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Seminar (1)

Smythes Ltd are facing a difficult future. Orders are hard to get and even then they fail
to make a profit. As the management accountant of the company you are asked to
investigate the situation and to make recommendations regarding the method of
charging overheads to jobs. At present the company charges overheads to jobs at the
rate of 120% of direct labour cost. The average labour rate is 4.50 per hour. You
decide that the company should change to a machine hour basis of charging overheads.
To illustrate your recommendations you are required to:
(a) Apportion the expenses to departments A,B,C and D and calculate machine hour
rates for each department,
(b) Prepare an estimate of the overhead cost of jobs PQ and RS, firstly, on the old
basis of 120% direct labour hours , secondly, using the above machine hour rate.
Hours to be spent on Job:
In Dept A
In Dept B
In Dept C
In Dept D

PQ
10
60
50
-

120 hrs

Allocation and apportionment bases:


A
B
Floor (sq metres)
1800
1500
Kilo-watt hrs
270000
66000
Machine cost
30000
20000
Ind. labour persons 3
3
Total labour persons 19
24
Machine maint. hrs 3000
2000
Tooling costs
3500
4300
Supervision
2050
2200
Small tool supplies 491
441
Mach. hrs available 3200
4000
Mach. running hrs 3000
3600
The companys budget for the year is as follows:
Supervision
Indirect workers
Holiday pay, national insurance
Tooling costs
Machine maintenance labour cost
Power
Small tools and supplies
Insurance of machinery
Insurance of buildings
Rent and rates
Depreciation of machinery

C
800
85000
8000
1
12
3000
1000
1775
66
2100
1900

RS
60
10
50

120 hrs

D
900
65000
16000
1
7
1000
600
1500
173
800
800

7525
6000
6200
9400
4500
1944
1171
185
150
2500
9250

Total
5000
486000
74000
8
62
9000
9400
7525
1171
10100
9300

48825

Answer:
Allocation and apportionment to departments:

Expense

Basis

Supervision
Ind. Labour
Hol. Pay
Tooling cost
Mach. maint.
Power
Small tools
Insure mach.
Insure bldg.
Rent & rates
Depreciation

Allocate
No. of persons
Total persons
Allocate
Maintenance hrs
Kwh
Allocate
Capital cost
Floor (sq metres)
Floor (sq metres)
Capital cost

A
B

2050 2200
2250 2250
1900 2400
3500 4300
1500 1000
1080
264
491
441
75
50
54
45
900
750
3750 2500
17550 16200

1775
750
1200
1000
1500
340
66
20
24
400
1000
8075

1500
750
700
600
500
260
173
40
27
450
2000
7000

Total

7525
6000
6200
9400
4500
1944
1171
185
150
2500
9250
48825

2100
1900
4.25

800
800
8.75

10100
9300

Calculating the machine hour rate:


Available machine hours
Machine running hours
Machine hour rate ()

3200
3000
5.85

4000
3600
4.50

Applying the new machine hour rate and comparing it to the old direct labour cost rate:
Job PQ

Job RS

10 hrs in A @ 5.85
60 hrs in B @ 4.50
50 hrs in C @ 4.25
0 hrs in D @ 8.75
120

58.50
270.00
212.50
541.00

60 hrs in A @ 5.85
10 hrs in B @ 4.50
0 hrs in C @ 4.25
50 hrs in D @ 8.75
120

351.00
45.00
437.50
833.50

Old DLC Method


120
@ 120% x 4.50=

648.00

120

648.00

@ 120% x 4.50=

Spare Question and Answer:


TT Plc has three production departments - Machining, Assembling, Spraying, and two
service departments - Internal Transport, Quality Control. During 2006 the company
plans to produce 5,000 products, the estimated costs being:

Material:
Direct
75,000
Internal Transport
5,000
Labour:
Machining 20,000 hours @ 60p
5,000 hours @ 50p
Assembling 10,000 hours @ 60p
10,000 hours @ 50p
10,000 hours @ 40p
Spraying
8,000 hours @ 50p
2,000 hours @ 40p
Internal Transport:
3,000
Quality Control:
6,000
Other Allocated Costs:
Machine Shop
11,120
Assembly Shop
9,360
Spray Shop
4,020
Internal Transport
2,000
Quality Control
2,000
On the basis of estimated benefit received, the service departments costs are
apportioned as follows:
Internal Transport
Machine Shop 60%, Assembly Shop 30%, Spray Shop 10%
Quality Control
Machine Shop 30%, Assembly Shop 30%, Spray Shop 30%, Internal Transport 10%.
Required:
(1) Prepare a statement showing the overhead to be absorbed by each of the three
production departments.
(10 marks)
(2) Briefly describe three methods by which overhead can be absorbed.
( 3 marks)
(3) Using the method you consider most appropriate calculate the overhead absorption
rate for each production department.
( 3 marks)
(4) The assumption underlying the above overhead absorption methods is that all
overheads are related to production volume. In comparison to Activity Based Costing
methods briefly discuss whether this assumption is still valid today. ( 9 marks)
Total 25 marks

