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Chapter 24
Product Costing
Types of production processes
Job Production
↪ individual items made to consumers specifications ↪ labour intensive industry - more direct labour horses ↪ high price Eg → tailor made clothes
Batch Production
↪ limited number of identical items made on production run ↪ machine intensive Eg → various flavours of crisps
Mass/Flow Production
↪ identical items made continuously ↪ manymachine horses used in production process Eg → pens, markers, toilet paper
Purpose of product costing
↪ set selling price ↪ control cost ↪ value closing stock ↪ aid planning & decision making
High-Low Method
↪ an accounting technique used to establish fixed & variable elements of a mixed cost
Limitations of the High-Low Method
↪ assumes a linear relationship between cost and activity - over-simplified analysis of how costs behave Eg economies of scale are ignored ↪ does not represent all the data as it is based on just two activity levels ↪ fails to take inflation into account
Stock Valuation
↪ process of determining the value of a bus. trading stock end of financial year
SSAP 22
↪ says stock must be valued at the lower of cost or net realisable value
S tandard S tatement of A ccounting P ractice
Correct valuation of stock is important because:
↪ Incorrect valuation of stock will distort profits ↪ If closing stock is overvalued, then profits would be understated and vice versa, prudence ensures that profits are not overstated and losses are not understated ↪ prudence concept states that caution should be exercised when preparing financial statements, i.e. you can anticipate a loss but not a gain. ↪ As a result, only realised profits should be included in the accounts, while provision should be made for all expected expenses and losses. Therefore stocks should be valued at the lower of cost or net realisable value.
FIFO
F irst I n F irst O ut ↪ a method of stock valuation which assumes the first items received into stock are the first items issued to production ↪ using this method - closing stock valued at most recent price
The three A's
Absorption
- Overhead costs are charged to units of products in order to be recovered
- Overheads are absorbed into the cost of a product using predetermined overhead absorption rates (OAR).
- These are calculated on a suitable basis such as per unit, per labour hour, per machine hour, or a percentage of prime cost
- OARs are based on direct labour or direct machine hours or on a per unit basis, whichever is the dominant activity Eg Rent Depreciation Fixed interest Apportionment
- Process of dividing overheads which cannot be specifically identified with any one department (cost centre)
- Overheads are apportioned (divided) among the various cost centres using a suitable basis of apportionment, e.g. floor area Eg Light and heat Insurance Cleaning Canteen costs
Apportionment → Basis of apportionment
Number of employees Factory canteen Uniform costs Volume in meter cubed - (^) m 3 ❑ Light of factory → electricity Heat of factory
Floor area → space
Insurance Cleaning
Book value → cost
Depreciation on machines / factory buildings Actual Materials Labour
Reapportionment
↪ the process of making a new equitable division of overheads to cost centres Service department ↪ a cost centre that provides services to the rest of the business ⤷ maintenance department ⤷ information technology department → Do no work directly on producing the final product → Secondary to production → cannot recover costs → Therefore their costs must be reapportioned to production departments → so overheads can be absorbed into final product
