Session 9

Accounting - 1

Accounting – Marginal and Absorption Costing/Labour Cost

Definitions
 Arbitrary means that something is subject to an individual’s will or
judgement without restriction, e.g. absorption base.
 Marginal Costing is the principle whereby only variable costs are charged
to cost units for production or service. The fixed cost or overhead
relating to the period is written off in full against the contribution.
 Absorption Costing is a method of classifying costs, in which, an
absorption base is determined.
 Job cost Sheet is the primary document for tracking the costs associated
with a given job.
 Predetermined overhead rate (POHR) is used to appl overheads to jobs
before the period begins

Concepts
Marginal vs. Absorption Costing
 Stock valuation
o In what order should we consider goods to be used?
o Should we value stick at marginal cost or should we add a
proportion of fixed overheads which were incurred in the period
when the goods were manufactured, and use absorption costing?
o Marginal Costing:
 Fixed production overhead is wholly charged against profit
in the period in which the goods are produced regardless of
when they are sold.
o Absorption Costing:
 Part of the fixed production overhead is carried forward to
the period in which the goods are sold.
 Under absorption costing, profit will always be higher than
under marginal costing (only if products are carried onwards
to the next period).
o Is there a difference?
 Whichever method is used the total profit over the whole
lifetime will remain the same, the only difference being the
years in which the profit is reported. (Total Cost and total
profit will be the same)
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Accounting - 2

o Deal with an exercise:

 Calculate OAR (units produced)
 Calculate closing stock and gross profit at the end of each
month using a) absorption b) marginal costing.
 See Hint

Hint

Job-Order Costing
 Costs are traced and allocated to jobs (see pic)
o 1. Charge direct material/labour costs to each job as work is
performed.
o Apply overhead to each job using a predetermined rate.
 Sequence of events
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Accounting - 3

o Receive orders from customers  schedule jobs  order

materials  begin production

Job-Order Costing – Tracing Costs and Documents

 Job Cost Sheet
PearCo Job Cost Sheet
Job Number A - 143 Date Initiated 3-4-01
Date Completed
Department B3 Units Completed
Item Wooden cargo crate
Direct Materials Direct Labour Manufacturing Overhead
Req. No. Amount Ticket Hours Amount Hours Rate Amount

Cost Summary Units Shipped

Direct Materials Date Number Balance
Direct Labour
Manufacturing Overhead
Total Cost
Unit Cost

 Materials Requisition Form

o Transfer data onto job cost sheet – direct materials
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Accounting - 4

 Employee Time Tickets

o Transfer data onto job cost sheet – direct labour

 Manufacturing Overhead
o Predetermined overhead rate (POHR)
 Maes it possible to estimate total job costs sooner.
o Ideally, the allocation base is a cost driver that causes overhead.
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑡𝑜𝑡𝑎𝑙 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑖𝑛𝑔 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑐𝑜𝑠𝑡 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑐𝑜𝑚𝑖𝑛𝑔 𝑝𝑒𝑟𝑖𝑜𝑑
POHR =
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑡𝑜𝑡𝑎𝑙 𝑢𝑛𝑖𝑡𝑠 𝑖𝑛 𝑡ℎ𝑒 𝑎𝑙𝑙𝑜𝑐𝑎𝑡𝑖𝑜𝑛 𝑏𝑎𝑠𝑒 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑐𝑜𝑚𝑖𝑛𝑔 𝑝𝑒𝑟𝑖𝑜𝑑

 POHR is based on estimates and determined before period

 Actual activity is the actual amount of the cost driver such as units
produced, direct labour hours, or machine hours incurred during the
period
Overhead applied = POHR * Actual Activity

Job-Order Costing – Flow Chart

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Accounting - 5