ACCA F5 - Performance Management
Absorption costing determines the full per unit cost of
production. It is required for external financial reports and for tax
reporting. Under absorption costing costs are divided into production costs
(Direct costs - material and labor, Indirect costs - variable, semi fixed and
fixed indirect costs e.g. rent, supervisor's salary, depreciation) which are
absorbed in determining the unit cost of production and non-production costs
(Variable/Fixed selling and administrative costs e.g. advertising, delivery and
administrative costs like cleaners and postage) which are treated as period
expenses and are excluded for product costs.
Estimating cost per unit of direct material and labour is
straightforward and easy. However, calculating per unit of indirect costs is
difficult to identify. Therefore, overhead cost per unit is calculated using a
suitable basis like units produced, labor hours or machine hours.
Under absorption costing, change in capacity of production
can result the change in unit cost of the product. This is because indirect
fixed overhead have push and pull effect on unit cost. Let go through capacity
concept in brief.
Source: Absorption/Variable costing ….. check link below
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Theoretical
capacity is the level of capacity based on producing at full efficiency all
the time. This measure of capacity does not allow for plant maintenance,
shutdowns, interruptions, or any other factors. It can be achieved for short
period but cannot be sustained. This represents ideal goal of capacity
utilization.
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Practical
capacity is the level of capacity that reduces theoretical capacity by
considering unavoidable operating interruptions - scheduled maintenance or
holidays, for example.
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Normal
capacity is the level of capacity utilization that satisfies average
customer demand over a period of time, frequently one year.
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Master
budget capacity utilization is the level of capacity that managers expect
for the current time period, frequently one year.
Theoretical and practical capacity measure capacity in terms
of what a plant can supply. Normal capacity and master budget utilization
measure capacity in terms of demand.
Source: Absorption costing overview …. check link below
Absorption costing can be further classified into three
different types. They are:
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Job Order Costing - assigned to product in
batches or lots
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Process Costing - cost are systematically
assigned to the product - no batches to assign cost (e.g. Oil Distilling and
Soda Manufacturing)
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ABC Costing - assigns cost from cost centers to
the product best in multi-product environment
