CAPÍTULO 3: ESTUDIO DEL ESTADO DEL ARTE DE LAS TECNOLOGÍAS DE ILUMINACIÓN Y DE
3.2 COMPONENTES DE LA INSTALACIÓN
3.2.6 CARACTERIZACIÓN DE LUMINARIAS
It is not as easy to calculate the fixed manufacturing cost per unit. The cost of inventory needs to be known during the year for quoting purposes as well as for any reports needing to be provided during the year. Since the standard requires that the cost of inventory includes fixed manufacturing overheads, we need to calculate a fixed cost per unit, which we call the fixed manufacturing overhead application rate (FOAR).
We won’t be able to calculate an accurate fixed cost per unit until the end of the year since we will only know the extent of the actual production at the end of the year. As mentioned above, however, a rate is needed at the beginning of the year for the purposes of quoting, budgeting and interim reporting. This means that a budgeted fixed overhead application rate (BFOAR) using budgeted normal production as the denominator, is calculated as an interim measure:
Fixed manufacturing overheads Normal production
The actual fixed overhead application rate (AFOAR), however, would depend on the actual level of inventory produced in any one period and can only be calculated at year-end.
Fixed manufacturing overheads Greater of: actual and normal production 5.3.2.1 Under-production and under-absorption
If the company produces at a level below budgeted production, a portion of the fixed overheads in the suspense account will not be allocated to the asset account. This unallocated overhead amount is termed an ‘under-absorption’ of fixed overheads and since it results from under-productivity, it refers to the cost of the inefficiency, which is quite obviously not an asset! This amount is expensed instead.
Example 12: fixed manufacturing costs – under-absorption
Fixed manufacturing overheads C100 000
Normal expected production (units) 100 000
Actual production (units) 50 000
Required:
A. Calculate the budgeted fixed manufacturing overhead application rate;
B. Calculate the actual fixed manufacturing overhead application rate; and
C. Journalise the fixed manufacturing costs.
Solution to example 12A: budgeted fixed manufacturing overhead application rate
= Fixed manufacturing
overheads Budgeted production
= C100 000
100 000 units
= C1 per unit
We use this C1 per unit when quoting to our customers and when drafting interim financial statements.
Solution to example 12B: actual fixed manufacturing overhead application rate
= Fixed manufacturing overheads
Greater of: budgeted and actual production
= C100 000
100 000 units
= C1 per unit
Explanation why the actual production could not be used in this example:
The actual application rate is calculated using the normal budgeted production since, in this case, the budgeted production exceeded the actual production. If the actual production had been used it would result in inventory being overvalued:
= Fixed manufacturing
overheads Actual production
= C100 000
50 000 units
= C2 per unit
Each unit would erroneously include fixed manufacturing costs of C2 instead of the normal C1 as a result of the company’s inefficiency! Bearing in mind that the Framework states that the value of an asset should represent the probable future economic benefits expected to flow from the asset, it does not make sense to show the cost of inventory at twice its normal value (C2 instead of C1) simply because the company was inefficient. Measuring the inventory using C2 would suggest that the future economic benefits are expected to double.
Another way of looking at it is: if we used C2 per unit, the value of 50 000 units inventory would represent the full amount of fixed overheads incurred (C100 000) when only half of the required inventory was produced (therefore, only half of the fixed overheads should be included in the inventory account). Half the fixed overheads were wasted and therefore 50%
x 100 000 should be expensed.
The answer to this problem is to capitalise only the normal cost per unit (C1) to the inventory asset and expense the balance of the fixed manufacturing overheads (actual: C2 – normal: C1
= wastage: C1) as abnormal wastage of company resources.