Answer:

Indirect materials
Indirect labour
Indirect expenses
Reapportionment:
Quality control
Internal transport

PRODUCTION
Machine
Assembly

Spray

11120
11120

9360
9360

4020
4020

2400
6480
20000

2400
3240
15000

2400
1080
7500

Units
Direct Labour Hours
Direct Labour Cost
Machine Hours

TCCO / DLH:
TCCO / DLH:
TCCO / DLH:

=
=
=
=

SERVICE
Int Transp

5000
3000
2000
10000
800
(10800)

TCCO / No. of units produced


TCCO / DLH
TCCO / DLC
TCCO / M/c Hrs

Machine
Assembly
Spraying

20000 / 25000 hrs


15000 / 30000 hrs
7500 / 10000 hrs

=
=
=

The question clearly points to DLH no substitutes allowed

See notes re last part

Quality C.

6000
2000
8000
(8000)

= overhead per unit


= overhead per DLH
= overhead per DLC
= overhead per M/c Hr

80p per DLH


50p per DLH
75p per DLH

Spare Q&A
Famous Engineering Co. has two production departments and a service department.
Budgeted overhead expenses for the next year were as follows:
Production Depts.
Founding
Finishing

Allocated overheads
Indirect labour
Depreciation of machines
Indirect overheads
Factory light & heat
Supervisory salaries

40,000
18,000

Service Dept
Maintenance

60,000
16,000

Total

24,000
10,000
25,000
60,000

Other information is as follows:

Cost of machinery ()
Floor space (sq. metres)
Maintenance hours
Number of employees
Machine hours

Founding
90,000
140,000
6,000
45
60,000

Finishing
80,000
90,000
4,000
40
40,000

Maintenance
50,000
20,000
5
-

Total
220,000
250,000
10,000
90
100,000

You are required to:


A)

Apportion the indirect overheads to the production and service departments and
then the service department overheads to the production departments using the
bases which you consider to be most appropriate. Using the machine hour basis,
calculate the departmental overhead rates by means of which overheads may be
charged to product costs.
(70% marks)

B)

Explain how such rates would be used in product costing.


(30% marks)

A
Indirect labour
Depreciation of machinery
Light and heat (floor area)
Supervisory salaries (employees)
Maintenance costs (maintenance manHours)
Total overhead costs
Machine hours
Machine hour overhead recovery rate

Funding

Finishing

Maintenance

40,000
18,000
14,000
30,000

60,000
16,000
9,000
26,667

25,000
10,000
2,000
3,333

23,600
125,600
60,000
2,093

15,733
127,400
40,000
3,185

39,333

Such an overhead recovery rate would be used to estimate product cost on


estimated number of machine hours such product was expected to spend in the
relevant departments.

Question 4
a) Alsace Hotel Overhead Statement
Basis
Residential Catering Housekeep. Maint.
Allocated
56,000
92,000
108,000
36,000
Allocated
66,000
52,000
46,000
22,000
Floor area
82,500
40,500
18,000
9,000
Value of equip. 28,000
20,000
6,000
6,000
Floor area
40,700
19,980
8,880
4,440
Value of equip. 70,000
50,000
15,000
15,000
343,200
274,480
201,880
92,440
Service depts.. re-apportioned
Maintenance 50:30:20
46,220
27,732
18,488 -92,440
Housekeeping 75:25
165,276
55,092 -220,368
Consumables
Staff costs
Rent and rates
Contents ins.
Heat and light
Depreciation

554,696

357,304

Total
292,000
186,000
150,000
60,000
74,000
150,000
912,000
912,000

b) Calculation of overhead absorption rates


Residential

554,696
8,600

64.50 per night

Catering

357,304
48,000

7.44 per meal

c) Calculation of under/over absorption

Absorbed

9,100 x 64.50
46,500 x 7.44

Residential
586,950

Actual
Under/over absorption

Catering
345,960

578,400

357,000

8,550
over

(11,040)
under

d) ABC is a costing technique which provides a system for apportioning overheads


realistically to obtain full costs of the service. The reasons for this are:
- The competitive nature of the market place
- Direct labour has shrunk as a percentage of total cost
- Arbitrary cost allocations should be eliminated.

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