You have been asked to suggest a method of deducing the full cost of various pro

Question

You have been asked to suggest a method of deducing the full cost of various production orders of Cheryl Ltd. This method will be used as a basis for setting prices. The production orders vary greatly in size and nature from one to the next. The following information has been taken from the budget for the forthcoming financial year: Direct labour hours 70,000 hours Machine hours 75,000 hours Direct material 16,000 kg £ Manufacturing costs: Power 40,000 Direct materials 200,000 Machine maintenance and repairs 38,000 Factory heat and light 4,000 Lubricants and cleaning materials 6,000 Direct labour 700,000 Depreciation: factory buildings 130,000 machinery 402,000 Indirect labour 100,000 1,620,000 The business is not departmentalised for accounting purposes. All direct labour is paid the same hourly rate. Required: (a) Calculate two feasible overhead rates (labour hours and machine hours) for the year. (5 marks) (b) Prepare full costings for Order No 101 using each of the rates calculated in (a) (that is, two separate costings). The cost sheet for Order No 101 shows the following: Direct materials 400kg Direct labour hours 1,200 hours Machine hours 800 hours (7 marks) (c) State briefly which of the two bases of overheads you prefer and why. How might you improve on the two possible costs that you derived in (b) by taking a slightly different approach? (

Explanation / Answer

It is a problem on full cost determination. Here full cost will include both direct and indirect costs. Direct costs are identifiable against a specific item produced. Indirect costs are not possible to make such direct link. It should be recovered on some suitable basis. In first part two approprate basis suggested are direct labor hour and machine hours worked. The recovery rate of indirect costs are calculated below:

                         Statement showing calculation of overhead recovery rate

70,000

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Answer: Now consider a specific job 101. Take direct material and direct labor cost. Recover overhead as per pre determined rate stated above. Details are shown below;

1. Material cost per unit: As per udget, direct material quantity is 16,000 kg. Total direct material cost is 200,000. So price per kg is 200,000/16000=$12.50

2. Direct labor rate per unit : Total direct labor hour as per budget is 70,000. Direct labor total cost is 700,000. Thus rate per hour is 700,000/70,000=$10

On the basis of above figures, total cost of work order 101has been calculated below:

Metod 2; Machine hour recovery:

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Answer (c) From the two different methods of recovering overhead rate, machine hour base is more preferred. If you cosider the overhead cost elements, then you will observe that most of the cost elements are best liked with hours worked. They are power, machie maintenance, heat and light, lubricants, depreciation of machinery Only factory indirect labor cost and depreciation of buildings are ot so linked. They can be better linked with direct labor hours.

You can take a slightly different approach to get better idea of full cost of job 101. Link all items of overhead except factory building depreciation and indirect labor cost with machie hours worked. Link remaining two items with direct labor hour. Thus instead of using one overhead recovery rate, use two recovery rates. It will recover overhead better. So total cost will be more accurate.

Details Amount Manufacturing costs: Power $40,000 Machine maintenance and repair $38,000 Factory Heat and light $4,000 Lubricants and cleaning materials $6,000 Depreciation: Factory building $130,000 Depreciation: Machinery $402,000 Indirect labor $100,000 1. Total overhead expenses: $720,000 2. Total direct labor hour

70,000

3. Overhead recovery rate per labor hour [1/2] $10.30 4. Total machine hour 75,000 5. Overhead recovery rate per machine hour [1/4] $9.60

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