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Management and Cost Accounting: Colin Drury
Management and Cost Accounting: Colin Drury
AND COST
ACCOUNTING
SIXTH EDITION
COLIN DRURY
Chapter Seven:
Income effects of alternative cost accumulation systems
Conclusion
1. Choice depends on the circumstances.
• Volatile sales and changing stock levels favour variable costing for
internal monthly or quarterly profit measurement.
•The fixed overhead rate will be significantly influenced by the choice of the
denominator level.
Example
Annual budgeted fixed overheads for a machine cost centre £192 000
The cost centre operates 3 shifts of 8 hours for 5 days per week for 50 weeks
(6 000 hours)
1. Theoretical maximum capacity of 6 000 hours = £32 per hour (£192 000/6 000
hours)
2. Practical capacity of 5 000 hours = £38.40 per hour (£192 000/5 000 hours)
3. Normal average long-run activity of 4 800 hours = £40 per hour
(£192 000/4 800 hours)
4. Budgeted activity of 4 000 hours = £48 per hour (£192 000/ 4 000 hours)
• Assuming actual activity and spending is the same as budget the annual costs will
be allocated as follows:
Allocated to Volume variance Total
products cost of unused (£)
capacity)
Practical £153 600 £38 400 192 000
capacity (4 000 hrs ×
£38.40) (1 000 hrs × £38.40)
• The choice of an appropriate activity level can have a significant effect on the
inventory valuation and profit computation.
• Assuming 90%of output is sold and no openings inventories the above costs will
be allocated as follows:
Allocated to Allocated to
cost of sales inventories Total
£ £ £
Practical capacity 176 640 15 360 192 000
Normal activity 176 000 16 000 192 000
Budgeted activity 172 800 19 200 192 000
• For many organizations the allocation of costs between cost of sales and
inventories is not an issue.