CMA ADNAN RASHID COMPLETE NOETS

Accounting for Overheads Chapter 1
1. Accounting for
Overheads
Accounting for
Overheads
Cost and Management Accounting 12

Direct and Indirect Costs
Direct Costs are costs that can be directly traced with accuracy to a specific cost unit (Product). There are
many examples of direct costs but royalties paid to a designer or fees paid to a subcontractor for a specific
job could be classed as direct costs.
Direct expenses are part of the prime cost of a product.
Indirect Costs cannot be directly traced to a specific cost unit (Product).
For example, the cost of renting a factory where shirts are manufactured is classified as an indirect cost
because it would be impossible to relate such costs to shirts only, if other clothes, such as dresses and
suits were also made in the same factory.
Indirect expenses are also known as overheads.
Costs Direct/ Indirect Cost Category of Overhead

Production supervisor salary Indirect cost Production Overheads
Accounts manager salary Indirect cost Administrative Overheads
Depreciation of delivery vans Indirect cost Selling Overheads
Depreciation of plant and Indirect cost Production Overheads
equipment
Wages of production worker Direct cost N/A
Production overheads are the total of indirect production costs:
Production overheads = indirect materials + indirect labour + indirect expenses
Few more examples of costs which will be included in production overheads are:
 heating the factory

 lighting the factory
 renting the factory
 Power of the factory
Cost of Product
What will be cost of a product in a factory, depends on the costing system company is following. Company
can adopt any of the following two systems according to its requirements and policy:
1. Marginal Costing
2. Absorption Costing
Under Marginal Costing cost of a product shall only comprise the variable costs of production (Direct
and indirect) whereas under Absorption Costing product cost includes a share from fixed production
overheads as well.
Non-production costs like selling, administrative, finance costs, whether variable or fixed, are never
included in product cost.

Following table can be viewed to understand the difference between marginal and absorption costing.
Description of cost Cost Under

Marginal Absorption
Costing Costing
Direct Material 100 100
Direct Labour 50 50
Direct Expenses 25 25
Variable Production Overheads 5 5
Fixed Production Overheads - 15
Product Cost 180 195
International Accounting Standard (IAS) 2:
Accounting standard on inventories encourages the use of absorption costing in valuing inventory when
required for preparing Financial Statements. As per IAS 2, product cost can be defined as under:
“The cost of inventories shall comprise all costs of purchase, costs of conversion and other costs
incurred in bringing the inventories to their present location and condition”.
Costs of conversion include costs directly related to the units of production, such as direct labour. They
also include a systematic allocation of fixed and variable production overheads that are incurred in
converting materials into finished goods.
Absorption costing
It is a process using which Production Overheads are recovered by absorbing them into the cost of a
product and this process is therefore called Absorption Costing.
The main aim of absorption costing is to recover/ absorb overheads in a way that fairly reflects the
amount of time and effort that has gone into making a product or service.
To implement absorption system, an organization will determine Overhead Absorption Rate (OAR) at the
beginning of a period (usually year) using budgeted (Estimated/ projected) data. This is done so as to
facilitate organization with costing of the products which organization may be producing in the coming
year. Thus it will need their cost information which in turn shall form basis for pricing. Actual values may
not be available until the year is over, thus may not be used during the year for pricing.
Basic Example on Absorption Costing
A company has estimated that its fixed production overhead will be Rs. 2,500,000 next year. Its estimated
production for the next year is 40,000 units.
A Company’s can calculate its fixed overhead cost per unit (Overhead Absorption Rate-OAR) as under:
OAR = Budgeted Production Overheads

Budgeted Production (units)
Rs. 2,500,000
40,000 units
Rs. 62.50 per unit
This is a basic scenario whereas reality, most of the time, is much different like:
 A company will be engaged in producing more than one product requiring different time and
efforts in their production thus overheads cost per unit may not be the same for all products.

 A company may be having different production departments (e.g. Cutting, Machining, Assembly,
Finishing etc.) working on its products. All departments may be spending different time and efforts
on different products.
Thus in order to absorb the production overheads a systematic approach needs to be adopted following
many steps namely:
Stages in Absorption Costing:
1. Identify the cost centers (Departments) operating in the factory. Cost center is a department for
which an organization wants to establish total cost against the work done by it.
2. Allocation involves recording department-wise identifiable costs in their respective cost centers.
Allocable Overhead Costs Cost Center (Department)

Tea bags, Biscuits, Sugar, Rice Canteen
Card Boxes, String Packing
Foreman’s Salary Repairs
3. Costs which are incurred jointly for different cost centers (e.g. Factory rent, Electricity, Plant
insurance etc.), are distributed amongst the cost centers using an appropriate Apportionment
basis.
Production Overheads cost Possible Apportionment Bases

Factory Rent and Rates Area occupied by each department
Plant/ Equipment Insurance Cost/ Book Value of Plant/ Equipment installed in
each department
Employee Insurance Number of Employees in each department
Illustration 1: Apportionment
ABC Ltd has four departments in its factory namely Assembly, Finishing, Maintenance and Canteen.
The following are budgeted costs for the next period:
Description Cost
(Rs.)
Indirect materials 20,000
Rent 15,000
Electricity 10,000
Machine depreciation 5,000
Indirect labour 16,520
Direct labour 125,000
The following information is also available:
Total Assembly Finishing Maintenance Canteen

Area (Square Meters) 4,000 1,000 2,000 500 500
KW hours consumed 10,000 2,750 4,500 1,975 775
Machine Value (Rs.) 100,000 45,000 35,000 11,000 9,000
Staff members 62 20 30 10 2
Direct Labour Hours 6,975 3,175 3,800 - -
Indirect Material Budget (Rs.) 20,000 7,000 8,000 3,000 2,000
Indirect Labour Budget (Rs.) 16,520 1,600 2,220 11,200 1,500
Required:

Using an appropriate basis, apportion joint costs and calculate total overheads for each department.
Illustration 2: Apportionment
A manufacturing company has four departments in its production factory. These include Machining,
Assembly, Repairs and Quality Control. The following information is available about various production
costs.
Total Machining Assembly Repairs Quality

(Rs.) control
Indirect labour cost 25,800 10,000 6,300 4,500 5,000
Indirect materials 7,800 2,500 2,500 1,900 900
Royalty 20,000
Factory rental 25,000
Power costs 7,200
Depreciation (note 1) 12,000
Building insurance 3,750
Plant and equipment insurance 4,000
Total 105,550
Note1: Depreciation relates to plant and equipment.
Indirect labour and indirect material costs have been allocated directly to these four cost centers. The
other overhead costs are shared between the cost centers and so cannot be allocated directly.
Other information:

control
Cost of plant/ equipment (Rs.) 80,000 43,000 17,000 8,000 12,000
Units produced 10,000 10,000 10,000 N/A N/A
Floor area (square meters) 2,500 800 1,000 300 400
Kilowatt hours (KWH) 1,200 800 150 150 100
Required:
Apportion the joint costs and calculate the total overhead of each cost center?
Production vs. Service departments in a factory
In most of the production facilities there are two broad categories of department i.e.:
 Production departments
 Service departments
Production Department is mainly involved in making of the product e.g. Cutting Department, Machining
Department, Assembly Department etc. whereas Service Departments do not work at all for making of
the product, rather they serve the production departments engaged in production. Examples of service
departments include Maintenance Department, Quality Control Department, Canteen etc.
As service departments do not work on the products, it is difficult to distribute their cost amongst the units
produced by the factory.
4. Reapportionment/ Secondary Apportionment is a process whereby service departments’ costs

are apportioned amongst the production departments using an appropriate basis.

Scenarios in Reapportionment
For reapportionment, a company may come across any of the following scenarios:
a. Service departments do not serve other service departments:
Cost of all the service departments are distributed amongst the production departments whom they have
served, using an appropriate basis. We can select service departments for distribution of their costs in
any sequence.
Illustration 3:
A manufacturing company has two production departments, PD1 and PD2. It also has two service
departments, Quality Control and the Repairs department.
Allocated and apportioned general overhead costs for each cost centre are as follows:
PD1: Rs.450,000
PD2: Rs.310,000
Quality Control: Rs.250,000
Repairs: Rs.330,000
Service departments only provide services to production department (No service is provided to other
service department).
Quality Control Department: 30% of its time is spent in PD1 and 70% of its time is spent in PD2.
Repairs Department: 60% of its time is spent on repair work for PD1 and 40% of its time is spent on repair
work for PD2.
Required:
Reapportion the service departments’ costs amongst the production departments and calculate total
overhead cost for each of PD1 and PD2.
Illustration 4:
A production factory located in Gujranwala has three production departments, PD1, PD2 and PD3. It also
has two service departments, Maintenance and the Canteen department.
PD1: Rs.180,000
PD2: Rs.310,000
PD3: Rs.250,000
S1: Rs.230,000
S2: Rs.175,000
Service departments only provide services to production department (No service is provided to other
service department).
S1: 30% of its time is spent on work for PD1, 45% of its time is spent on maintenance work for PD2 and
25% of its time is spent on work for PD3.
15% of its time is spent on work for PD3..

Required:
Reapportion the service departments’ costs amongst the production departments and calculated total
overhead cost for each of PD1, PD2 and PD3.
b. Only one service department serves other service departments (i.e. no reciprocal services
provided):
In such situation cost of service department serving other service department is apportioned first whereas
cost of remaining service departments (providing services to production departments), along with its
share of cost from previous service department, is apportioned later.
Illustration 5:
A manufacturing company has two production departments, PD1 and PD2. It also has two service
departments, Quality Control and the Repairs department.
PD1: Rs.450,000
PD2: Rs.310,000
Quality Control: Rs.250,000
Repairs: Rs.330,000
Quality control department is only providing services to production departments, whereas Repairs
department is also serving quality control department.
Quality Control Department: 30% of its time is spent in PD1 and 70% of its time is spent in PD2.
Repairs Department: 50% of its time is spent on repair work for PD1, 40% of its time is spent on repair
work for PD2 and 10% of its time is spent on repair work for quality control.
Required:
overhead cost for each of PD1 and PD2.
Illustration 6:
A production factory located in Gujranwala has three production departments, PD1, PD2 and PD3. It also
has two service departments, Maintenance and the Canteen department.
PD1: Rs.180,000
PD2: Rs.310,000
PD3: Rs.250,000
S1: Rs.230,000
S2: Rs.175,000
S2 department is only providing services to production departments, whereas S1 department is also

serving the S2.
S1: 30% of its time is spent on work for PD1, 35% of its time is spent on maintenance work for PD2, 25%
of its time is spent on work for PD3 and 10% of its time is spent on work for S2.
15% of its time is spent on work for PD3..

Required:
overhead cost for each of PD1, PD2 and PD3.
c. Where service departments are serving other service departments (Reciprocal services):
 Repeated Distribution Method
Illustration 7
A manufacturing company has two production departments, Machining and Assembly, and two service
departments, Repairs and Quality Control. The following information is available.

control
Allocated/apportioned 120,000 50,000 40,000 14,000 16,000
overhead costs
Work done by the service departments:

Repairs 100% 50% 20% - 30%
Quality Control 100% 30% 55% 15% -
Required:
Reapportion service departments’ cost amongst the production departments using repeated distribution
method and calculate total overheads of each production department.
 Simultaneous Equations Method
Step 1 – Formulate the simultaneous equations:
The first step is to establish two simultaneous equations. There should be one equation for each service
department.
Each equation should state the total amount of overheads of service department. This total overhead is
the original overhead cost of service department (after allocation and apportionment) plus the proportion
of the costs of the other service department that will be apportioned to it.
Step 2 – Solve these simultaneous equations to determine total overhead of each service department,
which should include its share from other department.
Step 3 – Reapportion above calculated overheads cost of each service department using the appropriate
basis amongst all departments including the other service departments.

Illustration 8
A manufacturing company has two production departments, Machining and Assembly, and two service
departments, Repairs and Quality Control. The following information is available.

control
overhead costs
Work done by the service departments:

Repairs 100% 50% 20% - 30%
Quality Control 100% 30% 55% 15% -
Required:
Reapportion service departments’ cost amongst the production departments using simultaneous
equations method and calculate total overheads of each production department.
Illustration 9
XYZ Ltd has three production departments, Alpha, Beta and Gamma, and two service departments,
Maintenance (M) and Payroll (P). The following table shows how costs have been allocated and the
relative usage of each service department by other departments.
Production Service
Department Alpha Beta Gamma M P
Cost (Rs.) 3,000 4,000 2,000 2,500 2,700
Proportion M (%) 20 30 25 - 25
Proportion P (%) 25 25 30 20 -
Required:
Illustration 10
Zee Ltd is a manufacturing organization and has two production departments, P1 and P2 and two service
departments, S1 and S2. The following table shows how costs have been allocated and the relative
usage of each service department by other departments.
Total Production Service

Department P1 P2 S1 S2
Cost (Rs.) 92,000 32,520 22,000 15,000 22,480
Proportion S1 100% 20% 60% - 20%
Proportion S2 100% 70% 20% 10% -
Required:
Reapportion service departments’ cost amongst the production departments and calculate total
overheads of each production department using:
 Repeated distribution method and
 Simultaneous equations method.

Illustration 11
ABC Ltd. has two production departments, Assembly and Finishing and two service departments,
Maintenance and Canteen. The total overheads allocated and apportioned to each department are as
follows:
Department Overheads cost

(Rs.)
Assembly 17,350
Finishing 23,970
Maintenance 18,600
Canteen 6,600
A suitable basis for sharing out the maintenance costs is the time spent servicing equipment. The amount
of time spent by the maintenance department servicing equipment in the other three departments has
been analysed as follows.
Assembly: 50%
Finishing: 40%
Canteen: 10%
The Canteen department’s overheads are to be reapportioned on the basis of the number of employees
in the other three departments.
Assembly Finishing Maintenance Canteen

Number of 15 25 10 2
employees
Required:
Now attempt Question 1: Service Departments
5. Absorption is process whereby production overheads which are allocated and apportioned into the
production departments are absorbed (made part of cost per unit) into the units of product.
Overheads can be absorbed into cost units using the following absorption bases:
 units produced (when company is producing one product only)
 machine hour rate (when production is machine intensive)
 labour hour rate (when production is labour intensive)
 percentage of prime cost
 percentage of direct wages.
Production overheads are usually calculated at the beginning of an accounting period in order to
determine how much cost to assign a unit before calculating a selling price
The overhead absorption rate (OAR) is calculated as follows:
Budgeted production overhead

OAR = –––––––––––––––––––––––––––––
Budgeted total of absorption basis

Illustration 12
JS Ltd is a manufacturing company producing Product X, which has the following cost card:
(Rs.)
Direct labour 4 hrs @ Rs. 5 per hour 20
Direct materials 2 kg @ Rs. 5 per kg 10
Direct expenses 2
Prime cost 32
JS Ltd produces and sells 2,000 units in a month. JS absorbed overheads based on the number of units
produced.
Based on past experience, JS Ltd estimates its monthly overheads will be as follows:
(Rs.)
Heating 6,000
Power 4,000
Maintenance 1,000
Total 11,000
Required:
Calculate:
i. The overhead cost absorbed in each unit of Product X.
ii. The cost per unit of Product X.
Illustration 13
Babar Ltd makes three products D, E and F. Each passes through two departments: Machining and
Assembly.
Labour hours used in each department by each product:
Machining Assembly
Product D 2 hr 2 hr
Product E 4 hr 1 hr
Product F None 8 hr
Production is expected to be as follows:
Product D 2,000 units

Product E 4,000 units
Product F 1,000 units
Overheads are budgeted as follows:
Machining Assembly
Rs. 400,000 Rs. 600,000
Required:
Calculate the followings:

i. Machining department OAR per hour
ii. Assembly department OAR per hour
iii. Overhead cost per unit of E using departmental OAR.

Departmental vs Blanket OARs
It is usual for a product to pass through more than one department during the production process. Each
department will normally have a separate departmental OAR.
• For example, a machining department will probably use a machine hour OAR.
• Similarly, a labour intensive department will probably use a labour hour OAR.
• An alternative to a departmental OAR is what is termed a blanket OAR.
• With blanket OARs, only one absorption rate is calculated for the entire factory regardless of the
departments involved in production.
• Blanket OARs are also known as single factory-wide OARs.
Illustration 14
Using the data from illustration 13, calculate:
i. Blanket OAR per hour

ii. Overhead cost per unit of E using blanket OAR.
Now attempt Question 2: Apportionment

Now attempt Question 3: Overhead Cost per Unit
Now attempt Question 4: Ternary Engineering Limited
Treatment of non-production overheads
Non-production overheads, i.e. administration and sales and distribution overheads, are never absorbed
into product costs. Instead, they are treated in full as an expense in the financial period in which these are
incurred.
However, it is possible to add non-production overheads to the full production cost of units produced and
sold (i.e. No cost will be carried forward to the next period in the form of closing stock), to obtain a full
cost of sale. When this happens, the basis for absorbing the overhead costs should be ‘reasonable’.
 Administration overheads might be added as a percentage of production costs.

 Sales and distribution overheads might also be added as a percentage of production costs.
Alternatively, they might be added as a percentage of the value of sales.
Recording Overheads cost
Debit Credit
Production overheads x
Cash x
Recording actual overheads cost, as and when incurred throughout the year.
Debit Credit
Work in process x
Overheads absorption based on actual activity, using predetermined rate. Overheads are charged
to WIP account as and actual activity (hours worked/ units produced) is performed.
Over/ Under Absorbed Overheads
If either or both of the estimates for the budgeted overheads or the budgeted level of activity are different
from the actual results for the year then this will lead to one of the following:
 Underabsorption (recovery) of overheads

 Overabsorption (recovery) of overheads.

