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S T U D Y T E X T proceeding MANAGEMENT BPP Learning Media is the sole ACCA atomic matter 78 sanctioned Learning diener sate for the ACCA qualification.In this, the provided reputation F5 subscribe text to be reviewed by the demonst strayr We discuss the exceed st esteemgies for per apply for ACCA exams We spotlight the most meaning(a) divisors in the program and the primeval skills you impart need We signpost how from from each one one chapter links to the syllabus and the claim guide We provide lots of exam focus predicts demonstrating what the examiner go forth exigency you to do We emphasise key points in regular stiff forwards summaries We test your acquaintance of what youve studied in quick quizzes We examine your down the stairsstanding in our exam question situate We reference any the important topics in our copious indexBPPs i-Pass result also supports this penning. FOR EXAMS IN 2011 counterbalance edition 2007 Fourth edition Novem ber 2010 ISBN 9780 7517 8921 8 (Previous ISBN 9870 7517 6367 6) British program library Cataloguing-in-Publication entropy A catalogue record for this book is avail adequate to(p) from the British Library Published by BPP Learning Media Ltd BPP Ho spend, Aldine Place London W12 8AA www. bpp. com/ schoolingmedia Printed in the building blocke Kingdom We argon grateful to the Association of Chartered Certified Accountants for licence to re gain past examination questions.The suggested solutions in the exam issue swan reserve been prepargond by BPP Learning Media Ltd, except where other(a)wise stated. in every our rights reserved. 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BPP Learning Media Ltd 2010 ii Contents Page base part you to pass the ONLY F5 subject field schoolbook reviewed by the examiner study F5 The exam paper v vii xi 3 21 33 41 49 63 73 95 123 157 173 199 215 233 267 287 319 337 365 387 403 419 463 donation A Specia itemisation toll and worry score techniques 2a 2b 2c 2d 2e 3 4 5 6 7 8 9 10 11 12 13 14 15 16 apostrophize performance found be Target be vitalitycycle damageing Throughput business relationship Environmental account damage quite a little earn (CVP) abstract control divisor analysis Pricing decisions in short- condition decisions Risk and uncertainty Objectives of reckonary control Budgetary systems vicenary analysis in budgeting Budgeting and standard representing Variance analysis Behavioural aspects of standard toll Performance criterion Divisional effect measures Further performance solicitude assort B downslopeision- pay techniques ram ify C BudgetingPart D Standard live and variances analysis Part E Performance measurement and control interrogatory question bank hang answer bank Index Review form and let loose prize draw Contents iii A note closely procure Dear Customer What does the little mean and why does it amour? 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A tiny minority ignore this and spoil in criminal action at law by illegally photocopying our material or supporting ecesiss that do.If they act illegally and unethically in on e bea, send a management you genuinely trust them? iv Helping you to pass the ONLY F5 force field Text reviewed by the examiner BPP Learning Media the sole Platinum Approved Learning Partner content As ACCAs sole Platinum Approved Learning Partner content, BPP Learning Media gives you the unique opport building blocky to use examiner-reviewed study materials for the 2011 exams. By incorporating the examiners comments and suggestions regarding the depth and b needth of syllabus coverage, the BPP Learning Media engage Text provides excellent, ACCA-approved support for your studies. NEW FEATURE the PER freshBefore you go off qualify as an ACCA member, you do not only have to pass all your exams but also fulfil a three course hardheaded experience requirement (PER). To abet you to mark beas of the syllabus that you might be able to apply in the study to achieve various performance objectives, we have introduced the PER alert feature. You volition distinguish this fe ature end-to-end the Study Text to remind you that what you atomic number 18 learning to pass your ACCA exams is evenly effective to the fulfilment of the PER requirement. Tackling studying examine fundament be a daunting prospect, particularly when you have lots of other commitments.The different features of the text, the purposes of which atomic number 18 explained justy on the Chapter features page, leave alone help you whilst studying and improve your chances of exam success. Developing exam awargonness Our Texts argon tout ensemble foc utilise on helping you pass your exam. Our advice on Studying F5 outlines the content of the paper, the necessary skills the examiner expects you to demonstrate and any brought forward receiptledge you ar expected to have. Exam focus points are involved within the chapters to highlight when and how limited topics were examined, or how they might be examined in the future. utilize the Syllabus and Study Guide You can find the syllab us and Study Guide on page xi of this Study Text Testing what you can do Testing yourself helps you develop the skills you need to pass the exam and also confirms that you can recall what you have learnt. We include principals lots of them some(prenominal) within chapters and in the Exam mind vernacular, as well as Quick Quizzes at the end of each chapter to test your knowledge of the chapter content. institution v Chapter features separately chapter contains a number of helpful features to guide you through each topic.Topic list Topic list Syllabus reference Tells you what you get out be studying in this chapter and the relevant section numbers, together the ACCA syllabus references. Puts the chapter content in the context of the syllabus as a whole. Links the chapter content with ACCA guidance. Highlights how examinable the chapter content is probably to be and the ways in which it could be examined. What you are mis evolven to know from previous studies/exams. Summaris es the content of primary(prenominal) chapter headings, al starting timeing you to preview and review each section easily. Demonstrate how to apply key knowledge and techniques.Definitions of important concepts that can a great deal earn you easy marks in exams. Tell you when and how particularised topics were examined, or how they may be examined in the future. Formulae that are not give in the exam but which have to be learnt. This is a immature feature that gives you a useful indication of syllabus areas that closely tinct to performance objectives in your Practical Experience Requirement (PER). doorway Study Guide Exam Guide Knowledge brought forward from primitively studies tight in the lead Examples break terms Exam focus points Formula to learn Question Case StudyGive you essential practice of techniques covered in the chapter. interpret real world examples of theories and techniques. Chapter Roundup Quick Quiz Exam Question Bank A estimable list of the Fast Forw ards include in the chapter, providing an easy source of review. A quick test of your knowledge of the main topics in the chapter. Found at the back of the Study Text with much than than comprehensive chapter questions. Cross referenced for easy navigation. vi Introduction Studying F5 The F5 examiner involves candidates to be able to apply management bill techniques in business environments.The key question you need to be able to answer is what does it all actually mean? Modern technology is capable of producing enormous substances of management story culture but it has to be used to help managers