CIMA C1

CIMA C1Fundamentals Of Management AccountingOverheads & Absorption CostingCIMA C1Fundamentals of Management AccountingClass Slides Ian WilsonPrepare cost statements for allocation & apportionment of overheads, including reciprocal departmentsCalculate direct, variable & full costs of products, services & activities using overhead absorption ratesApply information to pricing decisionsLearning Aims (CIMA)We have seen that business costs can be, and need to be classified by type & behaviour.Direct MaterialsDirect LabourDirect Expenses= Prime CostProduction Overheads= Total Production (Absorbed Cost)Non-production Overheads= Total CostContext & Link to Session 2Costs behave in a variety of ways:They are:Variable CostsSemi-Variable CostsStep CostsFixed CostsOnce costs types & behaviour is known, what happens next?Why did we collect this information?Context & Link to Session 2Key Emphasis in 4 areas of use:Stock Valuations, what is the value/cost of inventory?Planning, future forecastsControl, actual against planned performanceDecision Making, the right outcome in terms of cost/profit for the business

Context & Link to Session 2Direct Costs are easy to deal with, they relate to cost unitsBut what about indirect costs or overheads?By their very nature, they cannot be traced DIRECTLY to a cost unit.We have to find a way to charge theses indirect costs to a cost unit.Context & Link to Session 2The method Accountants used to charge indirect costs to cost unit is called ABSORPTION COSTING.CIMA definition:An overhead is expenditure on labour, materials, or services that cannot be economically identified with a specific saleable cost unitContext & Link to Session 2Absorption Costing is a method of sharing Overheads (Indirect Costs/Expenses) between a number of different Finished Products on a Fair basis.You will have to consider the 3 As:AllocationApportionment (& re-apportionment)AbsorptionPoint 3 leads to Over/Under Absorption Overhead Costs & Absorption CostingIt may be useful to sketch out how costs are allocated, apportioned and finally absorbed into a single product cost per unit.

This is a useful summary I always use to give you a map to follow & remember

Make sure you note this down:Absorption Cost DiagramA Company will have a Total Production Overhead spend in mind, say 500K.If it has 2 Departments, Cutting & Finishing, how much does it charge to each of these Departments?.Dividing up Overheads is a critical process as they will drive Absorption rates as we have already seenWe follow a 3 stage process:Allocation & ApportionmentAllocationApportionmentRe-Apportionment

You must be able to tackle all 3:Allocation & ApportionmentAllocation:Means:Charging cost centres with Overheads that are incurred solely in that centre.

eg: a salary of a supervisor in a particular cost centre Allocation & Apportionment

Apportionment:Means:Some costs relate to a business as a wholeSplitting shared Overheads between cost centres using some form of fair basis.eg: using floor area for rent & rates : using number of employees for canteen costs : using value of assets for Depreciation chargesAllocation & ApportionmentRe-ApportionmentMeans:Re-splitting Overheads from service cost centres to production cost centres.eg: moving service costs for say Canteen & Maintenance centres to production cost centres based on benefit & use of those service centresAllocation & ApportionmentExercise 1 page 36

We can complete this exercise to practice the theoryIndirect wages & Materials have already been ALLOCATED to the various cost centresAllocation & ApportionmentNot all departments are PRODUCTION based.Some departments provide services to production departments.These departments are called SERVICE departments.Secondary apportionment is therefore apportioning service centre costs to production cost centres.

Secondary ApportionmentWhat happens when service centres provide services for each other?There are 2 ways to deal with this issue:EliminationRepeated Distribution

Examples 2 & 3 provides the answer.

Reciprocal ServicingHaving allocated/apportioned our overheads to a Cost centre, we need to add them to, or absorb, these costs in to the Cost of Sales.Production Overheads are added to the Prime Cost seen earlier in the course.The OAR (Overhead Absorption Rate) can be seen as a charge out rate for Overheads. Authors also call this BOAR Budgeted Overhead Absorption RateOverhead Absorption Rates (OAR)There are 3 common ways to achieve this:A Rate per Unit (identical units)A Rate per Labour Hour (human time intensive)A Rate per Machine Hour (machine time intensive)All of the above are set at a pre-determined rate, using Budgets or expected estimates of production costs (BOAR). OARRates of Overhead HAVE to be available at the START of the production period.The business CANNOT wait until the end of the accounting period to see what the ACTUAL production overhead costs were.The BUDGET figures for Overheads are used

OAR = Budgeted Overheads for Production Budgeted Level of ActivityOARWe will work out Exercises 4 & 5Make sure you practice this at homeIt is vital for ALL CIMA Management Accounting papers you take!Note: OAR Rates can be:BlanketorDepartmental See page 39 of your notes.OAR Blanket & DepartmentalTry Exercise 6 Page 41This is a typical exam style question.You are given 4 answers!.Which is correct?EXAM FOCUSThe OAR is based on estimates. This estimate is quantified in the BUDGET.Overhead Costs & Output Activity Levels are estimated/Budgeted for a given period.One or both estimates may be different to what ACTUALLY takes placeActual Overheads are likely to be greater or less than the overheads absorbed into the cost of production & production may differ alsoOver & Under AbsorptionIn Simple Terms:

Over Absorbed: Absorbed Overhead > Actual Overhead

Under Absorbed:Absorbed Overhead < Actual OverheadOver & under AbsorptionA possible layout for your calculation:

Absorbed Overhead: xxx (Actual activity x OAR)

Actual Overhead: xxx

Under/Over Absorption: xx

Under & Over AbsorptionAurricula Ltd.

We can practice over/under absorption calculations for this problem.

Try & use the layout I suggested for this question.

Exercise 3 & 4We have seen that Costs can be used for:Valuing StockPlanningDecision makingControl What else will product/service costs be used for?

Costs

As a Management Accountant, you will be asked to price products based on their cost value.You will have to consider:Mark-up (profit expressed as a % of cost)Margin (profit expressed as a % of price)

Look out for Marginal costing also.Try my example (7)Pricing