Calculating an under or overabsorption:
There is a three step procedure:
Step 1 – calculate the OAR (based on budget)
Step 2 – calculate the overhead absorbed by actual activity
Overheads absorbed = predetermined OAR × actual level of activity
Step 3 – Compare absorbed to actual
If at the end of this period:
The Overheads Absorbed > Actual Overheads, then there has been an over-absorption of overheads.
The Overheads Absorbed < Actual Overheads, then there has been an under-absorption of overheads.
Illustration 15
The following data relate to Lion Ltd for the month of August.
Budget Actual
Overheads Rs. 160,000 Rs. 180,000
Labour hours 40,000 44,000
Required:
Calculate overheads over/ under absorbed for the month of August.
Illustration 16
The following data relate to Lion Ltd for the month of September.
Budget Actual
Overheads Rs. 297,500 Rs. 275,400
Labour hours 17,000 15,856
Required:
Calculate overheads over/ under absorbed for the month of September.
Accounting for Over/ under-absorbed overheads
Over-absorption of overheads results in overstatement of finished goods in the first place and then
cost of sales, when products are sold. Thus over-absorption is accounted for as under:
(i) When whole output is sold
Debit Credit
Cost of sales x

(ii) When part of production is sold and remaining is held as finished goods
Debit Credit
Cost of sales x
Finished Goods x
Over-absorbed overheads are credited to Cost of Sales and Finished Goods in the ratio of total
production sold and held in finished goods.
Under-absorption of overheads results in understatement of finished goods in the first place and then
cost of sales, when products are sold. Thus under-absorption is accounted for as under:
(i) When whole output is sold
Debit Credit
Cost of sales x
(ii) When part of production is sold and remaining is held as finished goods
Debit Credit
Cost of sales x
Finished Goods x
Under-absorbed overheads are debited to Cost of Sales and Finished Goods in the ratio of total
production sold and held in finished goods.
For example:
Assume that following production data relates to the month of July of A Limited:
Production Overhead Absorbed: Rs. 200,000

Production Overhead (Actual): Rs. 260,000
Production during the period: 30,000 Units
Closing Stock (out of current period’s production): 4,000 Units
Thus overheads are under absorbed by Rs. 60,000, and should be recorded as under
Debit Credit
Cost of sales (60,000 X 26,000 / 30,000) 52,000
Closing inventory finished goods (60,000 X 4,000 / 30,000) 8,000
Fixed production overheads 60,000
Illustration 17
Arif Ltd manufactures and sells a range of products in its factory. Its budgeted production overheads for
Year 2017 were Rs. 225,000, and budgeted direct labour hours were 75,000 hours.
Actual results in Year 2017 were as follows:

(Rs.)
Sales 945,000
Direct materials costs 195,000
Direct labour costs 240,000
Production overhead 210,000 (60,000 hours)
Administration overhead 105,000
Selling and distribution overhead 135,000

There was no opening or closing inventory at the beginning or end of 2017.
The company uses an absorption costing system, and production overhead is absorbed using a direct
labour hour rate.
Required:
(a) Calculate the production overhead absorption rate.

(b) Calculate the over or under absorption of fixed overhead.
(c) Calculate the full production cost.
(d) Show how the profit or loss for the year will be reported.
Now attempt Question 5: Opal Industries Limited (Autumn 2017, Q3)

Now attempt Question 6: Amber Limited
Now attempt Question 7: Zia Textile Mills
Now attempt Question 8: Omega Industries Limited (Spring 2016, Q5)

Answers to Illustrations
Illustration 1
Overheads Basis of Total Assembly Finishing Maintenance Canteen

Apportionment
Indirect materials Allocated 20,000 7,000 8,000 3,000 2,000
Rent Area (w1) 15,000 3,750 7,500 1,875 1,875
Direct labour (w2)
Electricity KWH (w3) 10,000 2,750 4,500 1,975 775
Machine depreciation Machine Value 5,000 2,250 1,750 550 450
(w4)
Indirect labour Allocated 16,520 1,600 2,220 11,200 1,500
Total 66,520 17,350 23,970 18,600 6,600
(w1)
Rent/ Sq. meter = (15,000/4,000) = Rs. 3.75
Assembly = 1,000 x 3.75 = 3,750
Finishing = 2,000 x 3.75 = 7,500
Maintenance = 500 x 3.75 = 1,875
Canteen = 500 x 3.75 = 1,875
(w2)
Direct labour is not an overhead and is therefore not part of overhead allocation and apportionment
process.
(w3)
Electricity/ KWH= (10,000/10,000) = Rs. 1.00
Assembly = 2,750 x 1.00 = 2,750
Finishing = 4,500 x 1.00 = 4,500
Maintenance = 1,975 x 1.00 = 1,975
Canteen = 775 x 1.00 = 775
(w4)
Depreciation= (5,000/100,000) = 5%
Assembly = 45,000 x 5%= 2,250
Finishing = 35,000 x 5% = 1,750
Maintenance = 11,000 x 5% = 550
Canteen = 9,000 x 5% = 450

Illustration 2
Basis of Total Machining Assembly Repairs Quality

Apportionment (Rs.) control
Indirect labour cost Allocated 25,800 10,000 6,300 4,500 5,000
Indirect materials Allocated 7,800 2,500 2,500 1,900 900
Royalty (w1) - - - - -
Factory rental Floor area (w2) 25,000 8,000 10,000 3,000 4,000
Power costs KWH (w3) 7,200 4,800 900 900 600
Depreciation Cost of plant 12,000 6,450 2,550 1,200 1,800
(w4)
Building insurance Floor area (w5) 3,750 1,200 1,500 450 600
Equipment insurance Cost of plant 4,000 2,150 850 400 600
(w6)
Total 85,550 35,100 24,600 12,350 13,500
(w1)
It is a direct cost thus not part of allocation and apportionment of overheads.
(w2)
Rent/ sq. meters = (25,000/2,500) = Rs. 10
Machining = 800 x 10 = 8,000
Assembly = 1,000 x 10 = 10,000
Repairs = 300 x 10 = 3,000
Quality Control = 400 x 10 = 4,000
(w3)
Power cost/ KWH = (7,200/1,200) = Rs. 6
Machining = 800 x 6 = 4,800
Assembly = 150 x 6 = 900
Repairs = 150 x 6 = 900
Quality Control = 100 x 6 = 600
(w4)
Depreciation = (12,000/80,000) = 15%
Machining = 43,000 x 15% = 6,450
Assembly = 17,000 x 15% = 2,550
Repairs = 8,000 x 15% = 1,200
Quality Control = 12,000 x 15% = 1,800
(w5)
Building Insurance/ sq. meters = (3,750/2,500) = Rs. 1.5
Machining = 800 x 1.5 = 1,200
Assembly = 1,000 x 1.5 = 1,500
Repairs = 300 x 1.5 = 450
Quality Control = 400 x 1.5 = 600
(w6)
Equipment Insurance = (4,000/80,000) = 5%
Machining = 43,000 x 5% = 2,150
Assembly = 17,000 x 5% = 850
Repairs = 8,000 x 5% = 400
Quality Control = 12,000 x 5% = 600

Illustration 3:
Basis of PD1 PD2 Quality Repairs

Apportionment Control
Allocated and 450,000 310,000 250,000 330,000
Apportioned costs
Quality Control (30:70) 75,000 175,000 (250,000)
Repairs (60:40) 198,000 132,000 (330,000)
Total 723,000 617,000 - -
Illustration 4:
Basis of PD1 PD2 PD3 S1 S2

Apportionment
Allocated and 180,000 310,000 250,000 230,000 175,000
Apportioned costs
S1 (30:45:25) 69,000 103,500 57,500 (230,000)
S2 (20:65:15) 35,000 113,750 26,250 (175,000)
Total 284,000 527,250 333,750
Illustration 5:
Basis of PD1 PD2 Quality Repairs

Apportionment Control
Allocated and 450,000 310,000 250,000 330,000
Apportioned costs
Repairs (50:40:10) 165,000 132,000 33,000 (330,000)
Quality Control (30:70) 84,900 198,100 (283,000)
Total 699,900 640,100 - -
Illustration 6:
Basis of PD1 PD2 PD3 S1 S2

Apportionment
Allocated and 180,000 310,000 250,000 230,000 175,000
Apportioned costs
S1 (30:35:25:10) 69,000 80,500 57,500 (230,000) 23,000
S2 (20:65:15) 39,600 128,700 29,700 (198,000)
Total 288,600 519,200 337,200
Illustration 7:

control
Allocated/apportioned overhead 120,000 50,000 40,000 14,000 16,000
costs
Quality Control (30:55:15) 4,800 8,800 2,400 (16,000)

Repairs (50:20:30) 8,200 3,280 (16,400) 4,920
Quality Control 1,476 2,706 738 (4,920)
Repairs 369 148 (738) 221
Quality Control 66 122 33 (221)
Repairs 16 7 (33) 10
Quality Control 3 5 2 (10)

Repairs 1 1 (2)
Total 64,931 55,069 - -
Note: Reapportionment can be started by selecting any of the available service department in the first
place.
Illustration 8:
The first step is to establish two simultaneous equations. There should be one equation for each service
department.
Each equation should state the total amount of overheads that will be apportioned from the service
department. This total overhead is the original overhead cost allocation/ apportionment for the service
department, plus the proportion of the costs of the other service department that will be apportioned to it.
Using the example, the two equations are formulated as follows:

Let the total overheads of the Repairs department be R.
Let the total overheads of the Quality Control department be Q.
Then:
R = Original overheads of Repairs department + 20% of Quality Control costs.
Q = Original overheads of Quality Control department + 30% of Repair costs.
This gives us:
R = 14,000 + 0.15Q ------- (i)
Q = 16,000 + 0.30R ------- (ii)
Step 2 – Solve these simultaneous equations:
Put value of Q from equation (ii) in equation (i).
R = 14,000 + 0.15 (16,000 + 0.30R)

R = 14,000 + 2,400 + 0.045R
R – 0.045R = 16,400
0.955R = 16,400
R = 16,400/0.955
R = 17,173
Using value of R above in equation (ii)
Q = 16,000 + 0.30 (17,173)

Q = 21,152

control
costs
Quality Control (30:55:15) 6,345 11,634 3,173 (21,152)

Repairs (50:20:30) 8,586 3,435 (17,173) 5,152
Total 64,931 55,069 - -

Illustration 9:
Let the total overheads of the Maintenance department be M.

Let the total overheads of the Payroll department be P.
Then:
M = Original overheads of Maintenance department + 20% of Payroll costs.
P = Original overheads of Payroll department + 25% of Maintenance costs.
This gives us:
M = 2,500 + 0.20P ------- (i)
P = 2,700 + 0.25M ------- (ii)
Put value of P from equation (ii) in equation (i).
M = 2,500 + 0.20 (2,700 + 0.25M)

M = 2,500 + 540 + 0.05M
M – 0.05M = 3,040
0.950M = 3,040
M = 3,040/0.95
M = 3,200
Using value of M above in equation (ii)
P = 2,700 + 0.25 (3,200)

P = 3,500
Alpha Beta Gamma M P

overhead costs
M (20:30:25:25) 640 960 800 (3,200) 800

P (25:25:30:20) 875 875 1,050 700 (3,500)
Total 4,515 5,835 3,850 0 0

Illustration 10
Repeated distribution method:

Production Service
Total P1 P2 S1 S2
costs
S2 (70:20:10) 15,736 4,496 2,248 (22,480)

S1 (20:60:20) 3,450 10,349 (17,248) 3,449
S2 2,414 690 345 (3,449)
S1 69 207 (345) 69
S2 48 14 7 (69)
S1 2 4 (7) 1
S2 1 - - (1)
Total 54,240 37,760 - -
Simultaneous equations
Let the total overheads of the S1 department be A.

Let the total overheads of the S2 department be B.
Then:
A = Original overheads of S1 department + 10% of S2 costs.
B = Original overheads of S2 department + 20% of S1 costs.
This gives us:
A = 15,000 + 0.10B ------- (i)
B = 22,480 + 0.20A ------- (ii)
Put value of B from equation (ii) in equation (i).
A = 15,000 + 0.10 (22,480 + 0.20A)

A = 15,000 + 2,248 + 0.02A
A – 0.02A = 17,248
0.98A = 17,248
A = 17,248/0.98
A = 17,600
Using value of A above in equation (ii)
B = 22,480 + 0.20 (17,600)

B = 26,000

P1 P2 S1 S2
Allocated/apportioned 32,520 22,000 15,000 22,480

overhead costs
S1 (20:60:20) 3,520 10,560 (17,600) 3,520

S2 (70:20:10) 18,200 5,200 2,600 (26,000)
Total 54,240 37,760
Illustration 11
Let the total overheads of the Maintenance department be M.

Let the total overheads of the Canteen department be C.
Then:
M = Original overheads of Maintenance department + 20% of Canteen costs (Note).
C = Original overheads of Canteen department + 10% of Maintenance costs.
This gives us:
M = 18,600 + 0.20C ------- (i)
C = 6,600 + 0.10M ------- (ii)
Note: Canteen cost will be shared between other three departments in the ration of their employees i.e.
Assembly: 15/50 =30%, Finishing: 25/50 =50% and Maintenance: 10/50 =20%. Canteen’s employees will
be ignored in this analysis.
Put value of C from equation (ii) in equation (i).
M = 18,600 + 0.20 (6,600 + 0.10M)

M = 18,600 + 1,320 + 0.02M
M – 0.02M = 19,920
0.98M = 19,920
M = 19,920/0.98
M = 20,327
Using value of M above in equation (ii)
C = 6,600 + 0.10 (20,327)

C = 8,633

Assembly Finishing Maintenance Canteen
Allocated/apportioned 17,350 23,970 18,600 6,600

overhead costs
Maintenance (50:40:10) 10,163 8,131 (20,327) 2,033

Canteen (30:50:20) 2,590 4,316 1,727 (8,633)
Total 30,103 36,417 - -
Illustration 12
i. Overhead cost absorbed in each unit of Product X = Rs. 11,000/2,000 = Rs. 5.50
ii. Cost per unit of Product X
(Rs.)
Prime cost per unit 32.00
Overheads 5.50
37.50
Illustration 13
i. OAR for machining department = Rs. 400,000/ {(2,000X2)+(4,000X4)} = Rs. 20 per hour
ii. OAR for assembly department = Rs. 600,000/ {(2,000X2)+(4,000X1)+(1,000X8)} = Rs. 37.50
per hour
iii. Overhead cost per unit of E = (4 hour X 20) + ( 1 hour X 37.50) = Rs. 117.50
Illustration 14
i. Blanket OAR = Rs. (400,000+600,000)/ (20,000+16,000) = Rs. 27.78

ii. Overhead cost per unit of E = (4 hour + 1 hour) X 27.78 = Rs. 138.90
Illustration 15
OAR = Rs. 160,000/ 40,000 = Rs. 4

Overheads absorbed = 44,000 X 4 = Rs. 176,000
Overheads under-absorbed = Rs. 180,000 – Rs. 176,000 = Rs. 4,000
Illustration 16
OAR = Rs. 297,500/ 17,000 = Rs. 17.50

Overheads absorbed = 15,856 X 17.50 = Rs. 277,480
Overheads over-absorbed = Rs. 277,480 – Rs. 275,400 = Rs. 2,080
Illustration 17
a. The predetermined absorption rate is Rs. 225,000/ 75,000 hours = Rs.3 per direct labour hour.
b. Under absorption
Rs.
Overhead absorbed (60,000 hours @ RS. 3 per hour) 180,000
Overhead incurred (actual cost) (210,000)
Under-absorption (30,000)

c. The full production cost:
Rs.
Direct materials costs 195,000
Direct labour costs 240,000
Production overhead absorbed (60,000 hours X Rs.3) 180,000
Full production cost (= cost of sales in this example) 615,000
The profit for the year is reported as follows. Notice that under-absorbed overhead is an adjustment
that reduces the reported profit. Over-absorbed overhead would be an adjustment that increases
profit.
Rs.
d. Sales 945,000
Full production cost of sales 615,000
Under-absorbed overhead 30,000
(645,000)
300,000
Administration overhead 105,000
Selling and distribution overhead 135,000
(240,000)
Profit 60,000

Past Papers with Suggested Answers

Question 1: Service Departments

Answer 1: Service Departments

Question 2: Apportionment

Answer 2: Apportionment

Question 3: Overhead Cost per Unit
Answer 3: Overhead Cost per Unit

Question 4: Ternary Engineering Limited
Answer 4: Ternary Engineering Limited


Question 5: Opal Industries Limited (Autumn 2017, Q3)
Answer 5: Opal Industries Limited (Autumn 2017, Q3)

Question 6: Amber Limited

Answer 6: Amber Limited

Question 7: Zia Textile Mills

Answer 7: Zia Textile Mills

Question 8: Omega Industries Limited (Spring 2016, Q5)

Answer 8: Omega Industries Limited (Spring 2016, Q5)

Question 9: Alpha Limited (Spring 2014, Q2)

Answer 9: Alpha Limited (Spring 2014, Q2)

Question 10: Zaiqa Limited (Autumn 2013, Q7)

Answer 10: Zaiqa Limited (Autumn 2013, Q7)

Question 11: Neutron Limited (Spring 2013, Q4)
Answer 11: Neutron Limited (Spring 2013, Q4)


Marginal and Absorption Costing Chapter 2
Marginal and
Absorption Costing

Marginal cost
 Marginal cost = variable cost only.

 Marginal cost of production = Direct material + Direct labour + Direct expenses + variable
production overheads
 Marginal cost of sales = Direct material + Direct labour + Direct expenses + variable production
overheads + Other variable overheads (i.e. selling and administration etc.)
Uses of marginal costing
 Used as an alternative profit measure to absorption costing

 Useful in preparing forecast
 Also used in calculating minimum sales volume to achieve a break-even (will be discussed later)
 A very useful tool in management decision making.
Assumptions in marginal costing
 Variable cost and sales price per unit is constant at all levels
 Total fixed cost is constant at all production levels
 Total costs are either fixed or variable or if are mixed, can be separated easily.
 Contribution per unit = Sales price – variable cost per unit (variable cost includes all production
and non-production variable costs)
 Total contribution = Contribution per unit X units sold (OR Total revenue – Total variable cost)
 Profit = Total contribution – Total fixed cost (fixed cost includes all production and non-production
costs)
Illustration 1:
Abbas Limited manufactures and sells two products, Alpha and Beta. Product Alpha has a variable cost
of Rs.60 and sells for Rs. 100 and product Beta has a variable cost of Rs.80 and sells for Rs.150.
During the month of July, 20,000 units of Product Alpha and 30,000 units of Product Beta were produced
and sold. Fixed cost incurred in the month was Rs. 2,500,000.
Required:
Calculate profit or loss for month of July using the marginal costing principle.
Illustration 2:
Buhner Ltd makes only one product, the cost card of which is:
Element of Cost Rs.

Direct materials 30
Direct labour 60
Variable production overhead 20
Fixed production overhead 40
Variable selling cost 50
The selling price of one unit is Rs. 210.
Sales during the period were 3,000 units and actual fixed production overheads incurred were Rs.
100,000.
Required:
(a) Calculate the total contribution earned during the period.