to make good decisions and manage effectively. The emphasis in this paper is at that placeof on practical elements and industry to the real world. The examiner does not want to trick you and papers pull up stakes be fair. The F5 examiner The examiner for this paper is Ann Irons, who replaced Geoff Cordwell from the December 2010 sitting onwards.Ann Irons has written several articles in student Accountant, including one on how to attack the paper (September 2010 issue). Make sure you read these articles to gain further insight into what the examiner is looking for. Syllabus update The F5 syllabus has been updated for the June 2011 sitting onwards. The full syllabus and study guide can be found in this Study Text on pages xi to cardinalii. The main changes are the omission of backflush history and the inclusion of environmental chronicle and personify volume simoleons (CVP) analysis. The syllabus order has also been changed, which has been reflected in this Study Text.A full summary of the changes to the F5 syllabus is disposed(p) on the attached page.. Introduction vii viii Introduction Introduction ix 1 What F5 is about The aim of this syllabus is to develop knowledge and skills in the application of management story techniques. It covers modern techniques, decision make, budgeting and standard constituteing, concluding with how a busines s should be managed and controlled. F5 is the middle paper in the management score section of the qualification structure. F2 concerns just techniques and P5 thinks strategically and considers environmental divisors.F5 requires you to be able to apply techniques and think about their equal on the organisation. 2 What skills are required? You are expected to have a core of management account statement knowledge from Paper F2 You pull up stakes be required to harbor out computer sciences, with clear litigateings and a logical structure You go out be required to interpret data You leave alone be required to explain management accounting techniques and discuss whether they are leave for a particular organisation You essential be able to apply your skills in a practical context 3 How to improve your chances of passing on that point is no choice in this paper, all questions have to be answered. You must in that respectfore study the entire syllabus, there are no short-cuts Practising questions below prison termd conditions is essential. BPPs Practice and Revision Kit contains 20 mark questions on all areas of the syllabus Questions will be found on truthful scenarios and answers must be focused and specific to the organisation resultant plans will help you to focus on the requirements of the question and enable you to manage your beat effectively Answer all parts of the question.Even if you cannot do all of the calculation elements, you will lifelessness be able to gain marks in the discussion parts Make sure your answers focus on practical applications of management accounting, common sense is essential Keep an eye out for articles as the examiner will use Student Accountant to convey with students Read journals etc to pick up on ways in which real organisations apply management accounting and think about your own organisation if that is relevant 4 Brought forward knowledge You will need to have a good working knowledge of basic m anagement accounting from Paper F2.Chapter 1 of this Study Text revises compriseing and brought forward knowledge is identified throughout the text. If you struggle with the examples and questions used to revise this knowledge, you must go back and revisit your previous work. The examiner will assume you know this material and it may form part of an exam question. x Introduction The exam paper Format of the paper The exam is a three- mo paper containing five compulsory 20 mark questions. You also have 15 minutes for reading and planning. There will be a assortment of calculations and discussion and the examiners aim is to cover as much of the syllabus as come-at-able.Syllabus and Study Guide The F5 syllabus and study guide can be found on the next page. Introduction xi xii Introduction Introduction xiii xiv Introduction Introduction xv xvi Introduction Introduction xvii xviii Introduction Introduction cardinal Analysis of past papers The table below provides details of when each element of the syllabus has been examined and the question number in which each element appeared. Further details can be found in the Exam Focus Points in the relevant chapters. Covered in Text chapter June 2010 Dec 2009 June 2009 Pilot PaperSPECIALIST COST AND MANAGEMENT ACCOUNTING TECHNIQUES 2a 2b 2c 2d 2e 3 4 5 6 7 8 9 9 10 8 activeness based be Target approaching Life cycle salute Throughput accounting Environmental accounting DECISION-MAKING TECHNIQUES Cost-volume- get ahead analysis Multi-limiting factors and the use of linear programming and shadow pricing Pricing decisions Make-or-buy and other short decisions Dealing with risk and uncertainty in decision-making BUDGETING Objectives Budgetary systems Types of budget Quantitative analysis in budgeting Behavioural aspects of budgeting STANDARD COSTING AND VARIANCE analytic thinking 11 12 12 13 13 14 15 16 Budgeting and standard personify Basic variances and operating systems substantive unify and yield variances Pl anning and operational variances Behavioural aspects of standard comprise PERFORMANCE MEASUREMENT AND CONTROL The scope of performance measurement Divisional performance and transfer pricing Performance analysis in not-for- make headway organisations and the public sphere 4 4 2 4 2 2 1 1 3 2 2 5 3 5 3 3 1, 4 4 4 1 1 2 1 xx Introduction Exam formulae Set out below are the formulae you will be given in the exam. If you are not sure what the symbols mean, or how the formulae are used, you should refer to the appropriate chapter in this Study Text. Chapter in Study Text Learning slue Y = axb Where Y a x b LR = cumulative average time per unit of measurement to produce x units = the time taken for the first unit of payoff = the cumulative number of units = the index of learning (log LR/log 2) = the learning rate as a decimal 10 Regression analysis y = a + bx b= a= 10 n ? xy ? ? x ? y n ? x 2 ? (? ) 2 ?y b? x ? n n (n? x 2 ? (? x)2 )(n? y 2 ? (? y)2 ) 5 r= n? xy ? ? x ? y Demand curv e P b a = a bQ = change in price change in quantity = price when Q = 0 MR = a 2bQ Introduction xxi xxii Introduction P A R T A specialiser greet and management accounting techniques 1 2 represent Topic list 1 be 2 The task of operating expenses 3 A modification of preoccupancy be 4 bash submergence 5 borderline be 6 assiduousness personifying and mouldingal belling compared Introduction Part A of this Study Text looks at specialist terms and management accounting techniques. This chapter serves as a revision of concepts you will have covered in your previous studies.In the pursuance chapter we will be looking at to a great extent complex techniques so it is important that you are familiar with the key concepts and terminology in this chapter. If you want to get free study material of CAT, ACCA, CIMA, CFA, CIA visit freefor911. wordpress. com 3 Exam guide This chapter serves as an introduction to your study of hail and management accounting techniques, as know ledge is assumed from Paper F2 Management Accounting and is still examinable at this level. Questions in this paper will focus on interpretation rather than doing calculations. 