1) Sparrow Engineering Ltd is an engineering company which makes batches of many

different products. The company has budgeted their total production overheads and
expected activity for the coming period as follows:

Budgeted total production overheads £1,040,500

Budgeted direct production labour hours 5,780 hours

Batch 605 – 1,000 units component Batch 606 – 1,000 units component
XL2 XL34
Materials £ £ Materials £ £
200kgs M64 6,420 200kgs M64 6,420
100kgs S24 7,920 100kgs S24 7,920
600kgs L54 1,490 600kgs L54 1,490
Boxes N92 520 Boxes N92 520
Total material 16,350 16,350
Direct labour Direct labour
Milling 2 hours x £20 40 Milling 2 hours x £20 40
Assembly 240 hours x 4,320 Assembly 170 hours 3,060
£18 x £18
Spraying 50 hours x 800 5,160 Spraying 120 hours x 1,920 5,020
£16 £16
Total direct costs 21,510 Total direct costs 21,370
Machine hours in milling 30 hours Machine hours in 70 hours
milling

Calculate:
a. the overhead absorption for each of these batches, based on direct production labour hours
b. the product prices based on a mark-up of 30 per cent on full production cost.
2. The company wants to move to using cost centre rates for charging overheads to products
(the two- stage traditional approach). For service departments it decides to use the specific-
order closing method, closing the stores department first.
Since the milling department is machine intensive, its costs will be allocated to products using
machine hours. Assembly and spraying costs will be allocated to products using labour hours.
Details of the cost centres are shown in the table below.

For the period in question the following amounts were budgeted:

Direct cost centre costs
Indirect materials £70,000 £25,000 £10,000 £15,000 £3,000 £17,000
Indirect labour £260,000 £52,500 £25,000 £22,500 £42500 £117,500
Contract maintenance £305,000 £185,000 £75,000 £45,000 0 0
work
General overheads to be apportioned
Fire and machine £21,000
insurance
Power £45,000
Heating and lighting £20,000
Rates £18,000
Machine depreciation £259,000
Canteen deficit £42,500
Total £1,040,500

Basic budgeted data relating to cost centres (departments)

Total Production cost centres Service cost centres
Measures of activity Milling Assembly Spraying Stores Maintenance
No. of employees 150 30 75 25 6 14
Direct labour hours 5,930 1,510 3,320 950 50 100
Machine hours 9,800 8,400 1,100 300
Machinery values £447,000 £225,000 £75,000 £45,000 £17,000 £85,000
Floor area (m) 22,500 7,500 10,000 3,500 500 1,000
Material requisitions 2,500 1,400 300 250 550
Maintenance hours provided by
maintenance department
1,700 800 700 200 – –
Kilowatt hours (kwh) (‘000) 600 300 70 50 10 170
Calculat
e:a. the full production cost after allocating costs to cost centres and allocating cost centre
costs to each product

b. a product price based on a mark-up of 30 per cent on full

production costs.
SOLUTION
 Production cost centres Service cost centres
Overhead Apportionment Total Milling Assembly Spraying Stores Maintenance
item basis
Allocated £ £ £ £ £ £
items
Indirect – 70,000 25,000 10,000 15,000 3,000 17,000
material
Indirect labour – 260,000 52,500 25,000 22,500 42,500 117,500
Contract
maintenance 305,000 185,000 75,000 45,000 0 0
Apportioned
items
Fire and Machinery values 21,000 10,570 3,520 2,120 790 4,000
machine ins*
Power KWH 45,000 22,500 5,250 3,750 750 12,750
Heating & Floor area 20,000 6,670 8,890 3,110 440 890
lighting
Rates Floor area 18,000 6,000 8,000 2,800 400 800
Machine Machinery values 259,000 130,370 43,460 26,070 9,850 49,250
depreciation
Canteen Employee no. 42,500 8,500 21,250 7,080 1,700 3,970
deficit
Totals 1,040,500 447,110 200,370 127,430 59,430 206,160

Secondary apportionment – specific-order closing approach

Stores Material requisitions 33,280 7,130 5,950 –59,430 13,070
Maintenance Maintenance hrs 103,170 90,270 25,790 –219,230
Total production dept overheads 1,040,500 583,560 297,770 159,170 – –
Overhead absorption basis Machine hrs Labour hrs Labour
hrs
£583,560 £297,770
Overhead absorption rates 8,400 20 £159,170
950
=£69.471 =£89.69 =£167.55
per machine per labour per labour
hr hr hr
Overheads analysis
*The amount apportioned to each cost centre is calculated by: total cost x usage by cost
centre/total

Product costing (using departmental rates)

Batch 605 – 1,000 units £ Batch 606 – 1,000 units £
component XL2 component XL34
Total direct costs (as previously) 21,510 21,370
Overheads:
 Milling (machine hrs) 30 hrs x 2,084 (machine hrs) 70 hours x £69.47 4,863
£69.47
Assembly (labour hrs) 240 hrs x 21,525 (labour hrs) 170 hours x £89.69 15,247
£89.69
Spraying (labour hrs) 50 hrs x 8,378 (labour hrs) 120 hours x £167.55 20,106
£167.55
Total cost 53,497 61,586
30% Mark up 16,049 18,476
Price? 69,546 80,062

