CFOS/Overheads/Exercise 4.1

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<Return to Unit 4

Exercise 4.1

Absorption of Overheads by Conventional Management Accounting Methods

This exercise is based on a simplified industrial scenario.

Consider the situation of a factory that produces two products, electric kettles and toasters. On any given day, the factory produces 1000 units of each product. It takes a worker half an hour to produce each kettle, whereas a toaster requires only twenty minutes to assemble. The direct labour cost for both products is £30 per hour.

Calculate the direct labour costs for one day's production:

  • Kettles (batch of 1000):
  • Toasters (batch of 1000):
  • Total Direct Labour Cost:

In order to ensure that the goods produced by the factory are of the highest quality, both products are inspected. Each batch of 1000 kettles requires ten inspection hours, but twenty hours of an inspector's time are required to check each batch of 1000 toasters. The total cost of inspecting one day's production in the factory is £750 (or £25 per inspection hour).

The costs of the quality control (inspection) unit are classified as an overhead of the production process and must be apportioned and absorbed by the products that come off the production line. In a conventional costing system the total overhead costs of inspection (£750) are apportioned in proportion to the cost of direct labour hours. What will be the apportioned cost of inspection (both total and per unit) for these two products?

Calculate the Cost of Inspection for:

  • Kettles – Total:
  • Kettles – Per Unit:
  • Toasters – Total:
  • Toasters – Per Unit:

(Source: Adapted from Rumble 1997, Example 7.1, page 54)

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