1 Costing libertine send Costing is the exhibit of determining the be of harvest-homes, services or activities.Cost accounting is used to limit the speak to of products, jobs or services (whatever the organisation happens to be involved in). much(prenominal)(prenominal) personify have to be built up using a dish out known as monetary value ingathering. In your in front studies you will have learnt how to accumulate the various cost elements which make up supply cost. preoccupancy cost cost accumulation system 2 The problem of belts FAST frontward In form be, or bangs, are cost incurred in making a product or providing a service, but which cannot be traced immediately to the product or service. assiduity be is a actor of incorporating a fair lot of these be into the cost of a unit of product or service provided.If a company manufactures a product, the cost of the product will include the cost of the raw materials and components used in it and cost of the get effort required to make it. These are educate cost of the product. The company would, however, incur umteen other be in making the product, which are not proposely attributable to a single product, but which are incurred commonplacely in the process of manufacturing a whopping number of product units. These are in take on be or smashers. much(prenominal) be include the following. grinder rent and pass judgment instrument depreciation Supervision be Heating and lighting 4 1 Costing ? Part A medical specialist cost and management accounting techniques Key termsA direct cost is a cost that can be traced in full to the product, service or department that is being costed. An indirect cost or smash-up is a cost that is incurred in the course of making a product, providing a service or running a department, but which cannot be traced without delay and in full to the product, service or department. In some companies, the smashs cost might greatly exceed the direct product be. It might seem unreasonable to ignore indirect cost all told when accumulating the costs of making a product, and yet there cannot be a completely satis pulverization way of sharing out indirect costs betwixt the many different items of action which benefit from them. 2. Using preoccupation cost to deal with the problem of hits Traditionally, the view has been that a fair share of hits should be added to the cost of units produced. This fair share will include a portion of all yield disk overhead using up and possibly administration and marketing overheads overly. This is the view embodied in the principles of preoccupation cost. 2. 1. 1 divinatory justification for using tightness cost All payoff overheads are incurred in the output of the organisations output and so each unit of t he product receives some benefit from these costs. Each unit of output should accordingly be flushd with some of the overhead costs. 2. 1. 2 Practical reasons for using preoccupancy cost (a) Inventory military ratings Inventory in hand must be valued for devil reasons. i) (ii) For the finis fund figure in the pedagogy of financial do For the cost of gross sales figure in the income education The rating of inventories will preserve advantageousness during a full point because of the way in which the cost of sales is calculated. Cost of goods sold = (b) Pricing decisions umteen companies attempt to set selling prices by calculating the full cost of action or sales of each product, and then adding a margin for reach. Full cost plus pricing can be particularly useful for companies which do jobbing or pack together work, where each job or contract is different, so that a standard unit sales price cannot be pertinacious. Without using acculturation be, a full cost is challenging to ascertain. c) Establishing the make headwayability of different products This argument in favour of tightness be states that if a company sells more than than than one product, it will be difficult to assay how boodleable each individual product is, unless overhead costs are shared on a fair basis and charged to the cost of sales of each product. cost of goods produced + the value of spread inventories the value of gag rule inventories 2. 2 Using bare(a) be to deal with the problem of overheads For many purposes dousing costing is less useful as a costing mode than marginal costing. In some situations, preoccupation costing can be misleading in the information it supplies.Advocates of marginal costing take the view that only the variable costs of making and selling a product or service should be identified. mend costs should be dealt with separately and handle as a cost of the accounting head rather than shared out somehow between units produced . Some overhead costs are, Part A Specialist cost and management accounting techniques ? 1 Costing 5 however, variable costs which increase as the agree level of application rises and so the marginal cost of outturn and sales should include an amount for variable overheads. 3 A revision of acculturation costing FAST FORWARD soaking up costing is a traditional approach to dealing with overheads, involving three wooden legs allocation, storage allocation and acculturation.Apportionment has two microscope stages, general overhead allotment and service department cost assignation. Key term Absorption costing is a method of product costing which aims to include in the fundamental cost of a product (unit, job and so on) an appropriate share of an organisations chalk up overhead, which is generally taken to mean an amount which reflects the amount of time and effort that has gone into producing the product. You should have covered assiduity costing in your earlier studies. We will therefore summarise the simpler points of the topic but will go into some detail on the more complex areas to refresh your memory. Knowledge brought forward from earlier studiesAbsorption costing merchandise costs are built up using absorption costing by a process of allocation, apportionment and overhead absorption. Allocation is the process by which whole cost items are charged without delay to a cost unit or cost centre. count on costs are allocated directly to cost units. command processing overhead times clearly identifiable with cost centres are allocated to those cost centres but costs which cannot be identified with one particular cost centre are allocated to general overhead cost centres. The cost of a store security guard would therefore be charged to the warehouse cost centre but heating and lighting costs would be charged to a general overhead cost centre.The first stage of overhead apportionment involves sharing out (or apportioning) the overheads within ge neral overhead cost centres between the other cost centres using a fair basis of apportionment (such as floor area occupied by each cost centre for heating and lighting costs). The second stage of overhead apportionment is to apportion the costs of service cost centres (both directly allocated and apportioned costs) to employment cost centres. The final stage in absorption costing is the absorption into product costs (using overhead absorption rates) of the overheads which have been allocated and apportioned to the take cost centres. Costs allocated and apportioned to non- occupation cost centres are usually deducted from the full cost of production to arrive at the cost of sales. Question Cost apportionmentBriefly discuss the type of factors which could affect the choice of the bases an organisation can use to apportion service department costs. 