtime premiums are charged to overheads, and are therefore not
included in the above job cost.
(a) To calculate product cost, we must calculate overhead absorption rates for the
production departments. You can see from the question that the service
departments serve each other, and it is therefore necessary to use the repeated
distribution method or the simultaneous equation method to reallocate the
service department costs. Both methods are illustrated below:
Cutting Machining Pressing Engineering Personnel
() () () () ()
Allocation
per question 154 482 64 316 58 452 56 000 34 000
Engineering
reallocation 11 200 (20%) 25 200 (45%) 14 000 (25%) (56 000) 5 600 (10%)
Personnel
reallocation 21 780 (55%) 3 960 (10%) 7 920 (20%) 5 940 (15%) (39 600)
Engineering
reallocation 1 188 (20%) 2 673 (45%) 1 485 (25%) (5 940) 594 (10%)
Question 3.35
8 COST ASSIGNMENT
Personnel
reallocation 327 (55%) 59 (10%) 119 (20%) 89 (15%) (594)
Engineering
reallocation
a
20 44 25 (89)
188 997 96 252 82 001
Note
a
The costs are so small that any further apportionments are not justified. Conse-
quently a return charge of 15% is not made to the engineering department and
the costs are apportioned in the ratio 55:10:20.
Simultaneous equation method
Let
E total overhead allocated to engineering department
and
P total overhead allocated to personnel department
Then
E 56 000 + 0.15P
P 34 000 + 0.10E
Rearranging the above equations,
E 0.15P 56 000 (1)
0.10E P 34 000 (2)
Multiplying equation (2) by 0.15 and equation (1) by 1,
E 0.15P 56 000
0.015E 0.15P 5 100
Adding these equations,
0.985E 61 100
and so E 62 030
Substituting for E in equation (1),
62 030 0.15P 56 000
6030 0.15P
and so P 40 200
We now apportion the values of E and P to the production departments in the
agreed percentages:
Cutting Machining Pressing
() () ()
Allocation per question 154 482 64 316 58 452
Allocation of engineering 12 408(20%) 27 914(45%) 15 508(25%)
Allocation of personnel 22 110(55%) 4 020(10%) 8 040(20%)

189 000 96 250 82 000

Overhead absorption rates
A comparison of the machine and direct labour hours in the machine department
indicates that machine hours are the dominant activity. Therefore a machine hour
rate should be used. A direct labour hour rate is appropriate for the cutting and
pressing departments. Note that unequal wage rates apply in the cutting depart-
ment, but equal wage rates apply in the pressing department. The direct wages
percentage and the direct labour hour methods will therefore result in identical
overhead charges to products passing through the pressing department, and
either method can be used. Because of the unequal wage rates in the cutting
department, the direct wages percentage method is inappropriate.
COST ASSIGNMENT 9
The calculation of the overhead absorption rates are as follows:
(hours)
Cutting: Product A (4000 9 hours) 36 000
Product B (3000 6 hours) 18 000
Product C (6000 5 hours) 30 000

Total 84 000

Absorption rate
1
8
8
4
9
0
0
0
0
0
0
2.25 per direct labour hour
Machining: Product A (4000 2) 8 000
Product B (3000 1 ) 4 500
Product C (6000 2 ) 15 000

27 500

Absorption rate

2
9
7
6
5
2
0
5
0
0
3.50 per machine hour
Pressing: Product A (4000 2) 8 000
Product B (3000 3) 9 000
Product C (6000 4) 24 000

41 000

Absorption rate

4
8
1
2
0
0
0
0
0
0
2 per direct labour hour
Product cost calculations
A (fully complete) B (partly complete)
() ()
Direct materials 7.00 4.00
Direct labour: Cutting (Skilled) 12.00 (3 4) 20.00 (5 4)
(Unskilled) 15.00 (6 2.50) 2.50 (1 2.50)
Machining 1.50 ( 3) 0.75 ( 3)
Pressing 6.00 (2 3)

Prime cost 41.50 27.25
Overhead: Cutting 20.25 (9 2.25) 13.50 (6 2.25)
Machining 7.00 (2 3.50) 5.25 (1 3.50)
Pressing 4.00 (2 2)

72.75 46.00


a(i) a(ii)
(b) The accounting entries for overheads are presented in Chapter 4. You will find
when you read this chapter that a credit balance in the overhead control account
represents an over recovery of overheads. Possible reasons for this include:
(i) actual overhead expenditure was less than budgeted expenditure;
(ii) actual production activity was greater than budgeted production activity.
10 COST ASSIGNMENT
(a) (i) Direct apportionment
Heat Maintenance Steam Processing Assembly Total
(000) (000) (000) (000) (000) (000)
Allocation 90 300 240 630
Heat (4 : 5) (90) 40 50
Maintenance (1 : 2) (300) 100 200
Steam (2 : 1) (240) 160 80

