A discussion of the basis and reasons for charging overheads

A discussion of the basis and reasons for charging overheads to individual production cost centres (Document 5) with particular emphasis on the following areas:
a. Using the figures in the tables above, explain the basis of the overhead charges to the Graphics Processing Unit cost centre. (275-325 words);
b. Using the figures in the table above to illustrate your points, critically discuss the process of absorption costing. (180-210 words).

Document 5- Full (absorption) costing Newtron Technologies Ltd\'s product costing team have provided you with the following information on the current method used to charge overhead costs to products. The table shows each overhead cost and the apportioned and reapportioned costs by cost centre together with the apportionment bases used Computer Processing Processors Memory Mainte Admin- nance istration Department Cards Total Units Direct costs Direct materials () 3,405,000 2,951,000 2,644,000 9,000,000 Direct labour () Overheads Indirect labour (E) Rent (E) Machine insurance 2,066,000 ,902,000 2,032,000 6,000,000 900.000 2,380,000 20,000 50.000 900.000 Heating (£) Machine power (£) Machine depreciation (£) 720,000 Value of machines 832,000 11,000 449,000 130,000 72 725,000 713,000 1,330,000 Floor area (m2) Machine hours Direct labour hours Employees 3,600,000 8,000 7,000 45,000 - 1,800,000 344.000 308 10,000 9,000 385,000 329,000 637,000 110,000 104,000 58 61 68 49

Solution

Under Activity based Costingoverhead is apportioned on the basis of the cost drivers that are used to perform that activity.

In the given table Newtron Technologies ltd has apportion the overhead on the basis of the cost drivers. Following explanation is given in the detail:

=2380000*(10000/45000)

-Machine insurance is divided in the ratio of value of the machine , which is correct because insurance value is calculated n the basis value of the underlying asset. Calulation is as follows:

=20000*(725000/3600000)

the overhead:

=900000*(385000/1800000)

    Further under Activity Base Costing expenses which are common in nature will be reapportioned to the actual unit of the organization. So maintenance and Administration expenses are being divided among the units of the Newtron Technologies Ltd.

A total of 1023889 and 378000 is apportioned to the maintenance and administrative department respectively. Since these are common unit so these amount will be reapportioned on the basis of the machine hours and number of employees respectively.

B. Absorption costing is the process of dividing toal overheads incurred during the period on the basis of the single overhead rate instead of dividing the same on the basis of some rational cost driver.

In the process of absorption costing complete overhead will be divided against total of one main activity which is Direct labour hours in the given question and a specific rate is calculated by dividing the total overheads during the period to the total number of cost activity related to that particular cost driver.

After the calculation of rate such rate is applied to the total overhead of the individual units.

In the given question total absorption rate is calculated on the basis of the already apportioned overheads which is not the correct process of the absorption costing.