Cost and Management Accounting: Classification, Material, Labour and Overhead Costing
What the domain tests
This domain tests cost classification, material valuation, labour cost treatment and overhead absorption. You must decide whether a cost is direct or indirect, product or period, and how to calculate and clear over- or under-absorbed overhead.
Core rules
- Direct costs trace to a cost unit; indirect costs are overheads. Fixed, variable and semi-variable costs behave differently. Product costs attach to inventory; period costs are expensed.
- Material issues: FIFO and weighted average give different cost of sales and closing inventory. EOQ balances ordering and holding costs. Stock losses are not production cost.
- Labour: direct labour is traced to production. Idle time and normal overtime premium are usually overheads. Overtime premium caused by a specific customer may be direct.
- Overhead absorption: allocate specific overheads, apportion shared overheads, reapportion service departments, then absorb using a base such as labour hours or machine hours.
Worked example
Budgeted overhead 120,000; budgeted machine hours 20,000. Absorption rate = 6 per machine hour. Actual overhead 125,000; actual hours 21,000. Absorbed = 21,000 x 6 = 126,000. Over-absorbed = 126,000 - 125,000 = 1,000. Reason: absorbed overhead exceeds actual, so the difference is credited to profit or loss.
Traps
Do not absorb non-production overheads into production cost. Do not treat idle time as direct labour. Do not use actual hours to set the predetermined rate. FIFO is not the same as weighted average.