300 330 630

With the direct method of allocation, inter-service department apportion-

ments are ignored; service department costs are reapportioned to production
departments only.
(ii) Step-down method
This method is the specified order of closing described in Appendix 3.1. There
the service department that provided the largest proportion of services for
other services was closed first. In this answer the service department provid-
ing the largest value of cost inputs to other service departments (namely the
maintenance department) is closed first, and the department providing the
second largest value of cost input to other service departments (namely
steam) is closed next. Return charges are not made.
Heat Maintenance Steam Processing Assembly Total
(000) (000) (000) (000) (000) (000)
Allocation 90 300 240 630
Maintenance
a
30 (300) 45 75 150
Steam
a
60 (285) 150 75
Heat
a
(180) 80 100

305 325 630

Note
a
Proportions allocated to each department:
a
Maintenance 3/30, 4.5/30, 7.5/30, 15/30
a
Steam 192/912, 480/912, 240/912
a
Heat 4/9, 5/9.
(iii) Reciprocal method
Either the algebraic method or the repeated distribution method can be used
to take account of reciprocal service arrangements. Both are illustrated in this
answer.
Algebraic method
Let
h total cost of heating
m total cost of maintenance
s total cost of steam
Then
h 90 (3/30)m(192/960)s
m 300 (5/100)h (48/960)s
s 240 (5/100)h (4.5/30)m
Expressing these equations in decimal form, we get:
h 90 0.10m0.2s (1)
m 300 0.05h 0.05s (2)
s 240 0.05h 0.15m (3)
Substituting for s,
Question 3.36
COST ASSIGNMENT 11
h 90 0.10m0.2(240 0.05h 0.15m)
m 300 0.05h 0.05(240 0.05h 0.15m)
Expanding these equations gives:
h 90 0.10m48 0.01h 0.03m
m 300 0.05h 12 0.0025h 0.0075m
Rearranging,
0.99h 138 0.13m (4)
0.9925m312 0.0525h (5)
Substituting in equation (4) for m,
0.99h 138 0.13
(312
0

.9
0
9
.
2
0
5
525h)
0.99h 138 40.866 0.0069h
h
0
1
.
3
9
8
9

4
0
0
.0
.8
0
6
6
6
9
181.941
Substituting for h in equation (5),
0.9925m 312 0.0525(181.941)
m 324.165
Substituting into equation (3),
s 240 0.05 (181.941) 0.15 (324.165) 297.722
We now apportion the values of h, m and s to the production departments
according to the basis of allocation specified:
Processing Assembly
(000) (000)
Heat (181.941) 72.776 (40/100) 90.970 (50/100)
Maintenance (324.165) 81.041 (7.5/30) 162.082 (15/30)
Steam (297.722) 148.861 (480/960) 74.431 (240/960)
302.678 327.483
Repeated distribution method
Heat Maintenance Steam Processing Assembly
(000) (000) (000) (000) (000)
Allocation per
question (90.00 300.00 240.00
Heat
reallocation (90.00) 4.50(5%) 4.50(5%) 36.00(40%) 45.00(50%)
Maintenance
reallocation (30.45(10%) (304.50) 45.67(15%) 76.13(25%) 152.25(50%)
Steam
reallocation (58.03(20%) 14.51(5%) (290.17) 145.09(50%) 72.54(25%)
Heat
reallocation (88.48) 4.42(5%) 4.42(5%) 35.40(40%) 44.24(50%)
Maintenance
reallocation ( 1.89(10%) (18.93) 2.84(15%) 4.73(25%) 9.47(50%)
Steam
reallocation ( 1.45(20%) 0.36(5%) (7.26) 3.63(50%) 1.82(25%)
Heat
reallocation (3.34) 0.16(5%) 0.17(5%) 1.34(40%) 1.67(50%)
312 0.0525 (181.941)