Solution to example 12C: fixed manufacturing overheads – journals
During the year Debit Credit
Fixed manufacturing costs (Suspense account) 100 000
Bank/ Creditor 100 000
Fixed manufacturing overheads incurred: given
Inventory (A) 50 000
Fixed manufacturing costs (Suspense account) 50 000
Allocation of fixed manufacturing overheads to inventory over the year: 50 000 x C1 (BFOAR)
At year-end
Fixed manufacturing overhead expense (E) (under-absorption) 50 000
Fixed manufacturing costs (Suspense account) 50 000
Expensing of the balance of the fixed manufacturing overhead suspense account at year-end: 100 000 (total paid) – 50 000 (capitalised)
5.3.2.2 Over-production and over-absorption
If the company’s actual level of production exceeds budgeted production, the budgeted fixed overhead application rate per unit will be higher than the actual fixed overhead application rate per unit.
If the budgeted application rate is used to absorb fixed overheads into the cost of the inventory during the course of the year, fixed manufacturing overheads will be ‘over-absorbed’ into the cost of inventory by the end of the year if the entity produced more units that were budgeted (over-production). This means that the asset will be overstated as the costs capitalised are not the actual costs incurred (i.e. will be shown at a value that exceeds cost) and will therefore need to be reduced.
Example 13: fixed manufacturing costs – over-absorption
Fixed manufacturing overheads C100 000
Normal expected production (units) 100 000
Actual production (units) 200 000
Required:
A. Calculate the budgeted fixed manufacturing overhead application rate;
B. Calculate the actual fixed manufacturing overhead application rate; and C. Journalise the fixed manufacturing costs.
Solution to example 13A: budgeted fixed manufacturing overhead application rate
= Fixed manufacturing overheads
Budgeted production
= C100 000
100 000 units
= C1,00 per unit
Solution to example 13B: actual fixed manufacturing overhead application rate
= Fixed manufacturing overheads
Greater of: budgeted and actual production
= C100 000
200 000 units
= C0.50 per unit
Although we would have used the BFOAR of C1 per unit throughout the year for quoting our customers and for allocating fixed manufacturing costs to inventory during the period, the
final inventory balance would be valued using the actual cost (AFOAR) of C0.50 per unit instead.
If the company valued their final inventory balance using the budgeted fixed overhead application rate of C1 instead, C200 000 of fixed overheads would have been included in inventory (C1 x 200 000 units). This is not allowed since the actual fixed overheads incurred were only C100 000 (IAS 2, which governs inventories, prohibits the measurement of inventory at above cost).
Solution to example 13C: fixed manufacturing overheads - journal
During the year Debit Credit
Fixed manufacturing costs (suspense account) 100 000
Bank/ Creditor 100 000
Fixed manufacturing overheads incurred during the year: given
Inventory (A) 200 000 x C1 (BFOAR) 200 000
Fixed manufacturing costs (suspense account) 200 000
Allocation of fixed manufacturing overheads to inventory over the year
At year-end
Fixed manufacturing costs (suspense account) (over-absorption) 100 000
Inventory (A) 100 000
Reversing the excess fixed manufacturing costs transferred to the inventory account (the suspense account will now have a zero balance)
5.3.2.3 Budgeted versus actual overhead rates summarised
Budgeted production will seldom equal actual production and therefore the budgeted costs (BFOAR) per unit will generally not equal the actual costs (AFOAR) per unit. If, therefore, the budgeted fixed overhead absorption rate (BFOAR) is multiplied by the actual units produced, too much or too little of the overhead costs actually incurred are included in the inventory cost.
The budgeted fixed overhead application rate is therefore calculated at:
• the beginning of the year to measure the cost of inventory during the year; and then
• at the end of the year to measuring the inventory balance.
The budgeted fixed overhead application rate is calculated at the beginning of the year:
BFOAR = Fixed manufacturing overheads Budgeted production
The actual fixed overhead application rate (AFOAR) is calculated at the end of the year:
AFOAR = Fixed manufacturing overheads
Greater of: budgeted production and actual production
In the event that actual production is greater than budgeted production, the actual fixed overhead application rate (AFOAR) is calculated using actual production since this avoids inventory being overvalued as a result of over-efficiency.
In the event that actual production is less than budgeted production, the actual fixed overhead application rate is calculated using budgeted production, since this avoids inventory being overvalued as a result of company inefficiencies.
