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9706 · 2.2.2

Absorption costing — practice questions

Practice and worked examples for 9706 Absorption costing. Short previews only — attempt the full question in MarkScheme against the official scheme.

Worked example 1

Budgeted overhead $96,000; budgeted machine hours 12,000. Actual overhead $99,000; actual machine hours 11,500. Calculate OAR, absorbed overhead, and under/over absorption.

Show solution outline

OAR = 96,000 ÷ 12,000 = $8 per machine hour

Absorbed overhead = 11,500 × 8=∗∗8 = **92,000**

Actual overhead = **99,000∗∗99,000**

Under-absorption = 99,000 − 92,000 = **7,000∗∗7,000**

SPL adjustment: Add $7,000 to production costs (or cost of sales) — reduces profit.

Worked example 2

Alpha Manufacturing Co. provides the following data for the year:

  • Budgeted production: 10,000 units
  • Budgeted production overheads: 150,000150,000
  • Budgeted direct labour hours: 30,000 hours
  • Actual production: 9,500 units
  • Actual sales: 9,000 units at $50 per unit
  • Actual production overheads: 148,000148,000
  • Actual direct labour hours worked: 28,000 hours

Direct costs per unit are: Direct materials $12, Direct labour $8 (at $4 per hour). There was no opening inventory. The OAR is based on direct labour hours.

Calculate: (a) The overhead absorption rate. (b) The full production cost per unit. (c) The over or under absorption of overheads. (d) Prepare an Income Statement for the year.

Show solution outline

(a) Overhead Absorption Rate (OAR): OAR = Budgeted Production Overheads / Budgeted Direct Labour Hours OAR = $150,000 / 30,000 hours = $5 per direct labour hour

(b) Full Production Cost per Unit: Direct Labour hours per unit = Direct labour cost per unit / Labour rate per hour = 8/8 / 4 per hour = 2 hours Absorbed Overhead per unit = OAR × hours per unit = $5 × 2 hours = $10 Full Cost = Direct Materials + Direct Labour + Absorbed Overhead Full Cost = 12+12 + 8 + 10=∗∗10 = **30 per unit**

(c) Over/Under Absorption: Overheads Absorbed = OAR × Actual Labour Hours = $5 × 28,000 hours = $140,000 Actual Overheads = 148,000148,000 Under-absorption = Actual Overheads - Absorbed Overheads Under-absorption = 148,000−148,000 - 140,000 = $8,000 (Under-absorbed)

(d) Income Statement for the year:

$
Sales Revenue (9,000 units × $50)450,000$
Less: Cost of Sales
Production Cost (9,500 units × $30)285,000
------
Less: Closing Inventory (500 units* × $30)(15,000)
Cost of Goods Produced and Sold270,000
Add: Under-absorption of overheads8,000
Adjusted Cost of Sales(278,000)
Gross Profit172,000

(Closing inventory = 9,500 produced - 9,000 sold = 500 units)

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