(b) Calculate the total profit or loss for the period.
Preparing income statement under marginal costing when there is opening and closing stock for
any period
Illustration 3:
Zafar Manufacturing produces and sells only one product Zeta. Details relating to Zeta are as under:
Rs.
Selling price per unit 350
Variable costs:
Direct material per unit 70
Direct labour per unit 40
Variable production overhead per unit 15
Marginal production cost per unit (used in inventory valuation) 125
Variable selling cost per unit 20
Budgeted fixed production overheads are Rs. 160,000 per month and fixed administrative and selling
overheads are Rs. 75,000
The Following are the actual results of March and April 20x6:
March April
Fixed production costs Rs. 150,000 Rs. 155,000
Fixed administrative and selling overheads Rs. 78,000 Rs. 75,000
Production 3,500 units 3,000 units
Sales 2,500 units 4,000 units
There was no opening inventory at the start of March.
Required:
Prepare income statement using the principles of marginal costing for the months of March and April.
Absorption Costing
Illustration 4:
Zerox Ltd. commenced business on 1 July making one product only, the cost/ unit detail of which is as
follows:
(Rs.)
Direct labour 7
Direct material 12
Variable production overhead 4
Fixed production overhead 7
Full production cost per unit 30
The fixed production overhead figure has been calculated on the basis of a budgeted normal output of
40,000 units per annum. The fixed production overhead incurred in July was Rs. 25,000.
Selling, distribution and administration expenses are:
Fixed Rs. 15,000 per month

Variable 10% of the sales value
The selling price per unit is Rs. 45 and the number of units produced and sold were:

July
(units)
Production/ sales 3,000/ 2,500
Required:
Prepare the absorption costing and marginal costing income statements for July.
Illustration 5:
Zafar Manufacturing produces and sells only one product Zeta. Details relating to Zeta are as under:
Rs.
Selling price per unit 350
Variable costs:
Direct material per unit 70
Direct labour per unit 40
Variable production overhead per unit 15
Marginal cost per unit 125
Variable selling cost per unit 20
Budgeted monthly production is 3,200 units. Budgeted monthly fixed production overheads are Rs.
160,000 and monthly fixed administrative and selling overheads are Rs. 75,000.
The Following are the actual results of March and April 20x6:
March April
Fixed production costs Rs. 150,000 Rs. 155,000
Fixed administrative and selling overheads Rs. 78,000 Rs. 75,000
Production 3,500 units 3,000 units
Sales 2,500 units 4,000 units
There was no opening inventory at the start of March.
Required:
Prepare income statement using the principles of absorption costing for the months of March and April.
Illustration 6:
Tough Ltd. makes and sells two products, Xee and Bee. The following information is available for the
month of September:
Xee Bee
Production (units) 5,000 3,500
Sales (units) 4,600 3,200
Opening inventory (units) - -
Financial data:
Xee Bee
(Rs.) (Rs.)
Unit selling price 180 150
Unit cost:
Direct materials 30 24
Direct labour 36 24
Variable production overheads 24 16
Fixed production overheads (Pre-determined) 60 40
Variable selling overheads 2 2

Fixed production overheads for the period were Rs. 410,000 and fixed administration overheads were Rs.
154,000.
Required:
(a) Prepare an income statement for the month of September based on marginal costing principles.
(b) Prepare an income statement for the month of September based on absorption costing principles.
Reconciling Profits under Marginal Costing with Profits under Absorption Costing when OAR per
unit is same for both Opening Stock and Closing Stock
 Opening Stock value brings forward last year’s absorbed overheads to current year
 Closing Stock value carries forward current year’s absorbed overheads to next year
Thus if:
Closing stock units = Opening stock units

Profit under Absorption costing = Profit under marginal costing
However if:
Closing stock units > Opening stock units

Profit under Absorption costing > Profit under marginal costing
And if:
Closing stock units < Opening stock units

Profit under Absorption costing < Profit under marginal costing
Illustration 7:
Reconcile profits calculated under marginal costing with profits under absorption costing in “Illustration 4”.
Illustration 8:
Reconcile profits for the months of March and April calculated under marginal costing with profits under
absorption costing in “Illustrations 3 and 5” respectively.
Illustration 9:
Reconcile profits calculated under marginal costing with profits under absorption costing in “Illustration 6”.
Reconciling Profits under Marginal Costing with Profits under Absorption Costing when either:
 OAR per unit is Different for both Opening Stock and Closing Stock OR
 Units of opening stock and closing stock are not provided (Only values available)
Illustration 10:
A company uses marginal costing. In the financial period that has just ended, opening inventory was Rs.
20,000 and closing inventory was Rs. 35,000. The reported profit for the year was Rs. 192,000.
If the company had used absorption costing, opening inventory would have been Rs. 30,000 and closing
inventory would have been Rs. 55,000.
Required:
What would have been the profit for the year if absorption costing had been used?

Illustration 11:
A company uses absorption costing. In the financial period that has just ended, opening inventory was
Rs. 95,000 and closing inventory was Rs. 65,000. The reported profit for the year was Rs. 260,000.
If the company had used marginal costing, opening inventory would have been Rs. 58,000 and closing
inventory would have been Rs. 42,000.
Required:
What would have been the profit for the year if marginal costing had been used?
Illustration 12:
Azore Ltd uses absorption costing and following data is available relating to two different years:
Opening stock as on 1st January 2015 1,000 units valued at Rs. 25,000
Budgeted Fixed Production overheads for the year 2014 Rs. 200,000
Budgeted Production for the year 2014 20,000 units
Closing stock as on 31st December 2015 2,000 units valued at Rs. 54,000
Budgeted Fixed Production overheads for the year 2015 Rs. 300,000
Budgeted Production for the year 2015 25,000 units
Profits for the year 31st December 2015 Rs. 150,000
Required:
Illustration 13:
The following information relates to a manufacturing company for a Period.
Production 25,000 units Fixed production costs Rs. 150,000
Sales 20,000 units Fixed selling costs Rs. 70,000
There was no opening stock. Using absorption costing, the profit for this period would be Rs. 85,000
Required:
Illustration 14:
Red Company is a manufacturing company that makes and sells a single product. The following
information relates to the company’s manufacturing operations in the next financial year.
Opening stock Nil

Production 32,000 units
Sales 25,000 units
Fixed production overheads Rs.192,000
Fixed sales overheads Rs.120,000
Using absorption costing, the company has calculated that the budgeted profit for the year will be Rs.
75,000.
Required:
What would be the budgeted profit if marginal costing is used, instead of absorption costing?

Illustration 1:
Contribution per unit:

Product A: Rs. 100 – Rs. 60 = Rs. 40
Product B: Rs. 150 – Rs. 80 = Rs.70
(Rs.)
Contribution from Product A: (20,000 x Rs. 40) 800,000
Contribution from Product B: (30,000 x Rs.70) 2,100,000
Total contribution for the period 2,900,000

Fixed costs for the period (2,500,000)
Profit for the period 400,000
Illustration 2:
(a) Variable costs per unit = Rs. (30 + 60 + 20 + 50) = Rs. 160
Contribution per unit = Selling price less (All; production and non-production) Variable costs per unit) =
Rs. 210 – Rs. 160 = Rs. 50
Total contribution earned = 3,000 x Rs. 50 = Rs. 150,000
(b) Total profit/(loss) = Total contribution – Actual (All; production and non-production) fixed overheads
incurred
= Rs. (150,000 – 100,000)
= Rs. 50,000
Illustration 3:
Zafar Manufacturing
Income Statement under Marginal Costing
March April
(Rs.) (Rs.)
Sales
2,500 units x Rs. 350 875,000
4,000 units x Rs. 350 1,400,000
Opening inventory - 125,000
Variable production costs:
3,500 units x (70 + 40 + 15) 437,500
3,000 units x (70 + 40 + 15) 375,000
Closing inventory:
1,000 units @ (125) (125,000)
Zero closing inventory -
Variable Production cost of sales 312,500 500,000
Variable selling costs (2,500 units x 20) 50,000
(4,000 units x 20) 80,000
Variable cost of sales 362,500 580,000
Contribution 512,500 820,000
Fixed Overheads

Production (150,000) (155,000)
Administrative and Selling (78,000) (75,000)
Net Profit
284,500 590,000
Alternative Format
(Used when either there is no Opening Stock or cost per unit of Opening Stock units and current period
production is same)
March April
(Rs.) (Rs.)
Contribution
2,500 units x Rs. 205 (w1) 512,500
4,000 units x Rs. 205 (w1) 820,000
Fixed Costs:
Production (150,000) (155,000)
Administrative and Selling (78,000) (75,000)
Net Profit
284,500 590,000
(w1)
Contribution per unit = 350 – 70 – 40 – 15 – 20 = Rs. 205
Illustration 4:
Zerox Ltd.
July
(Rs.)
Contribution
2,500 units x Rs. 17.50 (w1) 43,750
Fixed Costs:
Production (25,000)
Administrative and Selling (15,000)
Net Profit/ (Loss)
3,750
(w1)
Contribution per unit = 45 - 7 - 12 - 4 - (10% x Rs. 45) = Rs. 17.50

Zerox Ltd.
Income Statement under Absorption Costing
July
(Rs.)
Sales
2,500 units x Rs. 45 112,500
Cost of Sales
Production cost (3,000 x Rs. 30) 90,000
Closing inventory (500 units x Rs. 30) (15,000)
(Over)/ Under absorbed Overheads (w2) 4,000
Cost of Sales 79,000
Gross Profit 33,500
Fixed Selling and Distribution expenses (15,000)
Variable Selling and Distribution expenses (10%x Rs.
112,500) (11,250)
Net Profit/ (Loss) 7,250
(w2)
(Rs.)
Over/ Under absorbed Overheads
Actual Overheads 25,000
Absorbed Overheads (3,000x7) 21,000
(Over)/ Under absorbed Overheads 4,000
Illustration 5:
Zafar Manufacturing
March April
Sales:
2,500 units x Rs. 350 875,000
4,000 units x Rs. 350 1,400,000
Opening inventory - 175,000
Production costs:
3,500 units x (70 + 40 + 15 + 50 (w1)) 612,500
3,000 units x (70 + 40 + 15 + 50) 525,000
Closing inventory: 1,000 units @ (175) (175,000) -
437,500 700,000
(Over)/ Under Absorbed Overheads (w2) (25,000) 5,000
Cost of sale 412,500 705,000
Gross Profit 462,500 695,000
Fixed Administrative and Selling Costs (78,000) (75,000)
Variable Selling Costs (50,000) (80,000)
Net Profit 334,500 540,000

(w1)
OAR = Rs. 160,000/ 3,200

OAR = Rs. 50
(w2)
March April
Actual Overheads 150,000 155,000
Absorbed Overheads (3,500x50; 3,000x50) 175,000 150,000
(Over)/ Under absorbed Overheads (25,000) 5,000
Illustration 6:
Tough Ltd.
September
(Rs.)
Contribution
(4,600x88)+(3,200x84) (w1) 673,600
Fixed Costs:
Production (410,000)
Administrative and Selling (154,000)
Net Profit/ (Loss)
109,600
(w1)
Contribution per unit:

Xee = 180 – 30 – 36 – 24 – 2 = Rs. 88
Bee = 150 – 24 – 24 – 16 – 2 = Rs. 84
Tough Ltd.
September
(Rs.)
Sales
(4,600x180)+(3,200x150) 1,308,000
Cost of Sales
(4,600x150)+(3,200x104) 1,022,800
(Over)/ Under absorbed Overheads (w2) (30,000)
Cost of Sales 992,800
Gross Profit 315,200
Fixed Administration expenses (154,000)
Variable Selling overheads (4,600x2)+(3,200x2) (15,600)
Net Profit/ (Loss) 145,600

(w2)
(Rs.)
Actual Overheads 410,000
Absorbed Overheads (5,000x60)+(3,500x40) 440,000
(Over)/ Under absorbed Overheads (30,000)
Illustration 7:
(Rs.)
Profit under Absorption costing 7,250
Difference in opening and closing stock units x (3,500)*
OAR {(0-500) x 7}
Profit under Marginal costing 3,750
*when closing stock units (500 units) > opening stock units (zero), profit reported using Absorption
Costing is higher.
Illustration 8:
(Rs.)
March April
Profit under Absorption costing 334,500 540,000
Difference in opening and closing stock units x (50,000) 50,000
OAR (1,000 x 50)
Profit under Marginal costing 284,500 590,000
Illustration 9:
(Rs.)
OAR {(0-400) x 60}+{(0-300) x 40}
*when closing stock units (400 units of Xee and 300 units of Bee) > opening stock units (zero for both Xee
and Bee), profit reported using Absorption Costing is higher.
Illustration 10:
(Rs.)
Adjustment (w1), Added as absorption costing reports higher profits 10,000
when closing inventory is higher.
(w1)
Difference in opening and closing inventory under marginal costing = (Rs. 35,000 - Rs. 20,000) = Rs.
15,000
Difference in opening and closing inventory under absorption costing = (Rs. 55,000 - Rs. 30,000) = Rs.
25,000
Difference of the difference = Rs. 25,000 – Rs. 15,000 = Rs. 10,000

Illustration 11:
(Rs.)
Adjustment (w1), Added as marginal costing reports higher profits 14,000
when opening inventory is higher.
(w1)
16,000
30,000
Illustration 12:
(Rs.)
Adjustment (w1), deducted as marginal costing reports lower profits (14,000)
when closing inventory is higher.
(w1)
OAR in opening stock (2014) = Rs. 200,000/20,000 = Rs. 10

OAR in closing stock (2015) = Rs. 300,000/25,000 = Rs. 12
Stock value under marginal costing = Value under absorption costing – fixed production overheads
absorbed
Opening stock value under marginal costing = Rs. 25,000 – (1,000 units x Rs. 10) = Rs. 15,000
Closing stock value under marginal costing = Rs. 54,000 – (2,000 units x Rs. 12) = Rs. 30,000
15,000
29,000
Illustration 13:
(Rs.)
OAR
{(25,000-20,000)x(150,000/25,000)
*when closing stock units (5,000 units) > opening stock units (zero), profit reported using Absorption
Costing is higher.
Note: Fixed selling costs are not included in inventory valuation.
Illustration 14:
(Rs.)
OAR
{(32,000-25,000)x(192,000/32,000)

*when closing stock units (4,000 units) > opening stock units (zero), profit reported using Absorption
Costing is higher.
Note: Fixed sales overhead are not included in inventory valuation.


Question 1: ATF Limited

Answer 1: ATF Limited

Question 2: Silver Limited

Answer 2: Silver Limited

Question 3: Zulfiqar Limited

Answer 3: Zulfiqar Limited
Question 4: XY Limited

Answer 4: XY Limited (Spring 2014, Q4)

Inventory Valuation Chapter 3
Inventory Valuation

Ordering and purchasing documentation
When an entity purchases materials from a supplier, the purchasing process should be properly
documented in order to maintain proper controls over the entire process and to ensure that correct
amounts are recorded and reflected in the financial reports.
Following measures should ensure an efficient system:
 maintain a list of approved and vetted vendors, which should be periodically updated and any
additions should be properly supervised.
 all purchase of materials from a supplier should be properly authorised and approved at the
appropriate management level, e.g.
 Upto Rs. 10,000 – Approval of Finance Manager

 Between Rs. 10,001-200,000 – Senior Manager Finance
 Greater than 200,000 – Finance Director
 Proper system of documentation should be introduced to ensure that approval has been
obtained, receipt of materials from a supplier is acknowledged, and the goods receipt note be
compared to the purchase requisition and purchase order to make sure that the goods that were
ordered have actually been delivered.
 Obtain an invoice from the supplier for the goods that have been delivered. The amount payable
for the materials provides documentary evidence about their cost.
 Materials received from a supplier, might be kept in a store or warehouse until needed under
appropriate storage conditions. When they are issued from the store, there should be a
documentary record of who has taken the materials and how many were taken. This is needed to
provide a record of the cost of materials used by different departments or cost centres.
Documentation of purchase process is therefore needed:
 to ensure that the procedures for ordering, receiving and paying for materials has been
conducted properly, and there is no error or fraud
 to provide a record of materials purchases for the financial accounts
 to provide a record of materials costs for the cost and management accounts.
 to ensure physical controls over the materials and to ensure they are used not used improperly
The detailed procedures for purchasing materials and the documents used might differ according to the
size, complexity and nature of the business. However, the basic requirements are same for all types of
business where material purchases are made.

Valuation of Inventory
Inventory valuation is important for:
 Financial reporting
 Costing
Inventory must be measured in the financial statements at the lower of:
 Cost, or
 Net Realisable Value (NRV).
NRV
NRV is the amount that can be obtained from disposing of the inventory in the normal course of business,
less any further costs that will be incurred in getting it ready for sale or disposal.
NRV is usually higher than cost unless the product is damaged or obsolete.
The cost and NRV should be compared for each separately-identifiable item of inventory, or group of
similar inventories, rather than for inventory in total.
Illustration 1:
ZZ Limited has five items in its inventory at year-end of 20x6. Details relating to inventory are as under:
Item Cost Sale value Selling cost

A 25,000 37,500 500
B 45,000 52,300 1,250
C 38,000 38,500 2,000
D 55,000 70,000 2,800
E 47,000 45,000 1,500
Required:
Calculate the value which should be included in statement of financial position at the year-end

Cost
Cost of one item may vary from time to time in a year thus identifying actual cost of each product may not
be possible. This requires a system/ basis under which a cost should be calculated and assigned.
Commonly used approaches are:
 First in, first out (FIFO)

 Weighted average cost (AVCO)
FIFO
Assumes that materials are issued out of inventory in the order in which they were purchased/ delivered
into inventory.
Illustration 2:
Majid Limited had the following material transactions during the first week in March.
Quantity Unit
(units) cost
(Rs.)
Opening balance 1st March 10 2.00
Receipts 2nd March 70 2.20
Issues 3rd March 40
Receipts 4th March 50 2.30
Issues 5th March 70
Required:
Determine cost of issues during the period and value of the inventory at the end of week using FIFO
approach.
Advantages:
 Logical – reflects the most likely physical flow.

 Easily understood.
 Inventory values at up-to-date prices.
 Acceptable under IAS-2.
 Inventory values are near to replacement cost.
Disadvantages:
 It is cumbersome to operate.
 Issues may be at out-of-date prices.
 In times of rising prices (as in this example), reported profits are high (‘high’ closing inventory
valuations).
 Cost comparisons between jobs are difficult.
AVCO
AVCO method of inventory valuation assumes that all units are issued at the current weighted average
cost per unit.
Normally average cost is calculated on perpetual basis i.e. company should calculate average cost after
every purchase and all later issues are made the most recent average cost calculated. Average cost if
calculate at every purchase using the following formula:

Average cost = Cost of inventory currently in store + Cost of new items received
Number of units currently in store + Number of new units received
Illustration 3:
Majid Limited had the following material transactions during the first week in March.
Quantity Unit
(units) cost
(Rs.)
Opening balance 1st March 10 2.00
Receipts 2nd March 70 2.20
Issues 3rd March 40
Receipts 4th March 50 2.30
Issues 5th March 70
Required:
Determine cost of issues during the period and value of the inventory at the end of week using AVCO
approach.
Illustration 4:
On 1 January AA Limited had an opening inventory of 1,000 units which cost Rs. 5 each.
During the year it made the following purchases:

15 March: 3,000 units at Rs. 5.50 each
10 June: 5,000 units at Rs. 6 each
7 September: 2,500 units at Rs. 7 each.
12 November: 1,500 units at Rs. 7.50
During the year it also sold 12,500 units as follows:

9 May: 500 units
25 July: 3,000 units
18 October: 3,500 units
23 November: 4,000 units
12 December: 1,500 units
Required:
Determine the cost of the units issued during the year and inventory in hand at the year-end using:
(i) FIFO
(ii) AVCO valuation approach.
Advantages:
 Smoothen out price movements.