6 1 Costing ? Part A Specialist cost and management accounting techniques Answer (a) (b) (c) (d) (e) The type of service being provi ded The amount of overhead ingestion involved The number of departments benefiting from the service The ability to be able to produce realistic estimates of the usage of the service The resulting costs and benefits Question More cost apportionment A company is preparing its production overhead budgets and determining the apportionment of those overheads to products. Cost centre expenses and related information have been budgeted as follows.Total $ 78,560 16,900 16,700 2, cd 8,600 3,400 40,200 402,000 light speed 35,000 25,200 45,000 Machine blackleg A $ 8,586 6,400 Machine shop B $ 9,190 8,700 prevarication $ 15,674 1,200 Canteen $ 29,650 600 Maintenance $ 15,460 Indirect wages consumable materials Rent and rates Buildings insurance mogul Heat and light depreciation ( railcarry) Value of utensilry Power usage (%) now promote (hours) Machine usage (hours) Area (sq ft) indispensable 201,000 55 8,000 7,200 10,000 179,000 40 6,200 18,000 12,000 22,000 3 20,800 15,000 6,0 00 2 2,000 Using the direct apportionment to production departments method and bases of apportionment which you consider most appropriate from the information provided, calculate overhead totals for the three production departments. AnswerTotal $ Indirect wages 78,560 Consumable materials 16,900 Rent and rates 16,700 Insurance 2,400 8,600 Power Heat and light 3,400 Depreciation 40,200 166,760 Reallocate Reallocate Totals 166,760 A $ 8,586 6,400 3,711 533 4,730 756 20,100 44,816 7,600 4,752 57,168 B $ 9,190 8,700 4,453 640 3,440 907 17,900 45,230 5,890 11,880 63,000 Assembly $ 15,674 1,200 5,567 800 258 1,133 2,200 26,832 19,760 46,592 MainCanteen tenance $ $ 29,650 15,460 600 2,227 742 320 107 172 453 151 33,250 16,632 (33,250) (16,632) Basis of apportionment real authentic Area Area Usage Area Val of mach station agitate Mach usage Part A Specialist cost and management accounting techniques ? 1 Costing 7 4 operating expense absorption FAST FORWARDAfter apportionm ent, overheads are clothed into products using an appropriate absorption rate based on budgeted costs and budgeted practise levels. Having allocated and/or apportioned all overheads, the next stage in absorption costing is to add them to, or absorb them into, the cost of production or sales. 4. 1 Use of a predetermined absorption rate Knowledge brought forward from earlier studies whole step 1 Step 2 Step 3 The overhead likely to be incurred during the coming year is estimated. The total hours, units or direct costs on which the overhead absorption rates are based (activity levels) are estimated. Absorption rate = estimated overhead ? budgeted activity level 4. 2 Choosing the appropriate absorption base Question Absorption basesList as many possible bases of absorption (or overhead recovery rates) as you can think of. Answer (a) (b) (c) (d) (e) (f) (g) (h) A percentage of direct materials cost A percentage of direct labour cost A percentage of prime cost A percentage of factory c ost (for administration overhead) A percentage of sales or factory cost (for selling and distribution overhead) A rate per car hour A rate per direct labour hour A rate per unit The choice of an absorption basis is a matter of judgement and common sense. There are no unmitigated rules or formulae involved. But the basis should realistically reflect the characteristics of a given cost centre, avoid undue anomalies and be fair.The choice will be significant in determining the cost of individual products, but the total cost of production overheads is the budgeted overhead expenditure, no matter what basis of absorption is selected. It is the relative share of overhead costs borne by individual products and jobs which is affected. Question Absorption rates Using the information in and the results of the question on page 7, determine budgeted overhead absorption rates for each of the production departments using appropriate bases of absorption. 8 1 Costing ? Part A Specialist cost and management accounting techniques Answer Machine shop A Machine shop B Assembly $57,168/7,200 = $7. 94 per railcar hour $63,000/18,000 = $3. 50 per machine hour $46,592/20,800 = $2. 24 per direct labour hour 4. 3 Over and below absorption of overheads FAST FORWARDUnder-/over- thoughtless overhead occurs when overheads incurred do not equal overheads absorbed. The rate of overhead absorption is based on estimates (of both numerator and denominator) and it is quite likely that either one or both of the estimates will not agree with what actually occurs. echt overheads incurred will probably be either greater than or less than overheads absorbed into the cost of production, and so it is almost inevitable that at the end of the accounting year there will have been an over absorption or under absorption of the overhead actually incurred. Over absorption means that the overheads charged to the cost of sales are greater than the overheads actually incurred.Under absorption means that i nsufficient overheads have been included in the cost of sales. surmise that the budgeted overhead in a production department is $80,000 and the budgeted activity is 40,000 direct labour hours, the overhead recovery rate (using a direct labour hour basis) would be $2 per direct labour hour. Actual overheads in the item are, say $84,000 and 45,000 direct labour hours are worked. $ command processing overhead time incurred (actual) 84,000 90,000 Overhead absorbed (45,000 ? $2) Over-absorption of overhead 6,000 In this example, the cost of production has been charged with $6,000 more than was actually spent and so the cost that is recorded will be similarly high.The over-absorbed overhead will be an adjustment to the cyberspace and freeing account at the end of the accounting goal to reconcile the overheads charged to the actual overhead. Question Under and over-absorption The total production overhead expenditure of the company in the questions above was $176,533 and its actual activity was as follows. Machine shop A Machine shop B Assembly strike labour hours 8,200 6,500 21,900 Machine usage hours 7,300 18,700 Required Using the information in and results of the previous questions, calculate the under- or over-absorption of overheads. Answer $ Actual expenditure Overhead absorbed Machine shop A Machine shop B Assembly $ 176,533 ,300 hrs ? $7. 94 18,700 hrs ? $3. 50 21,900 hrs ? $2. 24 57,962 65,450 49,056 172,468 4,065 Under-absorbed overhead Part A Specialist cost and management accounting techniques ? 1 Costing 9 4. 4 The reasons for under-/over-absorbed overhead The overhead absorption rate is predetermined from budget estimates of overhead cost and activity level. Under or over recovery of overhead will occur in the following circumstances. Actual overhead costs are different from budgeted overheads. The actual activity level is different from the budgeted activity level. Actual overhead costs and actual activity level differ from those budgeted. QuestionOver and under-absorption Elsewhere has a budgeted production overhead of $180,000 and a budgeted activity of 45,000 machine hours. Required Calculate the under-/over-absorbed overhead, and note the reasons for the under-/over-absorption in the following circumstances. (a) (b) (c) Actual overheads cost $170,000 and 45,000 machine hours were worked. Actual overheads cost $180,000 and 40,000 machine hours were worked. Actual overheads cost $170,000 and 40,000 machine hours were worked. Answer The overhead recovery rate is $180,000/45,000 = $4 per machine hour. (a) Actual overhead Absorbed overhead (45,000 ? $4) Over-absorbed overhead $ 170,000 180,000 10,000Reason Actual and budgeted machine hours are the corresponding(p) but actual overheads cost less than expected. (b) Actual overhead Absorbed overhead (40,000 ? $4) Under-absorbed overhead $ 180,000 160,000 20,000 Reason Budgeted and actual overhead costs were the said(prenominal) but fewer machine hours were worked than expected. $ (c) Actual overhead 170,000 160,000 Absorbed overhead (40,000 ? $4) Under-absorbed overhead 10,000 Reason A combination of the reasons in (a) and (b). 