Standard Rate

Product costs and prices

Batch 605 Batch 606
Total direct costs (see table above) 21,510 21,370
Allocated overheads 292 hours x £180 52,560 52,560
Total production cost 74,070 73,930
Mark up 30% 22,221 22,179
Price 96,291 96,109

For Discussion

Look at the results in Example 2.1 and explain why both product prices for batches 605 and 606)
are lower, using the cost centre rates compared to using the standard rate.
When considering the results of the cost centre approach, explain why the price of batch 606 is
much higher than batch 605, although the prices were very similar under the standard approach.
 3) Consider the Central Computer Department at the corporate headquarters of Fontaine
Informatique. For simplicity, assume that the only users of this facility are the
Microcomputer Division and the Peripheral Equipment Division. The following data apply
to the coming budget year:

––––––
Total Budgeted hours 1200

Fixed costs of operating the facility €300000 per

year
Total capacity available 1500 hours
Budgeted long-term usage (quantity) in
hours
Microcomputer Division 800
Peripheral Equipment Division 400

4) Honnigsvåg has two support departments (Plant Maintenance and

Information Systems) and two operating departments (Machining and Assembly) in its
manufacturing facility.

Plant Information Machining Assembly Total

Maintenance Systems
Budgeted €600000 €116000 €400000 €200000 €1316000
manufacturing
overhead costs
before any
interdepartment
cost
allocations
Support work 1,600 2,400 4,000 8,000
furnished 20% 30% 50% 100%
By Plant
Maintenance
Budgeted
labour-hours
%
By Information 200 1,600 200 2,000
Systems 10% 80% 10% 100%
Budgeted
computer time
%
Allocate the costs of the support department to Machining and Assembly using

Direct allocation method

Step Down Allocation Method

Reciprocal Method

Using the previous example of Sparrow Engineering Ltd, the budgeted hours for the
period and allocated costs were as shown in Table 2.1.

Cost centre Overheads allocated

Milling 8,400 hours × £69.471 £583,556

Assembly 3,320 hours × £89.69 £297,770
Spraying 950 hours × £167.55 £159,173
Total £1,040,499 (Differences
due to rounding)

Actual Hours Woked

Milling 8,234
Assembly 3,420
Spraying 930

Calculate the over or under absorption of overheads.

5)

Olympiakos, SA, provides outsourcing services and advice to both government and corporate
clients. For costing purposes, Olympiakos classifies its departments into two support
departments (Administrative/Human Resources and Information Systems) and two operating
departments (Government Consulting and Corporate Consulting). For the first quarter of 2007,
Olympiakos incurs the following costs in its four departments:
 Administrative/Human Resources (A/HR) €600 000
Information Systems (IS) €2 400 000
Government Consulting (GOVT) €8 756 000
Corporate Consulting (CORP) €12 452 000

The actual level of support relationships among the four departments for the first quarter of 2007
was:

A/HR IS GOVT CORP

Supplied A/HR – 25% 40% 35%

by IS 10% – 30% 60%

The Administrative/Human Resource support percentages are based on headcount. The

Information Systems support percentages are based on actual hours of computer time used.

Required
1 Allocate the two support department costs to the two operating departments using the
following methods:
a Direct method
b Step-down method (allocate Administrative/Human Resources first)
c Step-down method (allocate Information Systems first).
2 Compare and explain differences in the support department costs allocated to each operating
department.
3 What criteria could determine the sequence for allocating support departments using the step-
down method? What criterion should Olympiakos use if government consulting jobs require the
step-down method?

6) A computer-service centre of Madrid University serves two major users, the department of
Engineering and the department of Humanities and Sciences (H&S).

Required
1 When the computer equipment was initially installed, the procedure for cost allocation was
straightforward. The actual monthly costs were compiled and divided between the two
departments on the basis of the computer time used by each. In October, the costs were €100
000. H&S used 100 hours and Engineering used 100 hours. How much cost should be allocated
to each department? Suppose costs were €110 000 because of various inefficiencies in the
operation of the computer centre. How much cost would then be allocated? Does such an
allocation seem justified? If not, what improvement would you suggest?

2 Use the same approach as in requirement 1. The actual cost-behaviour pattern of the computer
centre was €80000 fixed cost per month plus €100 variable cost per hour [Link] November,
H&S used 50 hours and Engineering used 100 hours. How much cost would be allocated to each
department? Use a single-rate method.

3 As the computer-service centre developed, a committee was formed that included

representatives of H&S and Engineering. This committee determined the size and composition of
the centre’s equipment. The committee based its planning on the longrun
average utilisation of 180 monthly hours for H&S and 120 monthly hours for Engineering.
Suppose the €80 000 fixed costs are allocated through a budgeted monthly lump sum based on
long-run average utilisation. Variable costs are allocated through a budgeted unit rate of €100 per
hour. How much cost should be allocated to each department?What are the advantages of this
dual-rate allocation method over other methods?

4 What are the likely behavioural effects of lump-sum allocations of fixed costs? For example,if
you were the representative of H&S on the facility planning committee, what would your biases
be in predicting long-run usage? How would top management counteract the bias?