Management Accounting for Planning and Control

ABSORPTION COSTING

Treats all overhead costs the same

Uses a single absorption rate for all overheads

For example (Inverdon plc):

Product K Product L Product M

Direct 50.00 40.00 36.00
Materials
Direct 24.00 32.00 16.00
Labour
Production 42.24 56.32 28.16
Overheads 6 x 7.04 8 x 7.04 4 x 7.04
TOTAL 116.24 128.32 80.16
COST

Total overheads are 1,690,000

Total labour hours are (20,000 x 6) + (12,500 x 8) +
(5,000 x 4) = 240,000 hours
Overhead Absorption Rate is the Overheads per labour
hour = 1,690,000/240,000 hours = 7.04
 Management Accounting for Planning and Control

ACTIVITY BASED COSTING

Groups overhead costs into the main activities of

the business
Considers what drives the cost of each activity
the cost driver
Shares out the cost of each activity between the
products based on the cost drivers

For example (Inverdon plc):

Product K Product L Product M

Direct 50.00 40.00 36.00
Materials
Direct 24.00 32.00 16.00
Labour
Production 24.30 45.41 127.28
Overheads
TOTAL 98.30 117.41 179.28
COST
 Management Accounting for Planning and Control

ACTIVITY COST DRIVER COST PER

COST DRIVER
Set-up Production runs 160,000 /40 =
160,000 40 4000 per run
Engineering Production 180,000/50 =
180,000 orders 50 3600 per order
Goods Inward Material 300 000/160 =
300,000 Receipts 160 1875 per rec
Packaging Production 200 000/50 =
200 000 Orders 50 4 000 per order
Machining Machine hours 8.095 per
850,000 105,000 machine hour

Product K Product L Product M

Set-up 4000 x 5 4000 x 10 4000 x 25
runs = runs = runs =
20,000 40,000 100,000
Engineering 3600 x 15 3600 x 10 3600 x 25
orders = orders = orders =
54,000 36,000 90,000
Goods 28,125 46,875 225,000
Inward
Packaging 60,000 40,000 100,000
Machining 8.095 x 8.095 x 8.095 x
40,000 hrs = 50,000 hrs = 15,000 hrs =
323,800 404,750 121,425
TOTAL 485,925 567,625 636,425
Units 20,000 12,500 5,000
Overhead
Cost per unit 24.30 45.41 127.28