 Easier to operate.
 Acceptable under IAS-2.
 Logical because units all have the same value.
Disadvantages:
 Issue prices and inventory values may not be an actual purchase price (as in above example).
 Inventory values and issue prices may both lag behind current values.

Illustration 5:
Arif Limited has produced following stores transactions for the month of July 20x6:
July Opening balance 25 units at value of Rs. 162.50

1
4 Issue Req. no. 85 8 units
6 Receipt from B & Co. GRN no. 26 50 units @ Rs. 5.75
10 Return to B & Co. 10 units
15 Receipt from M & Co. GRN no. 33 25 units @ Rs. 6.10
19 Received replacement from B & Co. GRN no. 38 10 units
20 Returned from production MRN no. 4 5 units
22 Transfer from Job 182 to Job 187 in production. MTN no. 6 5 units
29 Transfer from Production department A to B. MTN no. 10 5 units
30 Shortage in physical stock taking. 2 units
Required:
Record all above transactions in store ledger and value month end closing inventory using FIFO
approach.
Now attempt Question 1: XYZ Limited

Now attempt Question 2: Mehanti Limited

Illustration 1:
Item Cost NRV = Lower of

Sale value – Selling cost Cost or NRV
A 25,000 37,500 – 500 = 37,000 25,000
B 45,000 52,300 – 1,250 = 51,050 45,000
C 38,000 38,500 – 2,000 = 36,500 36,500
D 55,000 70,000 – 2,800 = 67,200 55,000
E 47,000 45,000 – 1,500 = 43,500 43,500
Total 205,000
Illustration 2:
Date Receipts Issues Balance
Amount Amount Amount

Qty Rate (Rs.) Qty Rate (Rs.) Qty Rate (Rs.)
Balance b/f 10 2.00 20
2 March 70 2.20 154 10 2.00 20
70 2.20 154
80 174
3 March 10 2.00 20 40 2.20 88
30 2.20 66
40 86 40 88
4 March 50 2.30 115 40 2.20 88
50 2.30 115
90 203
5 March 40 2.20 88 20 2.30 46
30 2.30 69
70 157 20 46
 Closing inventory valuation = 20 units @ Rs. 2.30 = Rs. 46

 Closing inventory valuation = Opening inventory + receipts – issues
= Rs. 20 + (Rs. 154 + Rs. 115) – (Rs. 86 + Rs. 157) = Rs. 46

Illustration 3:

Balance b/f 10 2.00 20.00
2 March 70 2.20 154.00 10 2.00 20.00
70 2.20 154.00
80 2.18 174.00
3 March 40 2.18 87.20 40 2.18 87.20
4 March 50 2.30 115.00 40 2.18 87.20
50 2.30 115.00
90 2.25 202.20
5 March 70 2.25 157.50 20 2.25 45.00
 Closing inventory valuation = 20 units @ Rs. 2.25 = Rs. 45.00

 Closing inventory valuation = Opening inventory + receipts – issues
= Rs. 20 + (Rs. 154 + Rs. 115) – (Rs. 87.20 + Rs. 157.50) = Rs. 45.00
Illustration 4:
(i) FIFO

Balance b/f 1,000 5.00 5,000
15 March 3,000 5.50 16,500 1,000 5.00 5,000
3,000 5.50 16,500
4,000 21,500
9 May 500 5.00 2,500 500 5.00 2,500
3,000 5.50 16,500
500 2,500 3,500 19,000

10 June 5,000 6.00 30,000 500 5.00 2,500
3,000 5.50 16,500
5,000 6.00 30,000
8,500 49,000
25 July 500 5.00 2,500 500 5.50 2,750
2,500 5.50 13,750 5,000 6.00 30,000
3,000 16,250 5,500 32,750
7 September 2,500 7.00 17,500 500 5.50 2,750
5,000 6.00 30,000
2,500 7.00 17,500
8,000 50,250
18 October 500 5.50 2,750 2,000 6.00 12,000
3,000 6.00 18,000 2,500 7.00 17,500
3,500 20,750 4,500 29,500
12 November 1,500 7.50 11,250 2,000 6.00 12,000
2,500 7.00 17,500
1,500 7.50 11,250
6,000 40,750
23 November 2,000 6.00 12,000 500 7.00 3,500
2,000 7.00 14,000 1,500 7.50 11,250
4,000 26,000 2,000 14,750
12 December 500 7.00 3,500 500 7.50 3,750
1,000 7.50 7,500
1,500 11,000 500 3,750
Total Issues 12,500 76,500

(ii) AVCO

Balance b/f 1,000 5.00 5,000
15 March 3,000 5.50 16,500 1,000 5.00 5,000
3,000 5.50 16,500
4,000 5.38 21,500
9 May 500 5.38 2,688 3,500 5.38 18,813
10 June 5,000 6.00 30,000 3,500 5.38 18,813
5,000 6.00 30,000
8,500 5.74 48,813
25 July 3,000 5.74 17,228 5,500 5.74 31,585
7 September 2,500 7.00 17,500 5,500 5.74 31,585
2,500 7.00 17,500
8,000 6.14 49,085
18 October 3,500 6.14 21,474 4,500 6.14 27,610
12 November 1,500 7.50 11,250 4,500 6.14 27,610
1,500 7.50 11,250
6,000 6.48 38,860
23 November 4,000 6.48 25,907 2,000 6.48 12,953
12 December 1,500 6.48 9,715 500 6.48 3,238
Total Issues 12,500 77,012

Illustration 5:
Date Receipts Issues Balance Remarks

July 1 25 6.50 162.50
4 8 6.50 52.00 17 6.50 110.50
6 50 5.75 287.50 17 6.50 110.50
50 5.75 287.50
67 398.00
7 12 6.50 78.00 5 6.50 32.50
50 5.75 287.50
12 78.00 55 320.00
Return to
10 10 5.75 57.50 5 6.50 32.50 B
40 5.75 230.00 Note 2
45 262.50
12 5 6.50 32.50 30 5.75 172.50
10 5.75 57.50
15 90.00 30 172.50
13 20 5.75 115.00 10 5.75 57.50
15 25 6.10 152.50 10 5.75 57.50
25 6.10 152.50
35 210.00
17 10 5.75 57.50 25 6.10 152.50
19 10 5.75 57.50 25 6.10 152.50 Note 1
10 5.75 57.50
35 210.00

20 5 5.75 28.75 5 5.75 28.75 Note 3
25 6.10 152.50
10 5.75 57.50
40 238.75
26 5 5.75 28.75 20 6.10 122.00
5 6.10 30.50 10 5.75 57.50
10 59.25 30 179.50
30 2 6.10 12.20 18 6.10 109.80 Shortage
10 5.75 57.50
28 167.30
Closing stock value at month end is 28 units at the value of Rs. 167.30.
Notes:
(1) The material received as replacement from B & Co. on 19 July will be treated as fresh supply.
However, rate used will be the original i.e. Rs. 5.75.
(2) The material return to B & Co. on 10 July will be recorded in issue column.
(3) Return from production on 20 July will be recorded in receipt column and will be treated as oldest
material while issuing.
(4) Transfers from one job to other or from one production department to other do not affect the store
ledger account.

Question 1: XYZ Limited

Answer 1: XYZ Limited

Question 2: Mehanti Limited

Answer 2: Mehanti Limited


Inventory Management Chapter 4
Inventory
Management

Objective of inventory Management
Objective of inventory management is to minimize inventory related costs on annual basis while
maintaining it at appropriate level.
Costs associated with inventory:
1. Purchase cost: Paid to supplier

2. Reorder cost: Include administrative cost of placing an order also include transportation inward
cost for receiving the goods e.g.
a. Administrative cost of placing an order
b. Cost of inspection
c. Inward delivery cost etc.
3. Inventory holding cost: Cost of keeping inventory in warehouse e.g.
a. Warehousing cost (rent etc.)
b. Damage and obsolescence of stock
c. Stock insurance
d. Finance cost on funds which are invested on inventory etc.
4. Stock-out cost: Loss if company gets stock-out e.g.
a. Loss of profit
b. Loss of customer
c. Loss of goodwill
d. Cost of emergency purchase etc.
Calculating annual ordering and holding cost
Annual Ordering cost = Annual demand x Cost per order

Order size
Annual Holding cost = Average inventory x Cost of holding one unit for one year
Where;
Average inventory = Order Size

2
Illustration 1:
A company requires 10,000 units of material X per month. The cost per order is Rs. 300 regardless of the
size of the order. The holding costs are Rs. 2.88 per unit pa.
Required:
Investigate the total annual cost of buying and holding the material in quantities of 4,000, 5,000, or 6,000
units at one time. What is the cheapest option?
Economic Order Quantity (EOQ)
It is a reorder size that ensures that sum of annual cost of ordering and holding is minimized.
 As order size increase, annual ordering cost decreases due to decrease in number of orders in a
year.
 But with increase in order size, average inventory will increase thus annual holding cost will rise.
 EOQ strikes a balance by finding an optimum order size. In the above illustration order size of
5,000 can be termed as EOQ.
 At EOQ annual ordering and holding cost are equal.

EOQ can also be calculated using the following formula:
We can recalculate EOQ for above illustration using the formula as under:
2 Co D 2 x 300 x 120,000
EOQ=√ =√ = 5,000 units
CH 22.88
Illustration 2:
Monthly demand for a product is 5,000 units. The purchase price is Rs. 100/unit and the company’s cost
of finance is 10% pa. Warehouse storage costs per unit pa are Rs. 20. The supplier charges Rs. 2,000
per order for delivery.
Required:
Calculate:
(i) EOQ
(ii) Annual cost of inventory management.
Illustration 3:
A company uses the Economic Order Quantity (EOQ) model to determine the purchase order quantities
for materials.
The demand for material item X23 is 6,000 units every six months. The item costs Rs. 100 per unit, and
the annual holding cost is 8% of the purchase cost per year. The cost of placing an order for the item is
Rs. 500.
Required:
What is the economic order quantity for material item X23 (to the nearest unit)?
Illustration 4:
A company uses the Economic Order Quantity (EOQ) model to determine the purchase order quantities
for materials.
The demand for material item Z90 is 270,000 units per year. The item costs Rs. 200 per unit, and the
annual holding cost is 7.5% of the purchase cost per year. The cost of placing an order for the item is Rs.
1,000.
Required:
What are the annual holding costs for material item Z90?
Illustration 5:
A company uses a chemical, ABC in its production processes.
ABC costs Rs. 2,240 per kg. Each month, the company uses 10,000 kg of ABC and holding costs per kg.
per annum are Rs. 40. Every time the company places an order for XYZ it incurs administrative costs of
Rs. 360.
Required:
What is the economic order quantity for material item ABC (to the nearest Kgs)?
Minimizing purchase cost (optimum order size with purchase discounts available)
EOQ formula assumes that that the purchase cost per unit of material is constant, regardless of the order
quantity.
If a supplier offers a discount on the purchase price for orders above a certain quantity, the purchase
price becomes a relevant cost. When this situation arises, the order quantity that minimises total costs will
be either:
 the economic order quantity; or

 the minimum order quantity necessary to obtain the price discount.
The total costs each year including purchases, ordering costs and holding costs, must be calculated for
the EOQ and the minimum order quantity to obtain each discount on offer.
Step 1: Calculate EOQ, ignoring discounts.

Step 2: Calculate annual inventory cost (including purchase cost) for EOQ and other order sizes
qualifying for discount.
Step 3: Compare the costs in Steps 2 and select the order size with minimum annual cost.
Illustration 6:
Wajid Ltd is a retailer of barrels. The company has an annual demand of 60,000 barrels. The barrels cost
Rs. 20 each. Fresh supplies can be obtained immediately, with ordering and transport costs amounting to
Rs. 1,000 per order. The annual cost of holding one barrel in stock is estimated to be Rs. 12.
A 2% discount is available on orders of at least 5,000 barrels and a 2.5% discount is available if the order
quantity is 7,500 barrels or above.
Required:
Calculate the EOQ ignoring the discount and determine if it would change once the discount is taken into
account.
Illustration 7:
Dawood Limited uses component Z11 in its construction process. The company has a demand of 90,000
components pa. They cost Rs. 9 each. The delivery and ordering costs amount to Rs. 1,000 per order.
The annual cost of holding one component in inventory is estimated to be Rs. 6.50.
A 0.5% discount is available on orders of at least 5,000 components and a 0.75% discount is available if
the order quantity is 8,000 components or above.
Required:
Calculate the optimum order quantity.
Illustration 8:
Azhar Limited uses 100,000 units of Material Y each year, which costs Rs. 1,000 for each unit. The cost
of placing an order is Rs. 10,000 for each order. The annual cost of holding inventory each year is 8% of
the purchase cost.
The supplier offers a price discount of Rs. 10 per unit for orders of 10,000 or more.
Required:
Determine the optimum reorder quantity.
Illustration 9:
Abid Limited uses 250,000 units of Material A each year, which costs Rs. 25 for each unit. The costs of
making an order are Rs. 2,000. The annual cost of holding inventory is 10% of the purchase cost.
The supplier offers a price discount of Rs. 1 per unit for orders of 22,500 up to 29,999 units, and a
discount of Rs. 2 per unit for orders of 30,000 units or more.
Required:
Find the reorder quantity that will minimise annual inventory costs.
Now attempt Question 1: Inventory Control

Minimizing Stock out costs
To minimize stock out cost, company must set a reorder level, with or without buffer (safety) stock.
Reorder Level
 It is inventory level, when reached; new order should be placed to the supplier.
 It is required as lead time (time required for delivery from the time an order is laced) is involved with
almost every supplier.
 Reorder level is calculated and set for every item of inventory to avoid stock outs.
Reorder level – Certain lead time and constant demand
ROL = Demand for the material item per day/ week × Lead time in days/ weeks
Illustration 10:
Using the data for Wajid Limited from Illustration 6, assume that the company adopts the EOQ as its order
quantity and that it now takes two weeks for an order to be delivered.
Required:
(i) How much inventory will it have on hand when the order is placed?
(ii) How frequently will the company place an order?
Illustration 11:
Using the data for Dawood Limited from Illustration 7, ignoring discounts and assume that the company
adopts the EOQ as its order quantity and that it now takes three weeks for an order to be delivered.
Required:
(i) How much inventory will it have on hand when the order is placed?
(ii) How frequently will the company place an order?
Reorder level: Uncertain demand in lead time
ROL = Maximum demand for the X Maximum supply lead time in

material item per day/ week days/ weeks
Buffer/ Safety stock
With uncertain demand or lead time, increased ROL provides company with some safety stock which
prevents company from getting stock out in case demand or lead time exceeds the normal level.
Safety Stock = ROL – Average usage in average lead time

Illustration 12:
Record of Abbas limited for previous year shows following details relating to Material AA:
Daily usage Lead time

(Units) (Days)
Maximum 150 12
Average 120 10
Minimum 100 8
Required:
Calculate the following for Abbas Limited:
(i) Reorder level

(ii) Safety stock
Average inventory and Buffer stock
Average inventory value that is used in the calculation of annual inventory holding cost is recalculated
using following formula with the introduction of Safety stock:
Average inventory = Order Size + Safety stock

2
Maximum Inventory level
Company should set a maximum level for inventory. Inventory held above this would incur extra holding
cost without adding any benefit to the company.
Maximum level = ROL + Reorder quantity – (Minimum usage during minimum lead time)
Minimum inventory level
Another term used in the context of inventory management is Minimum inventory level which is EQUAL to
Safety stock. i.e.
Minimum inventory level = ROL – Average usage in average lead time
Illustration 13:
Record of AH Limited for previous year shows following details relating to material X:
Weekly usage Lead time

(Units) (Weeks)
Maximum 3,000 4
Average 2,400 3
Minimum 1,600 2
Reorder quantity for this material is 10,000 units.
Required:
Calculate the following for AH Limited:
(i) Reorder level

(ii) Safety stock
(iii) Maximum inventory level
(iv) Minimum inventory level
(v) Average stock
Illustration 14:
Record of ZA Limited for previous year shows following details relating to material JJ:
Monthly usage Lead time

(Units) (Months)
Maximum 5,000 2
Average 4,200 1.5
Minimum 3,500 1
Reorder quantity for this material is 12,000 units.
Required:
Calculate the following for ZA Limited:
(i) Reorder level

(ii) Safety stock
(iii) Maximum inventory level
(iv) Minimum inventory level
(v) Average stock
Illustration 15:
Asif Limited orders 40,000 units of item ZIGZAG when the inventory level falls to 80,000 units. Annual
consumption of ZIGZAG is 1,440,000 units.
The holding cost per unit is Rs. 1.20 per unit per year and the cost of making an order for delivery of the
item is Rs. 300 per order. The supply lead time is 2 weeks (assume a 50-week year and constant weekly
demand for the item).
Required:
Calculate the cost of the current ordering policy and calculate how much annual savings could be
obtained using the EOQ model.
Note: Whenever a question provides for reorder level, always check for existence of safety stock.
Now attempt Question 2: ABC

Now attempt Question 3: Robin Limited
Now attempt Question 4: Aroma Herbs (Spring 2017, Q2)
Now attempt Question 5: Choco-king Limited (Autumn 2015, Q7)
Now attempt Question 6: A Company (Spring 2014, Q1)
Now attempt Question 7: Ore Limited (Spring 2012, Q1)
Now attempt Question 8: Hockey Pakistan Limited (Autumn 2018, Q4)
Using probabilities to decide Reorder level
 Reorder level is set to avoid stock outs

 Safety stock is added to deal with the risk of stock out with uncertain demand or lead time.
 Adding safety stock adds to Stock Holding Cost while Reducing the Stock out Cost.
When a company is prepared to accept the risk of stock-outs, the optimal reorder level might be
estimated using probabilities of demand and a reorder level may be calculated that has the lowest
expected value of total cost (i.e. cost of holding safety stock and cost of stock out).