Example 14: fixed manufacturing costs – over-absorption
Budgeted production 1 000 units
Actual production 1 500 units
Budgeted fixed non-manufacturing overheads C10 000
Budgeted fixed manufacturing overheads C40 000
Prime costs per unit C12 per unit
Required:
A. Calculate the budgeted fixed overhead application rate at the beginning of the year.
B. Calculate the actual fixed overhead application rate at the end of the year.
C. Show the entries in the related t-accounts.
Solution to example 14A: budgeted fixed manufacturing overheads rate (AP > BP)
= Fixed manufacturing overheads
Budgeted production
= C40 000
1 000 units
= C40 per unit
Solution to example 14B: actual fixed manufacturing overheads rate (AP > BP)
= Fixed manufacturing overheads
Greater of: budgeted production and actual production
= C40 000
1 500 units
= C26,67 per unit
Solution to example 14C: t-accounts (AP > BP)
Bank Fixed manufacturing overheads (Suspense)
FOE 10
000
(1) Bank (2) 40 000 Inv (4) 60 000
FMOS 40
000
(2) Inv (5) 20 000
Inv 18
000
(3) (7) 60 000 (7) 60 000
Inventory (Asset) Fixed overheads (Expense)
Bank (3) 18 000 FMOS (5) 20 000 (1) 10 000
FMOS (4) 60 000 Balance c/d
58 000
78 000 78 000
Balance (6) 58 000
(1) payment of non-manufacturing fixed overheads: C10 000 – these are always expensed (2) payment of manufacturing fixed overheads: C40 000 – these are first accumulated in a
suspense account and then either capitalised to inventory or expensed
(3) payment of prime costs (direct materials and direct labour): C12 x 1 500 = C18 000, debited directly to inventory
(4) manufacturing fixed overheads are allocated to the inventory asset as follows (i.e.
absorbed into inventory) using the budgeted fixed overhead application rate:
BFOAR x actual production: C40 x 1 500 = C60 000
(5) since the manufacturing costs incurred only amounted to C40 000, C20 000 too much has been debited to inventory: this over-absorption is simply reversed. This is calculated as the excess of actual over-budgeted production x BFOAR: 500 x C40 = C20 000 (or C60 000 – C40 000)
(6) notice that the balance is C58 000, which equates with the prime cost per unit plus the final fixed manufacturing overheads per unit: (C12 + C26,67) x 1 500 = C58 000
(7) notice that the suspense account has been cleared out (has a zero balance)!
Example 15: fixed manufacturing costs – under-absorption
Budgeted production 1 000 units
Actual production 500 units
Budgeted fixed non-manufacturing overheads C10 000
Budgeted fixed manufacturing overheads C40 000
Prime costs per unit C12 per unit
Required:
A. Calculate the budgeted fixed overhead application rate at the beginning of the year.
B. Calculate the final fixed overhead application rate at the end of the year.
C. Show the entries in the related t-accounts.
Solution to example 15A: budgeted fixed manufacturing overheads rate (BP > AP)
= Fixed manufacturing overheads
Budgeted production
= C40 000
1 000 units
= C40 per unit
Solution to example 15B: actual fixed manufacturing overheads rate (BP > AP)
= Fixed manufacturing overheads
Greater of: budgeted production or actual production
= C40 000
1 000 units
= C40 per unit
Solution to example 15C: t-accounts (BP > AP)
Bank Fixed manufacturing overheads (Suspense)
FOE 10
000
(1) Bank 40
000
(2) Inv 20
000
(4)
FMOS 40
000
(2) FOE 20
000
(5)
Inv (3) 6 000 40
000
(7) 40
000
(7)
Inventory (Asset) Fixed overheads (Expense)
Bank (3) 6 000 Bank (1) 10
000 FMOS (4) 20 000 Balance
c/d
26 000
FMOS 20
000
(5)
26 000 26 000 30
000 Balance 26 000