VØS5 - Chapter 9 Absorption Cost Systems (C. Allocating Overhead to Jobs …
VØS5 - Chapter 9
Absorption Cost Systems
Absorption Cost Systems
Absorption cost systems ensure that all manufacturing costs are directly traced or by cost allocation
The cost objects are the products. If it costs $32 mil- lion to operate a factory that manufactures 620,000 pagers (16 different models), including units still in inventory, then an absorption cost system either directly traces or allocates the $32 million among the 620,000 pagers. Absorption cost systems display the same trade-off between decision making and control, but most of the discussion of this trade-off is deferred to the next two chapters; this chapter focuses on the mechanics of these cost systems
Job order Costing
is used in departments that produce output in distinct jobs (job order production) or batches (batch manufacturing). Job order costing is also widely used in assembly processes.
Alternatively, some assembly processes and continuous flow production processes use process cost systems. Production in these settings (e.g., soft-drink producers and oil refining) is continuous and distinct batches do not exist
B. Cost Flows through the T-Accounts
LIFO / FIFO
A. Job Order Costing
Job #5167 illustrates several important features of job order costing:
• The items being produced by the job are the objects being costed.
• All direct costs of manufacturing the job are traced directly to the job.
• Each job is charged for some indirect manufacturing overhead.
• An input measure, machine hours, is used to allocate overhead costs to jobs. An input
measure is the allocation base.
• The overhead rate (here, the rate per machine hour) is set at the beginning of the year, before the first jobs are started. This overhead rate is the ratio of expected factory overhead for the year divided by the expected machine hours for the year.
Reported product costs are average rather than variable or marginal costs. Each job is assigned a portion of the overhead. Since overhead contains both variable and fixed costs, overhead distributed to jobs contains some fixed costs.
C. Allocating Overhead to Jobs
3. Flexible Budgets to Estimate Overheard
4. Expected versus Normal Volume
Budgeted volume can be estimated as either the volume expected for the coming year (expected volume)
or the long-run average volume. Long-run average volume is called normal volume, or the average volume over both upturns and downturns in the economy.
Using normal volume improves decision management, particularly the pricing decision. For decision control reasons, however, senior managers might not want to use normal volume and may not want to have over/underabsorbed overhead charged to cost of goods sold
trade-off between decision management and decision control in making a design choice about the internal accounting system. Most firms use expected, not normal, volume. Thus, it appears that decision control is more important than decision management.
2. Over/Underabsorbed Overhead
There are three ways of disposing of the over/underabsorbed balance at year-end:
write it off to cost of goods sold
to allocate (pro- rate) it among work-in-process, finished goods, and cost-of-goods-sold T-accounts based on the amount of overhead in these categories
The third method of disposing of over/underabsorbed overhead is to recalculate the cost of each job using actual overhead incurred and actual volume to compute a revised, end-of- year overhead rate
1. Overheard Rates
Prospective overhead rate
A prospective overhead rate, set at the beginning of the year, allows jobs to be costed as they are produced.
Notice in Table 9–1 that factory volume is measured in machine hours, not units of production. That is, volume is being measured with an input measure, not an output mea- sure. This practice is common in most plants. Inputs are used to measure volume because most plants produce heterogeneous products. If a factory manufactures small pumps and large pumps, the number of pumps manufactured can give a misleading measure of plant output. Plant volume can actually fall while the total number of pumps increases if there is a shift from large to small pumps. Therefore, volume in plants manufacturing heterogeneous products is based on an input measure rather than an output measure.