0.9925
12 COST ASSIGNMENT
Maintenance
reallocation
a
(0.52) 0.17 0.35
Steam
a
(0.17) 0.11 0.06
302.6 327.4
Note
a
At this stage the costs are so small that no further reallocations between ser-
vice departments are justified. The costs of the maintenance department are
reapportioned in the ratio 7.5:15, while those of the steam department are
reapportioned in the ratio 480:240.
(b) The main problems encountered are as follows:
(i) The costs allocated to the service departments are the result of arbitrary
apportionments. The costs are then reallocated from the service to produc-
tion departments using further arbitrary allocations. Consequently, the
associated costs attached to products will be arbitrary and dependent
upon the selected apportionment methods.
(ii) If a substantial part of the service department costs are fixed and costs are
allocated to production departments on the basis of usage, there is a dan-
ger that the resulting unit product costs will fail to distinguish between
the fixed and variable cost categories. This could result in misleading
information being used for short-term decisions.
(iii) If the responsibility accounting system allocates the actual costs of the ser-
vice departments to the production departments, the production depart-
ments will be accountable for the inefficiencies arising in the service
departments. Consequently, the production managers will be demoti-
vated and the service department managers will not be motivated to be
efficient because they will always be able to recover their costs.
Possible solutions include the following:
(i) Avoid the use of arbitrary apportionments and identify appropriate cost
drivers for the main activities undertaken by the service/support depart-
ments using an activity-based costing (ABC) system. See Chapters 3 and
10 for an explanation of an ABC system.
(ii) Separate fixed and variable costs when reallocating service department costs
to production departments.
(iii) Charge service department costs to production departments on the basis
of actual usage at standard cost. If the production managers have no con-
trol over the usage of the service, the service department costs should be
regarded as uncontrollable (see Guidelines for applying the controllability
principle in Chapter 16 for a discussion of this point). The service depart-
ment managers will be motivated to control costs if they are accountable
for the difference between actual and standard usage multiplied by the
standard cost.
(c) The answer should include a discussion of the following points:
(i) In todays production environment an increasing proportion of total costs
are fixed, and short-term variable costs do not provide a useful measure of
the cost of producing a product. Managers require an estimate of long-run
product costs. The allocation of fixed costs to products provides a rough
guide of a products long-run cost. The answer should draw attention to
the criticisms that Kaplan and Cooper (see Chapter 10) have made of tra-
ditional cost allocation methods and explain that an ABC system is an
approach that has been recommended to overcome the problems of arbi-
trary overhead allocations.
(ii) It is a tradition in some industries (e.g. Government contracts) for selling
prices to be based on full product costs plus a percentage profit margin.
(iii) Total manufacturing costs are required for stock valuation for external
reporting. However, it is questionable whether costs computed for stock
valuation ought to be used for decision-making.
COST ASSIGNMENT 13
(iv) It is sometimes claimed that fixed costs should be allocated to managers in
order to draw their attention to those costs that the company incurs to sup-
port their activities. This is because the manager may be able to indirectly
influence these costs, and should therefore be made aware of the sums
which are involved. If this approach is adopted, controllable and non-
controllable costs ought to be distinguished in the performance reports.
(a) Cost of Job 123
Direct materials: () ()
Y (W1) (400 kg 0.505) 202.00
Z (W2) (265 kg 1.45) 384.25 586.25
Direct labour:
Department A (W3) (76 hrs 4.50) 342.00
Department B (W4) (110 hrs 4) 440.00 782.00
Overhead (W5):
Department A (76 hrs 2.70) 205.20
Department B (110 hrs 2.25) 247.50 452.70

1820.95

Workings and comments

(W1) (529.75) (600 0.50)

(500 0.50) (400 0.52)

0.505 weighted average price
1050 600 500 400
400 kg issued to job 123 is a direct cost
(W2) 9946.50 (16 000 1.46)
1.45 weighted average price.
6970 16 000
Direct issues to the job are 270 kg (300 30), but 5 kg were damaged and
destroyed. It is unlikely that the materials are a direct consequence of the job, and
therefore it is incorrect to regard the 5 kg as a direct cost to the job. If such losses
are expected to occur from time to time, the cost of the lost materials should be
charged to departmental overheads and included in the departmental overhead
rate calculation. If such losses are abnormal (as indicated in the question), they
should not be charged as product costs. Instead, they should be charged to an
abnormal losses account (see Chapter 5) and written off to profit and loss account
as a period cost.
(W3) 76 hours have been directly identified to the job at the hourly rate of 4.50.
Six hours were overtime, resulting in excess payments. As these hours are
likely to be due to the general high level of production, the overtime pre-
mium is included in the overhead rate and shared out amongst all jobs. An
additional 3 hours rectification were spent on the job, but such work is a
normal part of the work generally undertaken by the department. The cost of
rectification is therefore charged to overheads and included in the overhead
absorption rate.
(W4) 110 hours are charged to the job. Of these, 30 hours were overtime, but this
was a direct result of a customers requirement on another job. Therefore
the overtime premium is not charged to the job.
(W5) All direct items can be ignored when calculating overhead rates, but direct
materials include scrapped materials and direct labour includes rectification
work. However, scrapped materials are to be regarded as abnormal costs,
but 20 hours rectification should be charged to overheads. Department A
overtime premium is part of the overhead cost, but the overtime premium
for Department B is charged directly to another customer.
Question 3.37
14 COST ASSIGNMENT
Calculation of overhead rates Department A Department B
() ()
Rectification (20 4.50) 90
Indirect labour 2420 2960
Overtime premium 450
Lubricants 520 680
Maintenance 720 510
Other 1200 2150

5400 6300

Direct labour hours
2000

9000
a

2800

11 200

4.50 4
Direct labour hour overhead rate 2.70 2.25
Note
a
9000 90 rectification cost.
(b) Information on the cost of individual jobs can be used as follows:
(i) for stock valuation of partly completed and completed jobs;
(ii) to determine the selling price of a product where no established market price
exists;
(iii) as an assessment of the profitability of a job when the selling price is market
determined.
Note that the job cost calculation derived here may be inappropriate for decision-
making purposes. The major objective is to use the cost for stock valuation
purposes.
COST ASSIGNMENT 15