Illustration 16:
Zeeshan Limited uses item M in its production process. It purchases item M from an external supplier, in
batches. For item M, the following information is relevant:
Holding cost Rs. 30 per unit per year

Stock out cost/ unit Rs. 10 for each stock-out
Lead-time 1 week
EOQ 540 units
Zeeshan Limited operates for 48 weeks each year. Weekly demand for unit M for production is
variable, as follows:
Units demanded during Probability

the lead time
140 10%
160 20%
180 30%
200 40%
Required:
Suggest whether a reorder level of 180 units or 200 units would be more appropriate.
Illustration 17:
Yousaf Limited uses item P in its production process. It purchases item P from an external supplier, in
batches. For item P, the following information is relevant:
Holding cost Rs. 25 per unit per year

Stock out cost Rs. 11 for each stock-out
Lead-time 1 week
EOQ 288 units
Yousaf Limited operates for 48 weeks each year. Weekly demand for unit M for production is variable,
as follows:
Units demanded during Probability

the lead time
80 10%
110 20%
150 30%
188 40%
Required:
Suggest and optimum safety stock for Yousaf Limited.
Now attempt Question 9: Khan Limited (Spring 2018, Q6)

Now attempt Question 10: Alpha Motors (CA Final)
Now attempt Question 11: Orchid Limited (Spring 2019, Q4-b)

Illustration 1:
Order Quantity
4,000 units 5,000 units 6,000 units
Annual cost of:
 Ordering [(10,000X12)÷4,000]X300 [(10,000X12)÷5,000]X300 [(10,000X12)÷6,000]X300
= 9,000 = 7,200 = 6,000
 Holding (4,000÷2)X2.88 = 5,760 (5,000÷2)X2.88 = 7,200 (6,000÷2)X2.88 = 8,640
Total cost 14,760 14,400 14,640
Annual cost of inventory is least at reorder size of 5,000 units.
Illustration 2:
(i)
2 Co D 2 x 2,000 x 60,000
EOQ=√ =√ (100x10%)+20
= 2,828 units
CH
(ii)
2,828 units
Annual cost of:
 Ordering (60,000 ÷ 2,828) X 2,000 = 42,433
 Holding (2,828 ÷ 2) X 30 = 42,420
Total cost 84,853
Illustration 3:
2 Co D 2 x 500 x (6,000 x 2)
EOQ=√ =√ (100 x 8%)
= 1,225 units
CH
Illustration 4:
2 Co D 2 x 1,000 x 270,000
EOQ=√ =√ (200 x 7.5%)
= 6,000 units
CH
Illustration 5:
2 Co D 2 x 360 x 120,000
EOQ=√ =√ = 1,470 units
CH 40

Illustration 6:
2 Co D 2 x 1,000 x 60,000
EOQ=√ =√ = 3,162 units
CH 12
EOQ 5,000 units 7,500 units

(3,162 units)
Annual cost of:
 Purchase (w1) 1,200,000 1,176,000 1,170,000
 Ordering (w2) 18,975 12,000 8,000
 Holding (w3) 18,971 30,000 45,000
Total cost 1,237,946 1,218,000 1,223,000
When discounts are introduced, optimum order size is 5,000 units as annual inventory related
cost is minimum at that level.
(w1)
Order size Purchase cost

3,163 60,000 units X 20 = Rs. 1,200,000
5,000 1,200,000 X 98% = Rs. 1,176,000
7,500 1,200,000 X 97.50% = Rs. 1,170,000
(w2)
Order size Ordering cost

3,163 (60,000 ÷ 3,162) X 1,000 = Rs. 18,975
5,000 (60,000 ÷ 5,000) X 1,000 = Rs. 12,000
7,500 (60,000 ÷ 7,500) X 1,000 = Rs. 8,000
(w3)
Order size Holding cost

3,163 (3,162 ÷ 2) X 12 = Rs. 18,971
5,000 (5,000 ÷ 2) X 12 = Rs. 30,000
7,500 (7,500 ÷ 2) X 12 = Rs. 45,000
Illustration 7:
2 Co D 2 x 1,000 x 90,000
EOQ=√ =√ = 5,262 units
CH 6.50
EOQ * 8,000 units

(5,262 units)
Annual cost of:
 Purchase (w1) 805,950 803,925
 Ordering (w2) 17,104 11,250
 Holding (w3) 17,102 26,000
Total cost 840,156 841,175
* Order size of 5,000 units is not considered as the same discount will be available at EOQ, which is
better option.
EOQ remains optimum reorder quantity.

(w1)

5,262 90,000 units X 9 X 99.50% = Rs. 805,950
8,000 90,000 units X 9 X 99.25% = Rs. 803,925
(w2)

5,262 (90,000 ÷ 5,262) X 1,000 = Rs. 17,104
8,000 (90,000 ÷ 8,000) X 1,000 = Rs. 11,250
(w3)

5,262 (5,262 ÷ 2) X 6.50 = Rs. 17,102
8,000 (8,000 ÷ 2) X 6.50 = Rs. 26,000
Illustration 8:
2 Co D 2 x 10,000 x 100,000
EOQ=√ =√ = 5,000 units
CH Rs.1,000 x 8%
EOQ * 10,000 units

(5,000 units)
Annual cost of:
 Purchase (w1) 100,000,000 99,000,000
 Ordering (w2) 200,000 100,000
 Holding (w3) 200,000 396,000
Total cost 100,400,000 99,496,000
Reorder size of 10,000 units is optimum.
(w1)

5,000 100,000 units X 1,000 = Rs. 100,000,000
10,000 100,000 units X 990 = Rs. 99,000,000
(w2)

5,000 (100,000 ÷ 5,000) X 10,000 = Rs. 200,000
10,000 (100,000 ÷ 10,000) X 10,000 = Rs. 100,000
(w3)

5,000 (5,000 ÷ 2) X 1,000 X 8% = Rs. 200,000
10,000 (10,000 ÷ 2) X 990 X 8% = Rs. 396,000

Illustration 9:
2 Co D 2 x 2,000 x 250,000
EOQ=√ =√ = 20,000 units
CH 2.5
EOQ 22,500 units 30,000 units

(20,000 units)
Annual cost of:
 Purchase (w1) 6,250,000 6,000,000 5,750,000
 Ordering (w2) 25,000 22,222 16,667
 Holding (w3) 25,000 27,000 34,500
Total cost 6,300,000 6,049,222 5,801,167
When discounts are introduced, optimum order size is 30,000 units as annual inventory related
cost is minimum at that level.
(w1)

20,000 250,000 X 25 = Rs. 6,250,000
22,500 250,000 X 24 = Rs. 6,000,000
30,000 250,000 X 23 = Rs. 5,750,000
(w2)

20,000 (250,000 ÷ 20,000) X 2,000 = Rs. 25,000
22,500 (250,000 ÷ 22,500) X 2,000 = Rs. 22,222
30,000 (250,000 ÷ 30,000) X 2,000 = Rs. 16,667
(w3)

20,000 (20,000 ÷ 2) X 2.50 = Rs. 25,000
22,500 (22,500 ÷ 2) X 2.40 = Rs. 27,000
30,000 (30,000 ÷ 2) X 2.30 = Rs. 34,500
Illustration 10:
(i)
ROL = Weekly usage X Lead time in weeks = (60,000 ÷ 52) X 2 = 2,308 units
(ii)
Frequency of order = Time taken to consume EOQ = 3,163 ÷ (60,000 ÷ 365) = 19 days
(New order will be placed after every 19 days)

Illustration 11:
(i)
ROL = Weekly usage X Lead time in weeks = (90,000 ÷ 52) X 3 = 5,192 units
(ii)
Frequency of order = Time taken to consume EOQ = 5,262 ÷ (90,000 ÷ 365) = 21 days
(New order will be placed after every 21 days)
Illustration 12:
(i)
ROL = Maximum demand for the material item per day X Maximum supply lead time in days
= 150 X 12 = 1,800 units
(ii)

= 1,800 – (120 X 10)
= 600 units
Illustration 13:
(i)
ROL = Maximum demand for the material item per week X Maximum supply lead time in weeks
= 3,000 X 4 = 12,000 units
(ii)

= 12,000 – (2,400 X 3)
= 4,800 units
(iii)
= 12,000 + 10,000 – (1,600 X 2) = 18,800 units
(iv)
Minimum inventory level = Safety stock = 4,800 units (from part ii above)
(v)
Average stock = (order size/2) + Safety stock = (10,000/2) + 4,800 = 9,800 units
Illustration 14:
(i)
ROL = Maximum demand for the material item per month X Maximum supply lead time in months
= 5,000 X 2 = 10,000 units

(ii)

= 10,000 – (4,200 X 1.5)
= 3,700 units
(iii)
= 10,000 + 12,000 – (3,500 X 1) = 18,500 units
(iv)
Minimum inventory level = Safety stock = 3,700 units (from part ii above)
(v)
Average stock = (order size/2) + Safety stock = (12,000/2) + 3,700 = 9,700 units
Illustration 15:
Step 1: Calculate the buffer stock
Weekly demand = 1,440,000 ÷ 50 = 28,800 units

Buffer stock = ROL – usage during lead time
= 80,000 – (28,800 X 2) = 22,400 units
Step 2: Calculate annual cost of inventory under current policy
40,000 units
Annual cost of:
 Ordering (1,440,000 ÷ 40,000) X 300 = 10,800
 Holding [(40,000 ÷ 2) + 22,400] X 1.20 = 50,880
Total cost 61,680
Step 3: Calculate EOQ
2 Co D 2 x 300 x 1,440,000
EOQ=√ =√ = 26,833 units
CH 1.2
Step 4: Calculate annual cost of inventory with EOQ
26,833 units
Annual cost of:
 Ordering (1,440,000 ÷ 26,833) X 300 = 16,100
 Holding [(26,833 ÷ 2) + 22,400] X 1.20 = 42,980
Total cost 59,080
Annual saving by following EOQ = Rs. 61,680 – 59,080 = Rs. 2,600
Illustration 16:
 Average demand in the lead time = (140 X 10%) + (160 X 20%) + (180 X 30%) + (200 X 40%) = 180
units
 Annual demand = 48 X 180 units = 8,640 units
 As EOQ is 540 thus number of orders in a year = 8,640 ÷ 540 = 16 orders
 This there will be 16 lead times in a year and company will face risk of stock out 16 times in a year.
Total cost of stock out + Holding cost of buffer stock
(i) Suppose ROL is set at 180 units (Means ZERO safety stock, as ROL = Average demand during
lead time) and
Demand is 200 units
Stock out unit 20 units

Probability of stock out X 40%
Cost per units of stock out X Rs. 10
Number of orders in a year X 16
Annual stock out cost Rs. 1,280
Holding cost of safety stock 0
TOTAL cost Rs. 1,280
(ii) Suppose ROL is set at 200 units (Means 20 units of safety stock are being kept) and
Demand is 200 units
Safety stock 20 units

Holding cost per unit per annum X Rs. 30
Annual holding cost of safety stock Rs. 600
Annual stock out cost 0
TOTAL cost Rs. 600
ROL should be 200 units as total cost of holding safety stock and stock out cost is minimum at this level.
Illustration 17:
 Average demand in the lead time = (80 X 10%) + (110 X 20%) + (150 X 30%) + (188 X 40%) = 150
units
 Annual demand = 48 X 150 units = 7,200 units
 As EOQ is 288 thus number of orders in a year = 7,200 ÷ 288 = 25 orders
 This there will be 25 lead times in a year and company will face risk of stock out 25 times in a year.
Total cost of stock out + Holding cost of buffer stock
(i) Suppose ROL is set at 150 units (Means ZERO safety stock, as ROL = Average demand during
lead time) and
Demand is 188 units
Stock out unit 38 units

Probability of stock out X 40%
Cost per units of stock out X Rs. 11
Number of orders in a year X 25
Annual stock out cost Rs. 4,180
Holding cost of safety stock 0
TOTAL cost Rs. 4,180
(ii) Suppose ROL is set at 188 units (Means 38 units of safety stock are being kept) and
Demand is 188 units
Safety stock 38 units

Holding cost per unit per annum X Rs. 25
Annual holding cost of safety stock Rs. 950
Annual stock out cost 0
TOTAL cost Rs. 950
ROL should be 188 units as total cost of holding safety stock and stock out cost is minimum at this level.

Question 1: Inventory Control
Answer 1: Inventory Control

Question 2: ABC
Answer 2: ABC

Question 3: Robin Limited
Answer 3: Robin Limited

Question 4: Aroma Herbs (Spring 2017, Q2)
(Assume 360 days in a year)
Answer 4: Aroma Herbs (Spring 2017, Q2)

Question 5: Choco-king Limited (Autumn 2015, Q7)

Answer 5: Choco-king Limited (Autumn 2015, Q7)
Question 6: A Company (Spring 2014, Q1)

Answer 6: A Company (Spring 2014, Q1)

Question 7: Ore Limited (Spring 2012, Q1)
Answer 7: Ore Limited (Spring 2012, Q1)

Question 8: Hockey Pakistan Limited (Autumn 2018, Q4)

Answer 8: Hockey Pakistan Limited (Autumn 2018, Q4)

Question 9: Khan Limited (Spring 2018, Q6)
Answer 9: Khan Limited (Spring 2018, Q6)

Question 10: Alpha Motors (CA Final)
Answer 10: Alpha Motors (CA Final Past paper)
Not available

Question 11: Orchid Limited (Spring 2019, Q4-b)
Answer 11: Orchid Limited (Spring 2019, Q4-b)

Question 12: Replica Limited (Spring 2013, Q1)

Answer 12: Replica Limited (Spring 2013, Q1)


Process Costing Chapter 5
Process Costing

Process Costing
Used by companies engaged in mass production of identical goods. e.g.
 Chocolate bars
 Soup cans
 Soap cakes etc.
Features
 Products are identical and indistinguishable

 There might be process losses in production
 Output of a process may be input of the next process
 At times more than one products are produced from one process
Process accounting takes care of the above features to produce cost per unit of product produced.
Process account
 Maintained with two columns each on debit and credit side

 One column is used for quantity and the other is used for value
 All quantity of input units and costs are debited to process account
 Whereas losses and output are credited to the process account both in quantity and values.
Process Account
Description Units (Rs.) Description Liters (Rs.)
Direct materials 3,000 6,000 Output (actual) @ Rs. 3,000 7,000
3.30/ liter
Direct labour 600
Production overhead 400
absorbed
3,000 7,000 3,000 7,000
Issues in process accounting
Normal Loss:
This is the expected loss which is seen as normal in production process. It is unavoidable loss which is
considered necessary to get the good output.
Thus the rule is to distribute all the process cost between the expected output.
Expected output = Input units – Expected (normal) loss units
And
Cost per unit = Total Process costs

Expected output
Abnormal loss:
When actual loss is greater than normal loss, then abnormal loss must have arisen.
Abnormal loss = Actual loss – Normal loss
Or

Abnormal loss = Expected output – Actual output
Abnormal gain:
When actual loss is less than normal loss, then abnormal gain must have arisen.
Abnormal gain = Normal loss – Actual loss
Or
Abnormal gain = Actual output – Expected output
Illustration 1: Normal loss
A company puts 10,000 liters into the process. Normal loss of a process is 10% of input.
Required:
Calculate normal loss and expected output from the process.
Illustration 2: Abnormal loss
A company puts 10,000 liters into the process. Normal loss of a process is 10% of input. Actual output
from the process was 8,500 liters.
Required:
Calculate normal loss, abnormal loss and expected output from the process.
Illustration 3: Abnormal gain
A company puts 10,000 liters into the process. Normal loss of a process is 10% of input. Actual output
from the process was 9,400 liters.
Required:
Calculate normal loss, abnormal gain and expected output from the process.
Illustration 4: Losses and output
Following information is available for D Ltd for a period 7:

 Input 20,000 units
 Normal loss 15% of input
 Actual output 18,600 units
Required:
Calculate:
i. Normal loss
ii. Expected output
iii. Abnormal loss/ gain

Illustration 5: Cost per unit
A company puts 10,000 liters into the process costing Rs. 4.50 per liter. Normal loss of a process is 10%
of input whereas actual output was 9,200 liters.
Required:
Calculate cost per liter of output.
Illustration 6: Normal loss - no scrap value of loss units
The following information relates to a production Process of ABC Ltd.
Input quantities 3,000 liters

Normal loss 10%
Actual output 2,700 liters
Direct material cost Rs. 6,300
Direct labour cost Rs. 600
Production overhead absorbed Rs. 1,200
Required:
Calculate cost per liter of the output and prepare process account for Process.
Normal loss - with scrap value of loss units
Cost per unit = Total Process costs – Scrap value of normal loss units
Expected output
Illustration 7: Normal loss - with scrap value of loss units

Normal loss 10%
Scrap value of loss units Rs. 1.80/ liter
Required:
Normal loss - with disposal cost of loss units
Cost per unit = Total Process costs + Disposal cost of normal loss units
Expected output

Illustration 8: Normal loss - with disposal cost of loss units

Normal loss 10%
Disposal cost of loss units Rs. 2.70/ liter
Required:
Treatment of Abnormal loss
Abnormal loss units are assigned full cost incurred in making them. e.g. if inspection is carried at the end
of process, Abnormal loss unit’s cost is equal to a finished (good) output unit’s cost.
Abnormal loss reflects inefficiency of the organization and value of abnormal loss is cost of this
inefficiency, which is charged to income statement as cost.
Illustration 9: Abnormal loss - no scrap value of loss units

Normal loss 10%
Required:
Calculate cost per liter of the output and prepare process account for Process and abnormal loss
account.
Illustration 10: Abnormal loss - with scrap value of loss units

Normal loss 10%
Required:
Calculate cost per liter of the output and prepare process accounts for Process, Abnormal loss and
Scrap.

Illustration 11: Abnormal loss - with disposal cost of loss units

Normal loss 10%
Disposal cost of loss units Rs. 2.70/ liter
Required:
Calculate cost per liter of the output and prepare process accounts for Process and Abnormal loss.
Illustration 12: Abnormal loss with scrap value of loss units
Hafeez Ltd produces a chicken feed that involves several processes. At each stage in the process,
ingredients are added, until the final stage of production when the feed is boxed up ready to be sold.
In Process 2, Hafeez Ltd has initiated a quality control inspection. This inspection takes place at the end
of Process 2. The inspection is expected to yield a normal loss of 5% of the input from Process 1. These
losses are sold as waste for Rs. 1 per kg.
The following information is for Process 2 for the period just ended:
Units (Rs.)
Transfer from Process 1 1,000 kg 1,500
Material added in Process 2 600 kg 600
Labour 400 hrs 1,600
Overheads - 1,000
Actual output 1,510 kg -
Required:
Prepare the process account, abnormal loss account, and scrap account for Process 2 for the period just
ended.
Treatment of Abnormal gain
Principle of abnormal gain valuation is the same as it is followed for abnormal loss units. i.e. if inspection
is carried at the end of process, Abnormal gain unit’s (appear on the debit side of process account) value
is equal to a finished (good) output unit’s cost.
Abnormal gain reflects efficiency of the organization and value of abnormal gain is the benefit of this
efficiency, which is transferred to income statement as income.
Illustration 13: Abnormal gain - no scrap value of loss units

Normal loss 10%

Required:
Calculate cost per liter of the output and prepare process account for Process and Abnormal loss/ gain
account.
Illustration 14: Abnormal gain - with scrap value of loss units

Normal loss 10%
Required:
Calculate cost per liter of the output and prepare process account for Process, Abnormal loss/ gain and
Scrap.
Illustration 15: Losses with no scrap value of loss units
Following information relates to the Process-I of Waqar Ltd.