10 1 Costing ? Part A Specialist cost and management accounting techniques 5 marginal costing FAST FORWARD In marginal costing, inventories are valued at variable production cost whereas in absorption costing they are valued at their full production cost. borderline cost is the cost of one unit of a product/service which could be avoided if that unit were not produced/provided. Contribution is the diversion between sales gross and variable (marginal) cost of sales. Marginal costing is an alternative to absorption costing. Only variable costs (marginal costs) are charged as a cost of sales. bushel costs are treated as period costs and are charged in full against the clear of the period in which they are incurred. Knowledge brought forward from earlier studies Key terms Marginal costing In marginal costing, enlistmentp ing point inventories are valued at marginal (variable) production cost whereas, in absorption costing, inventories are valued at their full production cost which includes absorbed fit(p) production overhead.If the source and closing stock levels differ, the profit report for the accounting period under the two methods of cost accumulation will therefore be different. But in the long run, total profit for a company will be the same whichever is used because, in the long run, total costs will be the same by either method of accounting. Different accounting conventions merely affect the profit of individual periods. Question Absorption and marginal costing A company makes and sells a single product. At the beginning of period 1, there are no opening inventories of the product, for which the variable production cost is $4 and the sales price $6 per unit.Fixed costs are $2,000 per period, of which $1,500 are stubborn production costs. median(prenominal) output is 1,500 units per period. In period 1, sales were 1,200 units, production was 1,500 units. In period 2, sales were 1,700 units, production was 1,400 units. Required Prepare profit statements for each period and for the two periods in total using both absorption costing and marginal costing. Answer It is important to notice that although production and sales volumes in each period are different, over the full period, total production equals sales volume. The total cost of sales is the same and therefore the total profit is the same by either method of accounting.Differences in profit in any one period are merely timing differences which cancel out over a perennial period of time. Part A Specialist cost and management accounting techniques ? 1 Costing 11 (a) Absorption costing. The absorption rate for set(p) production overhead is $1,500/1,500 units = $1 per unit. The fully absorbed cost per unit = $(4+1) = $5. $ gross sales employment costs covariant Fixed Add opening catalogue b/f little closi ng broth c/f Production cost of sales Under-absorbed o/hd Total costs Gross profit Other costs lucre profit (300? $5) (300? $5) consummation 1 $ 7,200 $ Period 2 $ 10,200 Total $ $ 17,400 6,000 1,500 7,500 7,500 1,500 6,000 6,000 1,200 (500) 700 5,600 1,400 7,000 1,500 8,500 8,500 100 8,600 1,600 (500) 1,100 1,600 2,900 14,500 1,500 16,000 1,500 14,500 100 14,600 2,800 (1,000) 1,800 (b) Marginal costing The marginal cost per unit = $4. sales Variable production cost Add opening enrolment b/f slight closing inventory c/f Variable prod. cost of sales Contribution Fixed costs Profit Period 1 $ 7,200 6,000 6,000 1,200 4,800 2,400 2,000 400 $ Period 2 $ 10,200 5,600 1,200 6,800 6,800 3,400 2,000 1,400 $ Total $ 11,600 1,200 12,800 1,200 11,600 5,800 4,000 1,800 $ 17,400 (300? $4) (300? $4) Question look labour Direct materials Production overhead Standard production cost per unit 3 hours at $6 per hour 4 kilograms at $7 per kg Variable Fixed Marginal and absorption costing $ 18 28 3 20 69RH makes and sells one product, which has the following standard production cost. Normal output is 16,000 units per annum. Variable selling, distribution and administration costs are 20 per cent of sales value. Fixed selling, distribution and administration costs are $180,000 per annum. There are no units in finished goods inventory at 1 October 20X2. The fixed overhead expenditure is spread evenly throughout the year. The selling price per unit is $140. Production and sales budgets are as follows. sextuplet calendar months ending sextette months ending 31 skirt 20X3 30 September 20X3 Production 8,500 7,000 Sales 7,000 8,000 12 1 Costing ? Part A Specialist cost and management accounting techniquesRequired Prepare profit statements for each of the six-monthly periods, using the following methods of costing. (a) (b) Marginal costing Absorption costing Answer (a) Profit statements for the year ending 30 September 20X3 Marginal costing basis Six months ending 31 March 20X3 $000 $000 Sales at $140 per unit 980 possible action inventory Std. variable prod. cost (at $49 per unit) 416. 5 416. 5 ratiocination inventory (W1) 73. 5 343 637 Variable selling and so on costs 196 Contribution 441 Fixed costs production (W2) 160 selling and so on 90 250 Net profit 191 Profit statements for the year ending 30 September 20X3 Absorption costing basis Six months ending 31 March 20X3 $000 $000 Sales at $140 per unit 980 Opening inventory Std. cost of prod. at $69 per unit) block inventory (W1) (Over-)/under-absorbed overhead (W3) Gross profit sell and so on costs Variable Fixed Net profit 586. 5 586. 5 103. 5 483. 0 (10. 0) 473 507 196 90 286 221 224 90 314 234 Six months ending 30 September 20X3 $000 $000 1,120 73. 5 343. 0 416. 5 24. 5 392 728 224 504 160 90 250 254 (b) Six months ending 30 September 20X3 $000 $000 1,120 103. 5 483. 0 586. 5 34. 5 552. 0 20. 0 572 548 Part A Specialist cost and management accounting techniques ? 1 Costing 13 Workings 1 Op ening inventory Production Sales Closing inventory Marginal cost valuation (? $49) Absorption cost valuation (? $69) 2 3 Normal output (16,000 ? 2) Budgeted output Difference ? std. ixed prod. o/hd per unit (Over-)/under-absorbed overhead Six months ending 31 March 20X3 Units 8,500 8,500 7,000 1,500 $73,500 $103,500 Six months ending 30 September 20X3 Units 1,500 7,000 8,500 8,000 500 $24,500 $34,500 Budgeted fixed production o/hd = 16,000 units ? $20 = $320,000 pa = $160,000 per six months Six months ending 31 March 20X3 8,000 units units 8,500 500 units ? $20 ($10,000) Six months ending 30 September 20X3 8,000 units 7,000 units 1,000 units ? $20 $20,000 6 Absorption costing and marginal costing compared FAST FORWARD If opening and closing inventory levels differ profit account under the two methods will be different.In the long run, total profit will be the same whatever method is used. 6. 1 Reconciling the profit figures given by the two methods The difference in sugar reporte d under the two costing systems is due to the different inventory valuation methods used. (a) If inventory levels increase between the beginning and end of a period, absorption costing will report the high profit because some of the fixed production overhead incurred during the period will be carried forward in closing inventory (which reduces cost of sales) to be set against sales revenue in the following period instead of being written off in full against profit in the period concerned.If inventory levels decrease, absorption costing will report the dishonor profit because as well as the fixed overhead incurred, fixed production overhead which had been carried forward in opening inventory is released and is also included in cost of sales. (b) 6. 