Units introduced 2,000 @ Rs. 20 per unit
Labour cost Rs. 10,800
Production overheads Rs. 14,000
Normal loss 10% of input (no scrap value available)
Units produced 1,700
Required:
Prepare Process-I account and Abnormal loss account
Illustration 16: Two processes with losses and scrap value
A product is produced from two distinct processes, Process-I and Process-II. On completion it is
transferred to finished stock. Following particulars are available relating to the month of December 2015.
Process-I Process-II
Units introduced 10,000 9,000
Units Transferred to next process/ finished stock 9,000 8,250
Normal loss (on input units) 10% 5%
Scrap value of loss units (per unit) Rs. 2 Rs. 4
Costs incurred: (Rs.) (Rs.)
Direct materials 40,000 -
Direct labour 20,000 20,000
Direct Expenses 12,000 8,600
Production overheads are absorbed at 100% of direct labour.
Assume that there was no opening or closing stock of raw materials or work-in-progress and scrap were
sold for cash.
Required:
Prepare Process accounts, Abnormal loss account and Scrap account.

Illustration 17: Two processes with losses/ gains and scrap value
A product is produced from two distinct processes, Process-A and Process-B. On completion it is
transferred to finished stock. Following particulars are available relating to the month of November 2015.
Process-A Process-B
Units introduced 2,000
Transfer to next process/ finished stock 1,800 1,750
Normal loss (on input units) 5% 5%
Scrap value of loss units (per unit) Rs. 2 Rs. 2
Costs incurred: (Rs.) (Rs.)
Direct materials 11,000 1,000
Production overheads absorbed 2,800 2,240
Assume that there was no opening or closing stock of raw materials or work-in-progress and scrap were
sold for cash.
Required:
Prepare Process accounts, Abnormal gain account, Abnormal loss account and Scrap account.
Now attempt Question 1: Process Costing-Basic Rules
Process costing with closing work-in-process (WIP)
 In a continuous process there will always be opening WIP and closing WIP
 Whenever there is unfinished stock at the end of process its value can’t be the same as for
completed output (should be less).
Normally:
Cost per unit = Total input cost

Output
But with closing WIP all output (finished and WIP) can’t assigned the same value, thus a concept of
equivalent units is introduced.
Equivalent units (EU)
EU means “Equal to finished complete units”
Simple idea is that 100 units which are 50% worked (complete) are equal to 50 complete units in terms of
cost incurred. Or EU of 150 units which are 30% complete are 45.
Cost per unit = ____Total input cost____

Equivalent units of Output
Illustration 18: Closing WIP and equivalent units
Vicky Ltd introduced 100,000 units into a production process during the month of July 20x6. At the end of
month only 70,000 units could be finished, whereas 30,000 were still in process (unfinished) and were
only 40% complete (no losses).
Total input cost incurred in the process during July was Rs. 328,000.

Required:
Calculate equivalent units of output and cost per unit of output for the month of July.
For process X in DEF Co the following is relevant for the latest period:
Period costs Rs. 8,880

Input 1,600 units
Output 1,200 fully worked units and 400 units only 70% complete
Required:
Calculate equivalent units of output and cost per unit of output.
A Complication
WIP may have different degrees of completion for different elements of costs.
For example consider a scenario where material is introduced at the start of process and conversion cost
(Direct Labour + FOH) is incurred evenly throughout the process. Now if this process has some closing
WIP, it will be 100% with respect to material but partially complete with respect to conversion costs.
Thus in such scenario EU and cost per unit is calculated for each element of cost separately and this is
done in three stage process:
1. Prepare statement of EU for each input element of cost

2. Calculate cost per unit for each element of cost
3. Prepare a statement to calculate the value of finished output and closing WIP from the statement
of EU in 1st step and cost per unit in 2nd step.
Illustration 20: Closing WIP and equivalent units (Different degrees of completion)
For Process-E in GHI Ltd the following is relevant for the latest month:
Material costs 1,000 units @ Rs. 80 per unit

Labour Rs. 42,240
Overheads 150% of labour cost
Output 800 fully worked units, transferred to Process-F. 200 units only 40% complete
with respect to conversion, but 100% complete with respect to materials.
There were no process losses.
Required:
Produce the process account.
The following information relates to a production process Z of Zeeshan Ltd for the month of December
20x6.

Completed output 7,000 liters
Closing WIP 1,000 units
All the direct materials are added to production at the beginning of the process.

Closing inventory of 1,000 units is therefore 100% complete for materials but is only 60% complete for
conversion.
Rs.
The costs incurred in the period were:
Direct materials 100,000
Conversion costs 26,600
Required:
Prepare account for process Z for the month of December.
A firm operates a process costing system. Details of Process-G for the month of August are as follows.
During the period 24,750 units were received from the previous process at a value of Rs. 1,361,250,
conversion cost incurred (labour and overheads) was Rs. 1,050,180 and material introduced was Rs.
79,800, which are added only when production passes 80% stage.
At the end of August the closing WIP was 4,800 units which were 60% complete in respect of conversion.
The balance of units was transferred to finished goods.
There was no opening WIP or process loss.
Required:
Calculate the cost per Equivalent Unit of each element of cost, the value of finished goods and closing
WIP.
Now attempt Question 2: Process 1 and Process 2
Opening work-in-process (WIP)
For the treatment of opening WIP, two approaches are allowed under IAS 2:
 Weighted average costing (AVCO)

 First in first out (FIFO)
AVCO
Principle: All units completed and closing WIP are valued at same cost per unit.
Average cost per unit is calculated for each element of cost and both finished output and closing WIP are
valued at this cost per unit.
Four stage process followed is as under:
1. Prepare statement of EU for Finished goods and closing WIP

2. Calculate cost per unit of EU for each element of cost using the following formula:
Cost per unit = Cost of opening stock + Cost incurred in the period
Equivalent units of output
3. Prepare a statement of evaluation to calculate the value of finished output and closing WIP from
the statement of EU in 1st step and cost per unit in 2nd step.

4. Prepare process account.
Illustration 23: Opening WIP (AVCO Method)
EZ Ltd makes a product requiring several successive processes. Details of the first process for November
are as follows:
Opening WIP: 800 units
Degree of completion:
Materials (valued at Rs. 79,520) 100%
Conversion (valued at Rs. 14,900) 25%
Units transferred to Process 2 3,400 units
Closing WIP: 600 units
Materials 100%
Conversion 50%
Costs incurred in the period:
Material Rs. 400,000
Conversion Rs. 344,000
Required:
Prepare the process account for November using the weighted average method.
Zed Ltd makes one product that passes through a single process. The business uses AVCO costing. The
details of the process for the last period are as follows:
Materials Rs. 147,000

Labour Rs. 90,000
Units added to the process 1,500
There were 300 units of opening WIP which are valued as follows:

Labour Rs. 10,440
There were 450 units of closing WIP fully complete as to materials but only 60% complete for labour and
50% complete for overheads.
Required:
Prepare the process account for the above period using the weighted average method.
The following information relates to a production process-Zampa of Lucky Ltd for the month of January
20x6.
Opening WIP: 4,500 units

Material cost (100% complete) Rs. 18,900
Conversion cost (30% complete) Rs. 1,455
During the January

Production started 10,500 units
Completed output 12,000 units
Closing WIP (100% complete for material cost and 60% complete for 3,000 units
conversion cost).
All the materials are added to production at the beginning of the process whereas conversion cost is
incurred evenly throughout the process.
The costs incurred in the January were: (Rs.)

Material cost 56,100
Conversion cost 26,145
Required:
Prepare process account of Zampa for the month of January 20x6 using AVCO method.
A manufacturing company makes one product that passes through many processes. The details of the
first process for the month of April 20x1 are as follows:

Labour Rs. 195,000
Overheads Rs. 97,500
Units introduced into the process and transferred to 17,500
next process
There were 5,000 units of opening WIP which are valued as follows:

Labour Rs. 7,500
Overheads Rs. 4,000
Closing WIP was fully complete as to materials but only 50% complete for labour and 50% complete for
overheads.
There were no process losses during the month.
Required:
Using AVCO method, calculate cost of:
i. Output transferred to the next process

ii. Closing WIP
FIFO
Principle: Units of opening WIP process are completed first in the production process and valued as
under:
Value of opening stock completed = Value of opening WIP + cost incurred to complete them
Remaining completed units of output (Total finished output – opening WIP completed) are valued using
the cost incurred in the period under consideration.

Illustration 27: Opening WIP (FIFO Method)
EZ Ltd makes a product requiring several successive processes. Details of the first process for November
are as follows:
Opening WIP: 800 units

Materials (valued at Rs. 79,520) 100%
Conversion (valued at Rs. 14,900) 25%
Units transferred to Process 2 3,400 units
Closing WIP: 600 units
Materials 100%
Conversion 50%
Costs incurred in the period:
Material Rs. 400,000
Conversion Rs. 344,000
Required:
Prepare the process account for November using the FIFO method.
Admi Ltd operates a process costing system. Details of Process 1 are as follows.
All materials used are added at the beginning of the process. Labour costs and production overhead
costs are incurred evenly as the product goes through the process. Production overheads are absorbed
at a rate of 100% of labour costs.
The following details are relevant to production in the period:
Units Materials Labour and

production overheads
Opening WIP 400 100% complete 75% complete
Closing WIP 200 100% complete 50% complete
Opening inventory
Costs associated with these opening units are Rs. 18,000 for materials. In addition Rs. 40,000 had been
accumulated for labour and overhead costs.
Period costs
Costs incurred during the period were:

Labour costs Rs. 190,000
During the period 4,200 units were passed to Process 2. There were no losses.
The company uses a FIFO method for valuing process costs.
Required:
Prepare process account for process 1.

The following information relates to a production process-Zampa of Lucky Ltd for the month of January
20x6.
Opening WIP: 4,500 units

Material cost (100% complete) Rs. 18,900
Conversion cost (30% complete) Rs. 1,455
During the January

Production started 10,500 units
Closing WIP (100% complete for material cost and 60% complete for 3,000 units
conversion cost).
All the materials are added to production at the beginning of the process whereas conversion cost is
incurred evenly throughout the process.
The costs incurred in the January were: (Rs.)

Material cost 56,100
Required:
Prepare process account of Zampa for the month of January 20x6 using FIFO method.
Illustration 30: Opening WIP (FIFO or AVCO ?)
Zebra Ltd uses process costing for determining the cost per unit of its output. The following data relates to
Process-I for the month of April 20x6:
(i) Opening WIP

Quantity 1,500 units
Value Rs. 4,500
(ii) Introduced during the April 5,000 units
(iii) Transferred to process-II 5,500 units
(iv) Closing WIP 1,000 units
(v) Degree of completion: Opening WIP Closing WIP

Materials 100% 100%
Labour and overheads 80% 60%
(vi) Cost added during April

Material Rs. 10,000
Labour Rs. 9,800
Overheads Rs. 4,900
Required:
Calculate the cost of output transferred to process-II and closing WIP for April.
A manufacturing company P Ltd makes one product that passes through many processes. The details of
the process A for the month of June 20x6 are as follows:

Labour Rs. 72,000
Units introduced into the process 19,500
Materials Rs. 4,800

Labour Rs. 3,200
Overheads Rs. 6,400
Units transferred to next department were 18,200 whereas 1,800 units were in closing WIP. Closing WIP
was fully complete as to materials but only 50% complete for labour and 50% complete for overheads.
There were no process losses during the month.
Required:
Calculate cost of:
i. Output transferred to the next process

ii. Closing WIP
Losses and gains at different stages in the process
Illustration 32: Losses/ gains at different stages
The following information relates to a production process-Z of Alpha Ltd.
Input quantities 25,000 units

Normal loss 10%
Actual output 21,250 units
Direct materials are added in full at the beginning of the process whereas conversion cost is incurred
evenly through the process. Inspection occurs when the products are 60% through the process, where
loss units are identified and separated from good output.
The costs incurred in the period were: Rs.

Conversion costs: 33,000
Required:
Prepare process account.
The following information relates to a production process-Z of Alpha Ltd.

Normal loss 10%
Actual output 24,000 units
Direct materials are added in full at the beginning of the process whereas conversion cost is incurred
evenly through the process. Inspection occurs when the products are 60% through the process, where
loss units are identified and separated from good output.

The costs incurred in the period were: Rs.
Conversion costs: 33,000
Required:
Prepare process account.
WIP and Losses
Illustration 34: Closing WIP and losses
The following information relates to a production process A.

Normal loss (all units having a scrap recovery of Rs. 10) 10% of input
Closing WIP 750 units
All the direct materials are added to production at the beginning of the process.
Inspection of the units occurs when they are 50% complete. (Note that this must relate to conversion as
they are 100% complete for material).
Closing inventory of 750 units is therefore 100% complete for materials but is 60% complete for
conversion.
The costs incurred in the period were:
Rs.
Conversion costs 111,000
Required:
Prepare process account
Illustration 35: Opening WIP and losses (AVCO)
A manufacturing company P Ltd makes one product that passes through many processes. The details of
the process A for the month of June 20x6 are as follows:

Labour Rs. 72,000
Materials Rs. 4,800

Labour Rs. 3,200
Overheads Rs. 6,400
Units transferred to next department were 18,200 whereas 400 units were in closing WIP. Closing WIP
was fully complete as to materials but only 50% complete for labour and 50% complete for overheads.

Normal loss in processing is 5% of the total input (Opening WIP and units introduced during the period),
which is identified at the end of process. Scrapped units fetch Rs. 1 each.
Required:
Prepare process account using AVCO method.
Illustration 36: Opening WIP and losses
A manufacturing company Q Ltd makes one product that passes through many processes. The details of
the process A for the month of July 20x5 are as follows:

Labour Rs. 179,500
There were 1,000 units of opening WIP which are valued as follows:

Labour Rs. 7,500
Total 1,500 units were scrapped during the month, which were 100% complete with respect to material
and 80% complete for labour and overheads.
1,000 units were in closing WIP were 100% complete with respect to material and 80% complete for
labour and overheads.
Units transferred to next department B were 17,500.
Normal loss in processing is 5% of the total input (Opening WIP and units introduced during the period).
Scrapped units fetch Rs. 20 each.
Required:
Prepare accounts for process, Abnormal loss/ gain and scrap for the month of July 20x5.
Illustration 37: Opening WIP and losses (FIFO)
The details of the process 1 of Asim Ltd for the month of January 20x5 are as follows:

Wages Rs. 16,740
There were 800 units of opening WIP at a value of Rs. 4,000. Degree of completion of opening WIP was
as under:
Materials 100%
Labour 60%
Overheads 60%
Total 1,200 units were scrapped during the month, which were 100% complete with respect to material
and 80% complete for labour and overheads.

900 units were in closing WIP were 100% complete with respect to material and 70% complete for labour
and overheads.
Units completed and transferred to next process were 7,900.
Normal loss in processing is 8% of the total input (Opening WIP and units introduced during the period),
which are scrapped at Rs. 4 each.
Required:
Prepare accounts for process using FIFO method.
The details of the process W of Sajid Ltd for the month of March 20x6 are as follows:
Direct materials Rs. 42,000

Conversion cost Rs. 26,145
There were 4,500 units of opening WIP valued at Rs. 20,355. Degree of completion of opening WIP was
as under:
Direct materials 100%

Conversion cost 30%
Total 750 units were scrapped during the month, which were 100% complete with respect to material and
50% complete for conversion costs.
3,000 units were in closing WIP were 100% complete with respect to material and 60% complete for
conversion costs.
Units completed and transferred to next process were 11,250.
Normal loss in processing is 5% of the units introduced during the month, which are scrapped at Rs. 1
each.
Required:
Prepare accounts for process.
Illustration 39: NL and different stages of inspection
Normal loss is expected as 10% of inspected units. Calculate the normal loss under following scenarios:
Stage of completion
Scenarios (a) (b) (c) (d)
Units
Opening work in process 1,000 50% 50% 70% 70%
Units introduced during the period 10,000
Closing work in process 2,000 80% 40% 40% 80%
Inspection stage 60% 60% 60% 60%
Normal loss is expected as 5% of inspected units. Calculate the normal loss under following scenarios:

Stage of completion
Scenarios (a) (b) (c) (d)
Units
Opening work in process 50,000 40% 60% 70% 80%
Units introduced during the period 600,000
Closing work in process 25,000 75% 70% 80% 40%
Inspection stage 50% 75% 60% 75%
Joint and By-products
Joint product
Where two or more products are:

 Simultaneously generated
 From a single process
 Using common input and
 Having sufficiently high (similar) sale value.
By-products
By-products are produced jointly along with the main product and possesses following features:
 Relatively minor in quantity and value
 Produces incidentally (not intended or desired) in the manufacturing of the main product.
Industry Joint products By-products
Petroleum refinery Petrol, diesel, kerosene etc. Paraffin, tar etc.
Rice industry Patent rice Husk, bran
Soap Patent soap Glycerin
Treatment of Joint products
Joint cost of the input can be apportioned amongst the joint products (to determine cost per unit) using
any of the following three bases:
1. Units basis (cost per unit is the same for all the joint products)
2. Sale value at “split off point” (definition below).
3. Net realizable value (NRV), used when joint products are not saleable at split off point.
(NRV = final sale value – processing cost after split off point).
Split off point
It is a stage in manufacturing process where joint products become separately identifiable.
Illustration 41: Allocation of joint cost
Two joint products A and B are produced from a common process-X by Nasir Ltd.
During the month of January, 20,000 units of materials were introduced in the process-X. Total costs of
processing (direct materials and conversion costs) were Rs. 339,700. Output from the process during
January was 12,500 units of A and 7,500 units of B.
A has a sales value of Rs. 100 per unit at split off point (on completion of process-X) or alternatively it can
be sold for Rs. 300 per unit after further processing costs of Rs. 62.50 per unit.
B has a sales value of Rs. 137.50 at split off point or alternatively it can be sold for Rs. 200 per unit after
further processing costs of Rs. 37.50 per unit.

Required:
Allocate joint cost amongst the joint products using following basis and prepare process account in each
scenario:
i. Unit produced basis

ii. Sale value at split off point
iii. Net realizable value (NRV) basis
Zubair Ltd produced 10,000 liters of product A and 12,000 liters of product B from a single process during
the month of May. Following costs were incurred in the process for the above products:
Cost (Rs.)
Variable overheads 8,000
Fixed overheads 22,000
Sales value of the products at split off point is as under:

 A – 10,000 liters @ Rs. 5.20/ liter
 B – 12,000 liters @ Rs. 3.00/ liter
Required:
Allocate the joint cost to the products A and B under the following two alternative methods:
i. On the basis of quantity produced
ii. On the basis of sale value at split off point
Treatment of By-products
Sale value of the by-products can be treated by following any of the following methods:
1. As revenue (add to the revenue from the main products in income statement)- no cost/ value is
assigned in the process cost
2. As other income- no cost/ value is assigned in the process cost
3. As deduction from the process input cost (just like scrap value of normal loss units). This is
the most commonly used method.
While dealing with by-products:
Expected output = Input – Normal Loss – By-products
Illustration 43: Treatment of by products
Kawther Grain Rice Mills processed 100 tons of paddy during the month of December. Costs incurred in
the process were as follows:
i. 100 tons paddy @ Rs. 9,000 per ton

ii. Transportation cost Rs. 5,000
iii. Loading and unloading cost Rs. 2,000
iv. Other labour costs Rs. 8,000
v. Factory overheads Rs. 10,000
Output from the common process were:
i. Rice 80 tons
ii. Rice husk 18 tons (By product)

iii. Evaporation loss 2 tons (Normal loss)
Rice husk is expected to sell for Rs. 2,000 per ton.
Required:
Calculate cost per ton of the rice produced when Sale proceeds of rice husk is:
i. Treated as other income
ii. Deducted from the joint process cost
Illustration 44: Treatment of joint and by products
The following information relates to a company that produces two joint products, C and D and one
byproduct G, in a process.
Data for January

Materials input (87,500 units) Rs. 541,000
Conversion costs Rs. 210,000
Joint products output and value at split off point
C: 36,000 units Rs. 4,500,000
D: 30,000 units Rs. 1,500,000
Normal loss is 2,000 units. Units lost have a scrap value of Rs. 2 per unit. 12,000 units of byproduct
G are produced. Each unit is sold for Rs. 1 per unit.
Company policy is to credit by products sale value to the process account. Joint costs are distributed
amongst the joint products on sales value basis.
Required:
Prepare the process account for January.
The following information relates to a Yasir Ltd. that produces two joint products, X and Y and one
byproduct A, in a process.
Data for March:

Materials input (100,000 units) Rs. 600,000
Conversion costs Rs. 200,000
Joint products output and value at split off point
X: 50,000 units Rs. 2,500,000
Y: 25,000 units Rs. 1,000,000
Normal loss is 5,000 units. Units lost have a scrap value of Rs. 2.12 per unit. 22,000 units of by-product
A are produced. Each unit is sold for Rs. 2.70 per unit.
Company policy is to credit by products sale value to the process account. Joint costs are distributed
amongst the joint products on sales value basis.
Required:
Prepare the process account for the month of March.

Material from ICAP’s Examinable Supplement


Now attempt Question 3: Two Processes

Now attempt Question 4: Hornbill Limited
Now attempt Question 5: Bela Enterprises (Autumn 2016, Q3)
Now attempt Question 6: Ravi Limited (Spring 2017, Q3)
Now attempt Question 7: Platinum Chemicals (Autumn 2017, Q1)
Now attempt Question 8: Quality Chemicals (Spring 2016, Q6)
Now attempt Question 9: KS Limited (Spring 2015, Q4)
Now attempt Question 10: Ababeel Foods (Autumn 2014, Q1)
Now attempt Question 11: Tulip Enterprises (Spring 2019, Q1)

Illustration 1: Normal loss
Normal loss = 10,000 x 10% = 1,000 liters

Expected output = Input – Expected (Normal) loss = 10,000 – 1,000 = 9,000 liters
Illustration 2: Abnormal loss

Abnormal loss = Actual loss – Expected (Normal) loss = 1,500 – 1,000 = 500 liters
Illustration 3: Abnormal gain

Abnormal gain = Expected (Normal) loss – Actual loss = 1,000 – 600 = 400 liters
Illustration 4: Losses and output
Normal loss = 20,000 x 15% = 3,000 units

Expected output = Input – Expected (Normal) loss = 20,000 – 3,000 = 17,000 units
Abnormal gain = Expected (Normal) loss – Actual loss = 3,000 – 1,400 = 1,600 units
Illustration 5: Cost per unit
Cost/ unit = Input cost

Expected output
= Rs. 45,000 = Rs. 5
9,000
Note: Actual output is not considered while calculating cost/ unit of output.
Illustration 6: Normal loss - no scrap value of loss units
The cost per liter produced can be calculated as follows:
(Rs.)
Direct labour 600
Production overheads 1,200
Total production cost 8,100
Expected output (90% of 3,000) ÷2,700 liters
Cost per liter Rs.3.00
Process-2
Description Liters (Rs.) Description Liters (Rs.)
3.00/ liter
Direct labour 600 Normal loss 300
Production overhead 1,200
absorbed
3,000 8,100 3,000 8,100

Illustration 7: Normal loss - with scrap value of loss units
(Rs.)
Direct labour 600
Less scrap value of normal loss units (300 x 1.80) (540)
7,560
Process-2
2.80/ liter
Direct labour 600 Normal loss 300 540
absorbed
3,000 8,100 3,000 8,100
Illustration 8: Normal loss - with disposal cost of loss units
(Rs.)
Direct labour 600
Disposal cost of normal loss units (300 x 2.70) 810
8,910
Process-2
3.30/ liter
Direct labour 600 Normal loss 300 -
absorbed
Disposal cost of normal loss 810
units
3,000 8,910 3,000 8,910

Illustration 9: Abnormal loss - no scrap value of loss units
(Rs.)
Direct labour 600
Abnormal loss = Actual loss – Expected (Normal) loss = 500 – 300 = 200 liters
Process-2
3.00/ liter
Production overhead 1,200 Abnormal loss @ Rs. 200 600
absorbed 3.00/ liter
3,000 8,100 3,000 8,100
Abnormal Loss
Process-2 200 600 Income statement 200 600
200 600 200 600
Illustration 10: Abnormal loss – with scrap value of loss units

(Rs.)
Direct labour 600
7,560
Expected output (90% of 3,000) ÷2,700 litres
Process-2
2.80/ liter
Direct labour 600 Scrap-Normal loss 300 540
absorbed 2.80/ liters
3,000 8,100 3,000 8,100

Abnormal Loss
Process-2 200 560 Scrap @ Rs. 1.80/ liter 200 360
Income statement 200
200 560 200 560
Scrap
Process-2 300 540 Cash-Sale @ Rs. 1.8/ 500 900
liter
Abnormal loss 200 360
500 900 500 900
Illustration 11: Abnormal loss - with disposal cost of loss units
The cost per unit produced can be calculated as follows:

(Rs.)
Direct labour 600
Disposal cost of normal loss units (300 x 2.70) 810
8,910
Process-2
3.30/ liter
absorbed 3.30/ liters
Disposal cost of normal loss 810
units
3,000 8,910 3,000 8,910
Abnormal Loss
Process-2 200 660 Income statement 200 1,200
Disposal cost of Abnormal 540

loss units
200 1,200 200 1,200
Illustration 12: Abnormal loss with scrap value of loss units
The cost per kg produced can be calculated as follows:

(Rs.)
Cost from Process 1 1,500
Material added 600
Labour 1,600
Overheads 1,000

4,650
Expected output (1,600 kg – 5% of 1,000 kg) ÷1,550 litres
Cost per kg Rs. 3.00
Abnormal loss = Actual loss – Expected (Normal) loss = (1,600 – 1,510) – 5% of 1,000 = 40 kg
Process 2
Description kg (Rs.) Description kg (Rs.)
Transfer from process 1 1,000 1,500 Output (actual) @ Rs. 1,510 4,530
3.00/ kg
Material added 600 600 Scrap-Normal loss 50 50
Labour 1,600 Abnormal loss @ Rs. 40 120
3.00/ kg
Overhead 1,000
1,600 4,700 1,600 4,700
Abnormal Loss
Description Kg (Rs.) Description Kg (Rs.)
Process 2 40 120 Scrap @ Rs. 1.00/ kg 40 40
Income statement 80
40 120 40 120
Scrap
Description Kg (Rs.) Description kg (Rs.)
Process-2 50 50 Cash-Sale @ Rs. 90 90
1.00/ kg
Abnormal loss 40 40
90 90 90 90
Illustration 13: Abnormal gain - no scrap value of loss units

(Rs.)
Direct labour 600
Expected output (90% of 3,000) ÷2,700 litres
Abnormal gain = Expected (Normal) loss – Actual loss = 300 – 150 = 150 liters
Process-2
3.00/ liter
absorbed
Abnormal gain @ Rs. 3.00/ 150 450
liter
3,150 8,550 3,150 8,550
Abnormal Gain
Income statement 150 450 Process-2 150 450
150 450 150 450

Illustration 14: Abnormal gain – with scrap value of loss units

(Rs.)
Direct labour 600
7,560
Abnormal gain = Expected (Normal) loss – Actual loss = 300 – 150 = 150 liter
Process-2
2.80/ liter
Direct labour 600 Scrap-Normal loss 300 540
absorbed
Abnormal gain @ Rs. 2.80/ 150 420
liter
3,150 8,520 3,150 8,520
Abnormal Gain
Scrap @ Rs. 1.80/ liter 150 270 Process-2 150 420
150 420 150 420
Scrap
Process-2-Normal loss liter 300 540 Abnormal gain 150 270
Cash-Sale @ Rs. 1.8/ 150 270
liter
300 540 300 540
Illustration 15: Losses with no scrap value of loss units

(Rs.)
Materials 40,000
Expected output (90% of 2,000) ÷1,800 units
Cost per unit Rs. 36
Abnormal loss = Actual loss - Expected (Normal) loss = 300 – 200 = 100 units
Process-I
Description units (Rs.) Description units (Rs.)
Materials 2,000 40,000 Process-II (actual) @ 1,700 61,200
Rs. 36/ unit
Labour 10,800 Normal loss 200 -

Production overhead 14,000 Abnormal loss @ Rs. 100 3,600
absorbed 36/ unit
3,150 64,800 3,150 64,800
Abnormal Loss
Description Units (Rs.) Description units (Rs.)
Process-I 100 3,600 Income statement 100 3,600
100 3,600 100 3,600
Illustration 16: Two processes with losses and scrap value

Process-I Process-II
(Rs.) (Rs.)
Direct Materials 40,000
Transfer from Process-I - 90,000
Direct expenses 12,000 8,600
Production overheads (100% of direct labour) 20,000 20,000
Total production cost 92,000 138,600
Scrap value of normal loss units (1,000x2), (450x4) (2,000) (1,800)
90,000 136,800
Expected output (90% of 10,000) , (95% of 9,000) ÷9,000 units 8,550 units
Cost per unit Rs. 10 Rs. 16
Process-I: Abnormal loss = 0 {(Expected loss (1,000) = Actual loss (1,000)}

Process-II: Abnormal loss = Actual loss - Expected (Normal) loss = 750 – 450 = 300 units
Process-I
Direct materials 10,000 40,000 Process-II (actual) @ 9,000 90,000
Rs. 10/ unit
Direct labour 20,000 Scrap-Normal loss @ 1,000 2,000
Rs. 2/ unit
Direct expenses 12,000
absorbed
10,000 92,000 10,000 92,000
Process-II
Process-I 9,000 90,000 Finished stock (actual) 8,250 132,000
@ Rs. 16/ unit
Direct labour 20,000 Scrap-Normal loss @ 450 1,800
Rs. 4/ unit
Direct expenses 8,600 Abnormal loss @ Rs. 300 4,800
16/ unit
absorbed
9,000 138,600 9,000 138,600

Abnormal Loss
Process-II 300 4,800 Scrap @ Rs. 4/ unit 300 1,200
Income statement 3,600
300 4,800 300 4,800
Scrap
Process-I, Normal loss 1,000 2,000 Cash-Process-I loss 1,000 2,000
sold (1,000x2)
Process-II, Normal loss 450 1,800
Process-II, Abnormal loss 300 1,200 Cash-Process-II loss 750 3,000
sold (750x4)
1,750 5,000 1,750 5,000
Illustration 17: Two processes with losses/ gains and scrap value

Process-A Process-B
(Rs.) (Rs.)
Direct Materials 11,000 1,000
Transfer from Process-I - 19,800
Production overheads 2,800 2,240
Total production cost 21,100 27,540
Scrap value of normal loss units (100x2), (90x2) (200) (180)
20,900 27,360
Expected output (95% of 2,000) , (95% of 1,800) ÷1,900 units 1,710 units
Cost per unit Rs. 11 Rs. 16
Process-A: Abnormal loss = Actual loss - Expected (Normal) loss = 200 – 100 = 100 units
Process-B: Abnormal gain = Expected (Normal) loss - Actual loss = 90 –50 = 40 units
Process-A
Direct materials 2,000 11,000 Process-B (actual) @ 1,800 19,800
Rs. 11/ unit
Direct labour 7,300 Scrap-Normal loss @ 100 200
Rs. 2/ unit
Production overhead 2,800 Abnormal loss @ Rs. 100 1,100
absorbed 11/ unit
2,000 21,100 10,000 21,100
Process-B
Process-A 1,800 19,800 Finished stock (actual) 1,750 28,000
@ Rs. 16/ unit
Direct material 1,000 Scrap-Normal loss @ 90 180
Rs. 2/ unit
Direct labour 4,500
absorbed
Abnormal gain @ Rs. 16/ 40 640
unit
1,840 28,180 1,840 28,180

Abnormal Loss
Process-A 100 1,100 Scrap @ Rs. 2/ liter 100 200
100 1,100 300 1,100
Abnormal Gain
Scrap @ Rs. 2/ unit 40 80 Process-B 40 640
40 640 40 640
Scrap
Process-A, Normal loss 100 200 Abnormal gain, 40 80
Process-B
Process-A, Abnormal loss 100 200
Process-B, Normal loss 90 180 Cash 250 500
290 580 290 580
Equivalent
units
Fully complete 70,000
Work-in-process (40% x 30,000) 12,000
Complete equivalent units 82,000
Cost/ unit = Input cost of the process

Equivalent units of production
= Rs. 328,000 = Rs. 4

82,000
Equivalent
units
Fully complete 1,200
Work-in-process (70% x 400) 280
Complete equivalent units 1,480
Cost/ unit = Input cost of the process

Equivalent units of production
= Rs. 8,880 = Rs. 6

1,480

Step-I: Statement of equivalent units
Equivalent units
Output Total % age Direct Conversion
Units complete materials costs
Transfer to Process-F 800 100% 800 800
(Fully worked)
Closing WIP: 200
Materials 100% 200
Conversion 40% 80
1,000 1,000 880
Step-II: Statement of cost per equivalent unit
Direct Conversion
materials costs
Total costs (1,000x80), (42,240+150% of 42,240) Rs. 80,000 Rs. 105,600
Equivalent units ÷ 1,000 ÷ 880
Cost per equivalent unit Rs. 80 Rs. 120
Step-III: Statement of distribution of cost
(Rs.)
Transfer to Process-F (Fully worked) 160,000
(800 x (Rs. 80 + Rs. 120))
Cost of closing WIP:

Materials (200 units x Rs. 80) 16,000
Conversion (80 units x Rs. 120) 9,600
25,600
These costs would be recorded in the process account as follows.
Step-IV: Prepare Process account

Process-E
Direct material 1,000 80,000 Process-F 800 160,000
Labour 42,240 Closing WIP 200 25,600
Overheads 63,360
1,000 185,600 1,000 185,600

Equivalent units
Output Total % age Direct Conversion
Units complete materials costs
Finished output 7,000 100% 7,000 7,000
Closing WIP: 1,000
Materials 100% 1,000
Conversion 60% 600
8,000 8,000 7,600
Direct Conversion
materials costs
Total costs Rs. 100,000 Rs. 26,600
Equivalent units ÷ 8,000 ÷ 7,600
Cost per equivalent unit Rs.12.50 Rs. 3.50
(Rs.)
Cost of finished stock (7,000 x (Rs. 12.50 + Rs. 3.50)) 112,000

Materials (1,000 units x Rs. 12.50) 12,500
Conversion (600 units x Rs. 3.50) 2,100
14,600

Process-Z
Direct material 8,000 100,000 Finished stock 7,000 112,000
Conversion cost 26,600 Closing WIP 1,000 14,600
8,000 126,600 8,000 126,600

Equivalent units
Output Total % age Cost from Material Conversion
Units complete previous added costs
dept.
Finished output 19,950 100% 19,950 19,950 19,950
Closing WIP: 4,800
Cost from previous 100% 4,800
process
Materials 0% -
Conversion 60% 2,880
24,750 24,750 19,950 22,830
Cost from Material added Conversion

previous dept. costs
Total costs Rs. 1,361,250 Rs. 79,800 Rs. 1,050,180
Equivalent units 24,750 ÷ 19,950 ÷ 22,830
Cost per equivalent unit Rs. 55 Rs. 4 Rs. 46
(Rs.)
Cost of finished stock (19,950 x (Rs. 55+4+46)) 2,094,750

Cost from previous dept. (4,800 units x Rs. 55) 264,000
Material added -
Conversion (2,880 units x Rs. 46) 132,480
396,480
Equivalent units
Output Total % age Materials Conversion
Units complete
Transfer to Process 2 3,400 100% 3,400 3,400
Closing WIP: 600
Materials 100% 600
Conversion 50% 300
4,000 4,000 3,700
Materials Conversion
Cost of opening stock Rs. 79,520 Rs. 14,900
Cost for the period Rs. 400,000 Rs. 344,000
Total Cost Rs. 479,520 Rs. 358,900

Cost per equivalent unit Rs.119.88 Rs. 97.00
(Rs.)
Cost of stock Transfer to Process 2 737,392
(3,400 x (Rs. 119.88 + Rs. 97.00))

Materials (600 units x Rs. 119.88) 71,928
101,028

Process 1
Opening WIP 800 94,420 Transfer to Process 2 3,400 737,392
Direct material 3,200 400,000 Closing WIP 600 101,028
4,000 838,420 8,000 838,420
Equivalent units
Output Total % age Materials Labour Production
Units complete overheads
Transfer to Process 2 1,350 100% 1,350 1,350 1,350
Closing WIP: 450
Materials 100% 450
Labour 60% 270
Production overheads 50% 225
1,800 1,800 1,620 1,575
Materials Labour Production

overheads
Cost of opening stock Rs. 33,000 Rs. 10,440 Rs. 4,500
Cost for the period Rs. 147,000 Rs. 90,000 Rs. 58,500
Total Cost Rs. 180,000 Rs. 100,440 Rs. 63,000
Equivalent units ÷ 1,800 ÷ 1,620 ÷ 1,575
Cost per equivalent unit Rs. 100 Rs. 62 Rs. 40

(Rs.)
Cost of finished stock 272,700
(1,350 x (Rs. 100+62+40))

Labour (270 units x Rs. 62) 16,740
Production overheads (225 units x Rs. 40) 9,000
70,740