2 Example Reconciling profits The profits reported for period 1 in the question on page 11 would be reconciled as follows. Marginal costing profit Adjust for fixed overhead in inventory (inventory increase of 300 units ? $1 per unit) Abs orption costing profit $ 400 300 700 Exam focus point Remember that if opening inventory values are greater than closing inventory values, marginal costing shows the greater profit. 14 1 Costing ?Part A Specialist cost and management accounting techniques 6. 3 Marginal versus absorption costing report to management FAST FORWARD Marginal costing is more useful for decision-making purposes, but absorption costing is needed for financial reporting purposes to comply with accounting standards. We know that the reported profit in any period is likely to differ jibe to the costing method used, but does one method provide a more reliable guide to management about the organisations profit position? With marginal costing, contribution varies in direct proportion to the volume of units sold. profit will increase as sales volume rises, by the amount of extra contribution earned.Since fixed cost expenditure does not alter, marginal costing gives an accurate picture of how a firms cash coale sces and profits are affected by changes in sales volumes. With absorption costing, in contrast, there is no clear relationship between profit and sales volume, and as sales volume rises the total profit will rise by the sum of the gross profit per unit plus the amount of overhead absorbed per unit. Arguably this is a confusing and unsatisfactory method of monitor profitability. If sales volumes are the same from period to period, marginal costing reports the same profit each period (given no change in prices or costs). In contrast, using absorption costing, profits can straggle with the volume of production, even when the volume of sales is constant.Using absorption costing there is therefore the possibility of manipulating profit, only by changing output and inventory levels. 6. 4 Example Manipulating profits Gloom Co budgeted to make and sell 10,000 units of its product in 20X1. The selling price is $10 per unit and the variable cost $4 per unit. Fixed production costs were bud geted at $50,000 for the year. The company uses absorption costing and budgeted an absorption rate of $5 per unit. During 20X1, it became apparent that sales involve would only be 8,000 units. The management, concerned about the apparent effect of the low volume of sales on profits, decided to increase production for the year to 15,000 units.Actual fixed costs were still expected to be $50,000 in scandalize of the significant increase in production volume. Required Calculate the profit at an actual sales volume of 8,000 units, using the following methods. (a) (b) Absorption costing Marginal costing Explain the difference in profits calculated. Solution (a) Absorption costing Sales (8,000 ? $10) Cost of production (15,000 ? $9) Less over-absorbed overhead (5,000 ? $5) $ 135,000 (25,000) (110,000) (30,000) 63,000 33,000 $ 80,000 Closing inventory (7,000 ? $9) Profit Part A Specialist cost and management accounting techniques ? 1 Costing 15 (b) Marginal costing Sales Cost of sales Co st of production (15,000 ? $4) Closing inventory (7,000 ? $4) Contribution Fixed costs Loss $ $ 80,000 0,000 ((28,000) 32,000 48,000 50,000 (2,000) The difference in profits of $35,000 is explained by the difference in the increase in inventory values (7,000 units ? $5 of fixed overhead per unit). With absorption costing, the expected profit will be higher than the original budget of $10,000 (10,000 units ? ($10 9)) simply because $35,000 of fixed overheads will be carried forward in closing inventory values. By producing to absorb overhead rather than to satisfy customers, inventory levels will, of course, increase. Unless this inventory is sold, however, there may come a point when production has to stop and the inventory has to be sold off at lower prices.Marginal costing would report a contribution of $6 per unit, or $48,000 in total for 8,000 units, which fails to cover the fixed costs of $50,000 by $2,000. The argument above is not conclusive, however, because marginal costin g is not so useful when sales quaver from month to month because of seasonal variations in sales demand, but production per month is held constant in order to arrange for an even flow of output (and thereby prevent the cost of idle resources in periods of low demand and overtime in periods of high demand). Question Absorption v marginal costing A costume manufacturer makes a specific brand of jeans which it sells at a standard price of $100 per pair. The manufacturers costs are as follows.Standard variable production cost $16 per pair Total fixed production cost per month $240,000 (10,000 pairs are planned to be produced per month) Total fixed non-production costs $300,000 per month In month 1, when the opening inventory is 1,000 pairs, production of 10,000 pairs is planned and sales of 8,000 pairs are expected. In Month 2, sales are planned to be 9,000 pairs and production is still 10,000 pairs. Required (a) What would be the net profit for Months 1 and 2 under (i) (ii) (b) Abs orption costing Marginal costing What comments could you make about the performance of this business? 16 1 Costing ? Part A Specialist cost and management accounting techniques Answer (a) Absorption standard cost per unit = $16 + 240,000/10,000 = $40 Absorption costing Month 1 Month 2 $000 $000 $000 $000 800 900 Marginal costing Month 1 Month 2 $000 $000 $000 $000 800 900Sales 8,000 $100 Cost of sales Opening inventory (1,000 $40) Production (10,000 $40) Less closing inventory* (3,000 $40) Gross profit Contribution Less other costs Fixed production Fixed non-production 40 400 (120) (320) 480 120 400 (160) (360) 540 1,000 $16 10,000 $16 3,000 $16 16 160 (48) (128) 672 (240) (300) 48 160 (64) (144) 756 (240) (300) (300) 180 (300) 240 (540) 132 (540) 216 * Closing inventory = 1,000 + 10,000 8,000 (b) The absorption costing net profit is higher than the marginal costing net profit in both months because inventories are rising. Under absorption costing, where inventories are incre asing, a greater amount of the fixed production cost is carried forward n the closing inventory valuation than was brought forward in the opening inventory valuation. This means that the impact of these costs on profit is delayed under absorption costing. Under marginal costing, the full impact of the fixed production costs on profit is immediate. The business is gainful and sales have increased. However, a build up of inventories in the clothing manufacturing industry is unwise as demand is subject to tastes and fashion. The business postulate to respond rapidly to changes in demand or it will turn rapidly uncompetitive. Part A Specialist cost and management accounting techniques ? 