Process
Opening WIP 300 47,940 Finished stock 1,350 272,700
Materials 1,500 147,000 Closing WIP 450 70,740
Labour 90,000
1,800 343,440 1,800 343,440
Equivalent units
Units complete
Finished goods 12,000 100% 12,000 12,000
Closing WIP: 3,000
Material cost 100% 3,000
Conversion cost 60% 1,800
15,000 15,000 13,800
Total Cost Rs. 75,000 Rs. 27,600
Cost per equivalent unit Rs. 5.00 Rs. 2.00
(Rs.)
Finished goods (12,000 x (Rs. 5+2)) 84,000

Conversion (1,800 units x Rs. 2.00) 3,600
18,600


Process-Zampa
Opening WIP 4,500 20,355 Finished goods 12,000 84,000
Material cost 10,500 56,100 Closing WIP 3,000 18,600
15,000 102,600 15,000 102,600
Equivalent units
Output Total % age Materials Conversion*
Units complete
Transfer to next process 17,500 100% 17,500 17,500
Closing WIP: 5,000
Conversion cost 50% 2,500
22,500 22,500 20,000
*Labour and overheads are combined as completion stage of both in closing WIP is same.
Total Cost Rs. 268,875 Rs. 304,000
(Rs.)
Cost of units transferred to next process 475,125
(17,500 x (Rs. 11.95+15.20))

97,750

Equivalent units
Units complete
Opening WIP completed: 800
Materials 0%
Conversion 75% 600
For the period production 2,600 100% 2,600 2,600
Total units transferred to 3,400 2,600 3,200
Process 2
Closing WIP: 600

Materials 100% 600
Conversion 50% 300
4,000 3,200 3,500
Cost per equivalent unit Rs. 125 Rs. 98.286
(Rs.)
Opening WIP value from previous period 94,420
Conversion cost added to complete opening WIP (600 x 98.286) 58,972
Cost of complete 800 units from previous period 153,392
Cost of for the period production (2,600 x (125+98.286)) 580,543
Total cost of output transferred to next process 733,935

104,485

Process 1
Direct material 3,200 400,000 Closing WIP 600 104,485
4,000 838,420 8,000 838,420

Equivalent units
Units complete
Materials 0%
Conversion 25% 100
Process 2
Closing WIP: 200

Materials 100% 200
Conversion 50% 100
4,400 4,000 4,000
(Rs.)
Conversion cost added to complete opening WIP (100 x 95.00) 9,500
Cost of for the period production (3,800 x (47.50+95.00)) 541,500

19,000

Process 1
Labour costs 190,000
Overhead absorbed (100% 190,000
of labour costs)
4,400 628,000 4,400 628,000

Equivalent units
Units complete
Opening WIP completed: 4,500
Materials 0%
finished goods
Closing WIP: 3,000

15,000 10,500 12,450
Material cost Conversion cost

(Rs.)
Conversion cost added to complete opening WIP (3,150 x 2.10) 6,615
Cost of complete 4,500 units from previous period 26,970
Total cost of output transferred to finished goods 82,791

Material cost (3,000 units x Rs. 5.343) 16,029
Conversion cost (1,800 units x Rs. 2.10) 3,780
19,809

Process-Zampa
Material cost 10,500 56,100 Closing WIP 3,000 19,809
15,000 102,600 15,000 102,600

Note: Question does not state the method of valuation to be used in determining the cost of output i.e.
FIFO or Average. However, when opening stock information does not provide the break-up of its cost into
different elements (i.e. material, labour, overheads), we can only use FIFO method.
Equivalent units
Units complete
Materials 0%
Conversion 20% 300
Process 2
Closing WIP: 1,000

Conversion 60% 600
4,000 5,000 4,900
(Rs.)
Conversion cost added to complete opening WIP (300 x 3) 900
Cost of for the period production (4,000 x (2+3)) 20,000

Material (1,000 units x Rs. 2) 2,000
Conversion cost (600 units x Rs. 3) 1,800
3,800
Note: As opening stock information provides break-up of cost into different elements (i.e. material, labour,
overheads) but does not give information on the stage of completion of opening stock, only AVCO
method can be used.

Equivalent units
Units complete
Transfer to next process 18,200 100% 18,200 18,200
Closing WIP: 1,800
Conversion cost 50% 900
Expected output 20,000 20,000 19,100
Total Cost Rs. 191,000 Rs. 191,000
Cost per equivalent unit Rs. 9.55 Rs. 10
(Rs.)
Cost of units transferred to next process 355,810
(18,200 x (Rs. 9.55+10))

26,190
Quantity schedule:
Units
Input quantities 25,000
Normal loss (10% of 25,000) (2,500)
Expected output 22,500
Actual output 21,250
Abnormal loss 1,250

Equivalent units
Units complete
Finished goods 21,250 100% 21,250 21,250
Abnormal loss: 1,250
Expected output 22,500 22,500 22,000
(Rs.)
(21,250 x (Rs. 3+1.50))
Cost of Abnormal loss:

Materials (1,250 units x Rs. 3) 3,750
4,875

Process-Z
Direct materials 25,000 67,500 Finished goods 21,250 95,625
Conversion cost 33,000 Normal loss 2,500 -
Abnormal loss 1,250 4,875
25,000 100,500 25,000 100,500
Quantity schedule:
Units
Normal loss (10% of 25,000) (2,500)
Actual output (24,000)
Abnormal loss/ (gain) (1,500)

Equivalent units
Units complete
Finished goods 24,000 100% 24,000 24,000
Abnormal gain: (1,500)
Materials 100% (1,500)
Conversion cost 60% (900)
Expected output 22,500 22,500 23,100
(Rs.)
(24,000 x (Rs. 3+1.429))
Cost of Abnormal gain:

5,786

Process-Z
Conversion cost 33,000 Normal loss 2,500 -
Abnormal gain 1,500 5,786
26,500 106,286 26,500 106,286
Illustration 34: Closing WIP and losses
Quantity schedule:
Units
Normal loss (10% of 6,000) (600)
Closing WIP (750)
Abnormal loss/ (gain) 150

Equivalent units
Units complete
Finished goods 4,500 100% 4,500 4,500
Closing WIP: 750
Materials 100% 750
Abnormal loss: 150
Materials 100% 150
Expected output 5,400 5,400 5,025
Scrap value of normal (Rs. 6,000) -
loss (600x10)
Net process cost Rs. 354,000 111,000
(Rs.)
(4,500 x (Rs. 65.556+22.09))
Cost of Closing WIP:

59,107
Cost of Abnormal loss:

11,490

Process-A
Conversion cost 111,000 Closing WIP 750 59,107
Scrap a/c- Normal loss 600 6,000
Abnormal loss 150 11,490
6,000 471,000 6,000 *471,002
* Rounding off difference

Illustration 35: Opening WIP and losses (AVCO)
Quantity schedule:
Units
Opening WIP 500
Introduced into the process 19,500
Total available for processing 20,000
Normal loss (5% of 20,000) (1,000)
Closing WIP (400)
Equivalent units
Units complete
Finished goods 18,200 100% 18,200 18,200
Closing WIP: 400
Materials 100% 400
Abnormal loss: 400 100% 400 400
Expected output 19,000 19,000 18,800
Opening WIP Rs. 4,800 Rs. 9,600
Total input cost Rs. 191,000 Rs. 188,000
loss (1,000x1)
Net process cost Rs. 190,000 Rs. 188,000
(Rs.)
(18,200 x (Rs. 10+10))

6,000
Cost of Abnormal loss (400 x (Rs. 10+10)) 8,000

Process-A
Opening WIP 500 14,400 Finished goods 18,200 364,000
Labour 72,000 Scrap a/c- Normal loss 1,000 1,000
Overheads 106,400 Abnormal loss 400 8,000
20,000 379,000 20,000 379,000
Quantity schedule:
Units
Opening WIP 1,000
Normal loss (5% of 20,000) (1,000)
Closing WIP (1,000)
Note: Information suggests using AVCO method.
Equivalent units
Units complete
Finished goods 17,500 100% 17,500 17,500
Closing WIP: 1,000
Abnormal loss: 500
Materials 100% 500
Expected output 19,000 19,000 18,700
Opening WIP Rs. 40,000 Rs. 30,000
Total input cost Rs. 780,000 Rs. 748,000
loss (1,000x20)

(Rs.)
Cost of goods transferred to process B 1,400,000
(17,500 x (Rs. 40+40))

72,000
Cost of abnormal loss:

36,000

Process-A
Opening WIP 1,000 70,000 Process B 17,500 1,400,000
Materials 19,000 740,000 Closing WIP 1,000 72,000
Labour 179,500 Scrap a/c- Normal 1,000 20,000
loss
20,000 1,528,000 20,000 1,528,000
Abnormal loss
Process A 500 36,000 Scrap a/c 500 10,000
Income statement 26,000
500 36,000 500 36,000
Scrap
Process A 1,000 20,000 Cash 1,500 30,000
1,500 30,000 1,500 30,000
Illustration 37: Opening WIP and losses (FIFO)
Quantity schedule:
Units
Opening WIP 800
Normal loss (8% of 10,000) (800)
Closing WIP (900)

Equivalent units
Units complete
Materials 0%
Conversion 40% 320
next process
Closing WIP: 900

Materials 100% 900
Conversion 70% 630
Abnormal loss: 400
Materials 100% 400
loss (800x4)
(Rs.)
Conversion cost added to complete opening WIP (320 x 3) 960
Cost of for the period production (7,100 x (4+3)) 49,700

5,490

Conversion (320 units x Rs. 3) 960
2,560

Process 1
Opening WIP 800 4,000 Process 2 7,900 54,660
Labour 16,740 Normal loss 800 3,200
10,000 65,910 10,000 65,910
Note: Information suggests using FIFO method.
Quantity schedule:
Units
Opening WIP 4,500
Normal loss (5% of 10,500) (525)
Closing WIP (3,000)
Equivalent units
Units complete
Materials 0%
next process
Closing WIP: 3,000

Abnormal loss: 225
Materials 100% 225
Scrap value of normal (Rs. 525) -
loss (525x1)

(Rs.)
Conversion cost added to complete opening WIP (3,150 x 2.213) 6,971
Cost of complete 4,500 units from previous period 27,326

16,457

Materials (225 units x Rs. 4.158) 936
Conversion (113 units x Rs. 2.213) 250
1,186

Process W
Direct materials 10,500 42,000 Closing WIP 3,000 16,457
Conversion costs 26,145 Normal loss 525 525
15,000 88,500 10,000 *88,498
* Rounding off difference
(a) (b) (c) (d)
Opening work in process inspected 1,000 1,000 - -

Units introduced during the period 10,000 10,000 10,000 10,000
Closing work in process not inspected - (2,000) (2,000) -
Units inspected 11,000 9,000 8,000 10,000
Normal loss (5% of units inspected) 1,100 900 800 1,000
(a) (b) (c) (d)
Opening work in process inspected 50,000 50,000 - -

Units introduced during the period 600,000 600,000 600,000 600,000
Closing work in process not inspected 0 (25,000) - (25,000)
Units inspected 650,000 625,000 600,000 575,000
Normal loss (5% of units inspected) 32,500 31,250 30,000 28,750

Joint and By products
(i) Units produces basis
Products Units
A 12,500
B 7,500
20,000
Costs: Rs.
A: 12,500 units/20,000 units x Rs. 339,700 212,312.50
B: 7,500 units/20,000 units x Rs. 339,700 127,387.50
339,700.00
Process
Processing cost 20,000 339,700.00 A 12,500 212,312.50
B 7,500 127,387.50
20,000 339,700.00 20,000 339,700.00
(ii) Sale value at split off point basis
Products Sale Vaue at

split off point
(Rs.)
A (12,500x100) 1,250,000
B (7,500x137.50) 1,031,250
2,281,250
Costs: Rs.
A: 1,250,000/2,281,250xRs. 339,700 186,137
B: 1,031,250/2,281,250xRs. 339,700 153,563
339,700
Process
B 7,500 153,563.01
20,000 339,700.00 20,000 339,700.00
(iii) NRV (at split off point) basis
Note: Used when joint products are not saleable at split off point and these have to be processed further
before these are sold in the market.
NRV at split of point = Final sale value – processing cost after split off point
Products NRV at split

off point
(Rs.)
A {12,500x(300-62.50)} 2,968,750
B {7,500x(200-37.50)} 1,218,750
4,187,500

Costs: Rs.
A: 2,968,750/4,187,500xRs. 339,700 240,832.09
B: 1,218,750/4,187,500xRs. 339,700 98,867.91
339,700.00
Process
B 7,500 98,867.91
20,000 339,700.00 20,000 339,700.00
Total Joint cost to be allocated amongst A and B = 26,000+10,000+8,000+22,000 = Rs. 66,000
(i) On the basis of quantity produced
Products Units
A 10,000
B 12,000
22,000
Costs: Rs.
A: 10,000 units/22,000 units x Rs. 66,000 30,000
B: 12,000 units/22,000 units x Rs. 66,000 36,000
66,000
(ii) On the basis of sales value at split off point
Products Sale Vaue at

split off point
(Rs.)
A (10,000x5.2) 52,000
B (12,000x3) 36,000
88,000
Costs: Rs.
A: 52,000/88,000xRs. 66,000 39,000
B: 36,000/88,000xRs. 66,000 27,000
66,000
Illustration 43: Treatment of by products
Total joint process cost = 900,000+5,000+2,000+8,000+10,000 = Rs. 925,000
i. Cost per ton = Rs. 925,000/ 80 = Rs. 11,562.50

ii. Cost per ton = Rs. (925,000-36,000)/ 80 = Rs. 11,112.50

Process
Direct material 87,500 541,000 Joint product-C –(w1) 36,000 495,000
Conversion costs 210,000 Joint product-D–(w1) 30,000 165,000
By product-G 12,000 12,000
Normal loss 2,000 4,000
Abnormal loss–(w1) 7,500 75,000
87,500 751,000 87,500 751,000
(w1)
Cost per unit = Process cost – Scrap value of normal loss – sale value of by product G
Input units – normal loss units – by product G units
Average cost per unit = 541,000+210,000-4,000-12,000 = Rs. 10

87,500-2,000-12,000
Abnormal loss = 7,500x10 = Rs. 75,000
C’s cost = (4.50/6) x (751,000-12,000-4,000-75,000) = Rs. 495,000

D’s cost = (1.50/6) x 660,000 = Rs. 165,000
Process
Direct material 100,000 600,000 Joint product-X –(w1) 50,000 535,714
Conversion costs 200,000 Joint product-Y–(w1) 25,000 214,286
Abnormal gain (w1) 2,000 20,000 By product-A 22,000 59,400
Normal loss 5,000 10,600
102,000 820,000 87,500 820,000
(w1)
Cost per unit = Process cost – Scrap value of normal loss – sale value of by product A
Input units – normal loss units – by product A units
Average cost per unit = 600,000+200,000-10,600-59,400 = Rs. 10

100,000-5,000-22,000
Abnormal gain = 2,000x10 = Rs. 20,000
X’s cost = (2.50/3.5) x (820,000-10,600-59,400) = Rs. 535,714

Y’s cost = (1.00/3.5) x 750,000 = Rs. 214,286

Past Papres with Suggested Answers

Question 1: Process Costing-Basic Rules

Answer 1: Process Costing-Basic Rules


Question 2: Process 1 and Process 2

Answer 2: Process 1 and Process 2

Question 3: Two Processes

Answer 3: Two Processes


Question 4: Hornbill Limited

Answer 4: Hornbill Limited

Question 5: Bela Enterprises (Autumn 2016, Q3)

Answer 5: Bela Enterprises (Autumn 2016, Q3)

Question 6: Ravi Limited (Spring 2017, Q3)

Answer 6: Ravi Limited (Spring 2017, Q3)


Question 7: Platinum Chemicals (Autumn 2017, Q1)

Answer 7: Platinum Chemicals (Autumn 2017, Q1)

Question 8: Quality Chemicals (Spring 2016, Q6)
Answer 8: Quality Chemicals (Spring 2016, Q6)


Question 9: KS Limited (Spring 2015, Q4)

Answer 9: KS Limited (Spring 2015, Q4)

Question 10: Ababeel Foods (Autumn 2014, Q1)

Answer 10: Ababeel Foods (Autumn 2014, Q1)

Question 11: Tulip Enterprises (Spring 2019, Q1)

Answer 11: Tulip Enterprises (Spring 2019, Q1)

CMA ADNAN RASHID COMPLETE NOETS

Uploaded by

Copyright:

Available Formats

CMA ADNAN RASHID COMPLETE NOETS

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

CMA ADNAN RASHID COMPLETE NOETS

Uploaded by

Copyright:

Available Formats

Accounting for Overheads Chapter 1

Cost and Management Accounting 12

Direct expenses are part of the prime cost of a product.

Indirect Costs cannot be directly traced to a specific cost unit (Product).

Indirect expenses are also known as overheads.

Costs Direct/ Indirect Cost Category of Overhead

Production overheads are the total of indirect production costs:

Production overheads = indirect materials + indirect labour + indirect expenses

 heating the factory

Cost and Management Accounting 13

Description of cost Cost Under

International Accounting Standard (IAS) 2:

Basic Example on Absorption Costing

OAR = Budgeted Production Overheads

Rs. 62.50 per unit

Cost and Management Accounting 14

Stages in Absorption Costing:

Allocable Overhead Costs Cost Center (Department)

Production Overheads cost Possible Apportionment Bases

The following are budgeted costs for the next period:

The following information is also available:

Total Assembly Finishing Maintenance Canteen

Cost and Management Accounting 15

Total Machining Assembly Repairs Quality

Note1: Depreciation relates to plant and equipment.

Total Machining Assembly Repairs Quality

Production vs. Service departments in a factory

4. Reapportionment/ Secondary Apportionment is a process whereby service departments’ costs

Cost and Management Accounting 16

a. Service departments do not serve other service departments:

Cost and Management Accounting 17

S2 department is only providing services to production departments, whereas S1 department is also

Cost and Management Accounting 18

 Repeated Distribution Method

Total Machining Assembly Repairs Quality

Work done by the service departments:

 Simultaneous Equations Method

Step 1 – Formulate the simultaneous equations:

Cost and Management Accounting 19

Total Machining Assembly Repairs Quality

Work done by the service departments:

Total Production Service

Cost and Management Accounting 20

Department Overheads cost

Assembly Finishing Maintenance Canteen

Now attempt Question 1: Service Departments

The overhead absorption rate (OAR) is calculated as follows:

Budgeted production overhead

Cost and Management Accounting 21

Labour hours used in each department by each product:

Production is expected to be as follows:

Product D 2,000 units

Overheads are budgeted as follows:

Calculate the followings:

Cost and Management Accounting 22

Departmental vs Blanket OARs

Using the data from illustration 13, calculate:

i. Blanket OAR per hour

Now attempt Question 2: Apportionment

Treatment of non-production overheads