1 Costing 17 Chapter Roundup Costing is the process of determining the costs of products, services or activities.Indirect costs, or overheads, are costs incurred in making a product or providing a service, but which cannot be traced directly to the product or service. Absorption costing is a means o f incorporating a fair share of these costs into the cost of a unit of product or service provided. Absorption costing is a traditional approach to dealing with overheads, involving three stages allocation, apportionment and absorption. Apportionment has two stages, general overhead apportionment and service department cost apportionment. After apportionment, overheads are absorbed into products using an appropriate absorption rate based on budgeted costs and budgeted activity levels. Under-/over-absorbed overhead occurs when overheads incurred do not equal overheads absorbed.In marginal costing, inventories are valued at variable production cost whereas in absorption costing they are valued at their full production cost. If opening and closing inventory levels differ profit reported under the two methods will be different. In the long run, total profit will be the same whatever method is used. Marginal costing is more useful for decision-making purposes, but absorption costing is needed for financial reporting purposes to comply with accounting standards. 18 1 Costing ? Part A Specialist cost and management accounting techniques Quick Quiz 1 Here are some terms you should have encountered in your earlier studies. Match the term to the definition.Terms Direct cost Prime cost Overhead Classification by function Fixed cost Variable cost Product cost Avoidable cost Controllable cost germane(predicate) cost Cost centre Cost unit (b) (c) (d) (e) (f) (g) (h) (i) (j) (k) (l) 2 3 Definitions (a) Specific costs of, say, an activity, which would not be incurred if the activity did not exist Total of direct costs Future cash flow which will be changed as the result of a decision Product produced by an organisation Dividing costs into production, administration, selling and distribution, research and development and financing costs Cost that can be traced in full to whatever is being costed Organisations departments A cost that varies with the level of output A co st that is incurred in the course of making a product but which cannot be traced directly and in full to the product Cost that is incurred for a particular period of time and which, within certain activity levels, is unaffected by changes in the level of activity Cost identified with goods produced or purchased for resale and initially included in the value of inventory Cost which can be influenced by management decisions and actions is the process of determining the costs of products, activities or services. How is an overhead absorption rate calculated? A B C D Estimated overhead ? actual activity level Estimated overhead ? budgeted activity level Actual overhead ? actual activity level Actual overhead ? budgeted activity level 4 Over absorption means that the overheads charged to the cost of sales are greater than the overheads actually incurred. True False 5Fill in the blanks in the statements about marginal costing and absorption costing below. (a) (b) If inventory levels bet ween the beginning and end of a period, absorption costing will report the higher profit. If inventory levels decrease, costing will report the lower profit. 6 Fill in the following blanks with either marginal or absorption. (a) (b) (c) (d) (e) Using costing, profits can be manipulated simply by changing output and inventory levels. Fixed costs are charged in full against the profit of the period in which they are incurred when costing is used. costing fails to get by the importance of working to full capacity. costing could be argued to be preferable to costing in management accounting in order to be consistent with the requirements of accounting standards. costing should not be used when decision-making information is required. Part A Specialist cost and management accounting techniques ? 1 Costing 19 Answers to Quick Quiz 1 Direct cost Prime cost Overhead Classification by function Fixed cost Variable cost Product cost Avoidable cost Controllable cost Relevant cost Cost centre Cost unit Costing B True (a) (b) (a) (b) (c) (d) (e) Increase Absorption absorption marginal marginal absorption, marginal absorption (f) (b) (i) (e) (j) (h) (k) (a) (l) (c) (g) (d) 2 3 4 5 6 Now try the questions below from the Exam Question Bank amount Q1Level Introductory Marks 10 Time 18 mins 20 1 Costing ? Part A Specialist cost and management accounting techniques Activity based costing Topic list 1 Activity based costing 2 Absorption costing versus first principle 3 Merits and criticisms of rudiment Syllabus reference A1 (a), (b) A1 (c) A1 (c) Introduction Chapter 2 covers Part A of the syllabus, specialist cost and management accounting techniques. It has been shared into five sub-chapters to reflect the examiners emphasis that all five techniques are equally important and equally examinable. In this chapter we will be looking at the first alternative method of cost accumulation, activity based costing ( alphabet).first principle is a modern alternative to absorpti on costing which attempts to overcome the problems of costing in a modern manufacturing environment. If you want to get free study material of CAT, ACCA, CIMA, CFA, CIA visit freefor911. wordpress. com 21 Study guide Intellectual level A1 (a) (b) (c) Activity based costing let out appropriate cost device device number one woods under first principle Calculate costs per driver and per unit using ABC Compare ABC and traditional methods of overhead absorption based on production units, labour hours or machine hours 1 2 2 Exam guide There was a question on ABC in the Pilot Paper for F5. It was also examined in June 2008 and June 2010 and is therefore a crucial topic to understand. 1 Activity based costing FAST FORWARD /08, 6/10 An alternative to absorption costing is activity based costing (ABC). ABC involves the identification of the factors (cost drivers) which cause the costs of an organisations major(ip) activities. conduct overheads are charged to products on the basis of thei r usage of an activity. For costs that vary with production level in the short term, the cost driver will be volume related (labour or machine hours). Overheads that vary with some other activity (and not volume of production) should be traced to products using transaction-based cost drivers such as production runs or number of orders received. 1. 1 Reasons for the development of ABCThe traditional cost accumulation system of absorption costing was developed in a time when most organisations produced only a narrow range of products (so that products underwent similar operations and ingestd similar proportions of overheads). And overhead costs were only a very small fraction of total costs, direct labour and direct material costs accounting for the largest proportion of the costs. The benefits of more accurate systems for overhead allocation would probably have been comparatively small. In addition, information processing costs were high. In recent years, however, there has been a dramatic fall in the costs of processing information.And, with the advent of right manufacturing technology (AMT), overheads are likely to be far more important and in fact direct labour may account for as little as 5% of a products cost. It therefore now appears difficult to justify the use of direct labour or direct material as the basis for absorbing overheads or to believe that errors made in attributing overheads will not be significant. Many resources are used in non-volume related support activities, (which have increased due to AMT) such as setting-up, production programing, inspection and data processing. These support activities assist the efficient manufacture of a wide range of products and are not, in general, affected by changes in production volume.They tend to vary in the long term according to the range and complexity of the products manufactured rather than the volume of output. The wider the range and the more complex the products, the more support services wil l be required. Consider, for example, factory X which produces 10,000 units of one product, the Alpha, and factory Y which produces 1,000 units each of ten slightly different versions of the Alpha. Support activity costs in the factory Y are likely to be a lot higher than in factory X but the factories produce an identical number of units. For example, factory X will only need to set-up once whereas Factory Y will have to set-up the 22 2a Activity based costing ?Part A Specialist cost and management accounting techniques production run at least ten times for the ten different products. Factory Y will therefore incur more set-up costs for the same volume of production. Traditional costing systems, which assume that all products consume all resources in proportion to their production volumes, tend to allocate too great a proportion of overheads to high volume products (which cause relatively little diversity and hence use fewer support services) and too small a proportion of overheads to low volume products (which cause greater diversity and therefore use more support services). Activity based costing (ABC) attempts to overcome this problem. 1. Definition of ABC Key term Activity based costing (ABC) involves the identification of the factors which cause the costs of an organisations major activities. Support overheads are charged to products on the basis of their usage of the factor do the overheads. The major ideas behind activity based costing are as follows. (a) (b) (c) Activities cause costs. Activities include ordering, materials manipulation, machining, assembly, production computer programing and despatching. Producing products creates demand for the activities. Costs are assigned to a product on the basis of the products consumption of the activities. 1. 3 Outline of an ABC systemAn ABC system operates as follows. Step 1 Step 2 Key term Identify an organisations major activities. Identify the factors which determine the size of the costs of an activit y/cause the costs of an activity. These are known as cost drivers. A cost driver is a factor which causes a change in the cost of an activity. Look at the following examples. Costs Ordering costs Materials handling costs Production scheduling costs Despatching costs Possible cost driver Number of orders Number of production runs Number of production runs Number of despatches Step 3 Step 4 Collect the costs associated with each cost driver into what are known as cost pools.Charge costs to products on the basis of their usage of the activity. A products usage of an activity is measured by the number of the activitys cost driver it generates. Question Which of the following definitions best describes a cost driver? A B C D Any activity which causes an increase in costs A collection of costs associated with a particular activity A cost that varies with production levels Any factor which causes a change in the cost of an activity Cost driver Part A Specialist cost and management accounti ng techniques ? 2a Activity based costing 23 Answer D Any factor which causes a change in the cost of an activity. Exam focus pointABC is a popular exam topic. Questions on activity based costing often require a comparison with more traditional methods. The implications for the business of each approach is often required. 2 Absorption costing versus ABC 6/08, 6/10 The following example illustrates the point that traditional cost accounting techniques result in a misleading and inequitable course of costs between low-volume and high-volume products, and that ABC can provide a more meaningful allocation of costs. 2. 1 Example Activity based costing Suppose that Cooplan manufactures four products, W, X, Y and Z. Output and cost data for the period just ended are as follows.Number of production runs in the Material cost Direct labour Machine Output units period per unit hours per unit hours per unit $ W 10 2 20 1 1 X 10 2 80 3 3 Y 100 5 20 1 1 80 3 3 Z 100 5 14 Direct labour cost per h our $5 Overhead costs Short run variable costs Set-up costs Expediting and scheduling costs Materials handling costs Required Prepare unit costs for each product using stuffy costing and ABC. $ 3,080 10,920 9,100 7,700 30,800 Solution Using a conventional absorption costing approach and an absorption rate for overheads based on either direct labour hours or machine hours, the product costs would be as follows. W $ 200 50 700 950 10 $95 X $ 800 150 2,100 3,050 10 $305 Y $ 2,000 500 7,000 9,500 100 $95 Z $ 8,000 1,500 21,000 30,500 100 $305 Total $ Direct material Direct labour Overheads * Units produced Cost per unit 4,000 * $30,800 ? 440 hours = $70 per direct labour or machine hour. 24 2a Activity based costing ? Part A Specialist cost and management accounting techniques Using activity based costing and assuming that the number of production runs is the cost driver for setup costs, expediting and scheduling costs and materials handling costs and that machine hours are the cost dr iver for short-run variable costs, unit costs would be as follows. W $ 200 50 70 1,560 1,300 1,100 4,280 10 $428 X $ 800 150 210 1,560 1,300 1,100 5,120 10 $512 Y $ 2,000 500 700 3,900 3,250 2,750 13,100 100 $131 Z $ 8,000 1,500 2,100 3,900 3,250 2,750 21,500 100 $215 Total $Direct material Direct labour Short-run variable overheads (W1) Set-up costs (W2) Expediting, scheduling costs (W3) Materials handling costs (W4) Units produced Cost per unit Workings 1 2 3 4 $3,080 ? 440 machine hours = $10,920 ? 14 production runs = $9,100 ? 14 production runs = $7,700 ? 14 production runs = Conventional costing unit cost $ 95 305 95 305 44,000 $7 per machine hour $780 per run $650 per run $550 per run ABC unit cost $ 428 512 131 215 Difference per unit $ + 333 + 207 + 36 90 Difference in total $ +3,330 +2,070 +3,600 9,000 Summary Product W X Y Z (a) (b) The figures suggest that the traditional volume-based absorption costing system is flawed.It underallocates overhead costs to low-volume pro ducts (here, W and X) and over-allocates overheads to higher-volume products (here Z in particular). It underallocates overhead costs to smaller-sized products (here W and Y with just one hour of work needed per unit) and over allocates overheads to larger products (here X and particularly Z). 2. 2 ABC versus traditional costing methods Both traditional absorption costing and ABC systems adopt the two stage allocation process. 2. 2. 1 Allocation of overheads ABC establishes separate cost pools for support activities such as despatching. As the costs of these activities are assigned directly to products through cost driver rates, reapportionment of service department costs is avoided. 2. 2. Absorption of overheads The principal difference between the two systems is the way in which overheads are absorbed into products. (a) (b) Absorption costing most commonly uses two absorption bases (labour hours and/or machine hours) to charge overheads to products. ABC uses many cost drivers as absorption bases (eg number of orders or despatches). Absorption rates under ABC should therefore be more closely linked to the causes of overhead costs. Part A Specialist cost and management accounting techniques ? 2a Activity based costing 25 2. 3 Cost drivers The principal idea of ABC is to focus attention on what causes costs to increase, ie the cost drivers. a) The costs that vary with production volume, such as power costs, should be traced to products using production volume-related cost drivers, such as direct labour hours or direct machine hours. Overheads which do not vary with output but with some other activity should be traced to products using transaction-based cost drivers, such as number of production runs and number of orders received. (b) Traditional costing